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TTWO	2022-11-07	[ { "description": "Senior Vice President of Investor Relations and Corporate Communications", "name": "Nicole Shevins", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Strauss Zelnick", "position": "Executive" }, { "description": "President", "name": "Karl Slatoff", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Lainie Goldstein", "position": "Executive" }, { "description": "MKM Partners -- Analyst", "name": "Eric Handler", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Andrew Uerkwitz", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Eric Sheridan", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Matthew Thornton", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Matthew Cost", "position": "Analyst" }, { "description": "Stifel Financial Corp. -- Analyst", "name": "Drew Crum", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Mario Lu", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "David Karnovsky", "position": "Analyst" }, { "description": "Cowen and Company -- Analyst", "name": "Doug Creutz", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Martin Yang", "position": "Analyst" }, { "description": "Bernstein Investment Research and Management -- Analyst", "name": "Matti Littunen", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Brian Fitzgerald", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Omar Dessouky`", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Omar Dessouky", "position": "Analyst" }, { "description": "The Benchmark Company -- Analyst", "name": "Mike Hickey", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Clay Griffin", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good afternoon, and welcome to the Take-Two Interactive Software second quarter fiscal year 2023 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator instructions] Please note, this conference is being recorded.", "I will now turn the conference over to our host, Nicole Shevins, senior vice president of investor relations and corporate communications. Thank you. You may begin." ] }, { "name": "Nicole Shevins", "speech": [ "Good afternoon. Thank you for joining our conference call to discuss our results for the second quarter of fiscal year 2023 ended September 30, 2022. Today's call will be led by Strauss Zelnick, Take-Two's chairman and chief executive officer; Karl Slatoff, our president; and Lainie Goldstein, our chief financial officer. We will be available to answer your questions during the Q&A session following our prepared remarks.", "Before we begin, I'd like to remind everyone that statements made during this call that are not historical facts are considered forward-looking statements under federal securities laws. These forward-looking statements are based on the beliefs of our management, as well as assumptions made by information currently available to us. We have no obligation to update these forward-looking statements. Actual operating results may vary significantly from these forward-looking statements based on a variety of factors.", "These important factors are described in our filings with the SEC, including the company's most recent annual report on Form 10-K and quarterly report on Form 10-Q, including the risks summarized in the section entitled risk factors. I'd also like to note that unless otherwise stated, all numbers we will be discussing today are GAAP and all comparisons are year over year. Additional details regarding our actual results and outlook are contained in our press release, including the items that our management uses internally to adjust our GAAP financial results in order to evaluate our operating performance. Our press release also contains a reconciliation of any non-GAAP financial measure to the most comparable GAAP measure.", "In addition, we have posted to our website a slide deck that visually presents our results and financial outlook. Our press release and filings with the SEC may be obtained from our website at take2games.com. And now I'll turn the call over to Strauss." ] }, { "name": "Strauss Zelnick", "speech": [ "Thanks, Nicole. Good afternoon, and thank you for joining us today. I'm pleased to report that we delivered another consecutive quarter of solid results with net bookings of $1.5 billion. We experienced healthy player engagement, driven by exciting new game releases, host launch content updates, and bold beats for many of our mobile offerings, even as consumers continue to navigate the effects of various macroeconomic and geopolitical factors.", "We made excellent progress with our integration of Zynga, and we remain highly optimistic about the vast long-term growth potential for the mobile industry, which is expected to reach over $160 billion in gross bookings within the next four years. Some of our key achievements in the period include we successfully reached our 100-day integration milestone at the end of August. Zynga's president Frank Gibeau and his leadership team have evaluated our mobile portfolio, including existing games and titles in development, and they've identified numerous opportunities to enhance our performance. These initiatives include reorganizing several teams, sharing development tools, resources, and best practices across our mobile studios, conceptualizing new bold beats, and leveraging Zynga's highly valuable publishing platform, which is now even stronger following the recent acquisition of Storemaven.", "We're also starting to expand our direct-to-consumer efforts more meaningfully across our mobile portfolio further to enhance profitability. We remain committed to delivering $500 million of annual net bookings opportunities over time. The Zynga team has been working with our other labels to explore potential creative projects. As part of this process, we've identified certain underrepresented genres in our mobile portfolio that we believe we can pursue more aggressively over time.", "Our efforts to deliver cost synergies are tracking extremely well, and we're now confident that we can achieve over $100 million of annual savings within the first two years post close. I'd like to thank Frank, his leadership team, and all of our new colleagues at Zynga once again for helping to make our combination happen so seamlessly. We're thrilled to have Zynga as part of our Take-Two family. Turning to our second quarter results.", "Our net bookings performance was within our guidance range, led by Grand Theft Auto V, which exceeded our expectations and to date has sold more than 170 million units worldwide. Starting July 26, Grand Theft Auto Online launched its latest major update, The Criminal Enterprises, introducing expanded gameplay across the criminal careers of executives, bikers, nightclub owners, and gun-runners, as well as the opportunity to work with federal agents to uncover a criminal conspiracy in the new Operation Paper Trail series of contact missions. The update also featured a range of new vehicles and more, including the new Community Series, showcasing some of the most fun and unique experiences created by players across the globe. This major update also delivered a host of overall improvements to the gameplay experience, including increased payouts across a wide array of activities and several other player-requested features.", "The Criminal Enterprises was very well received, and we've seen millions of players engaging with significant new features such as the ability to run cell missions and private lobbies, new weapon wheel controls and more. In addition, Rockstar Games GTA+ subscription service continues to grow its members who enjoy a rotation of numerous exclusive in-game benefits, including vehicles, upgrades, and gear every month. On September 9, 2K and Visual Concepts successfully launched NBA 2K23 with the title earning an 80-plus Metacritic grading at launch and is receiving praise for raising the bar on the top-selling sports title in the U.S. To date, NBA 2K23 has sold in nearly 5 million units, alongside significant growth in virtual currency sales and a higher average selling price compared to NBA 2K22.", "Player engagement has been very strong with more than 2 million daily active users and 4% growth in average days played. We believe that NBA 2K23 will continue to grow its audience as the title provides a year-round experience for its fervent community of players throughout the world. I'd like to congratulate the teams of 2K and Visual Concepts for once again delivering such a stellar basketball experience. The franchise's momentum extends beyond the core console experience, with NBA 2K22 Arcade Edition for Apple Arcade remaining the No.", "1 game on the platform, and our recent launch of NBA 2K23 Arcade Edition offering many new features and improvements. Furthermore, NBA 2K Online continues to be the No. 1 PC online sports game in the country with nearly 59 million registered users. Red Dead Redemption 2 is continuing to impress, with sell-in of more than 46 million units worldwide to date and more active players in the second quarter than we've seen for the comparable period in previous years.", "2K supported WWE 2K22 and Tiny Tina's Wonderlands the final downloadable content packs for each title, which were made available individually and as part of the game's season passes. During the quarter, recurrent consumer spending rose 76% and accounted for 80% of net bookings. Zynga continues to experience strong engagement among its active players and we believe that we're maintaining our market share globally. Our mobile business delivered mid-teens growth in advertising bookings on a year-over-year basis, outperforming the broader industry.", "At the same time, in-app purchases continue to be under some pressure due to current macroeconomic conditions. Some key highlights of our mobile offerings during the quarter include: the Rollic business remained very strong and exceeded our plan. Notably, Rollic surpassed 2 billion lifetime downloads worldwide and have now launched 19 titles that have reached No. 1 or No.", "2 most downloaded game position in the U.S. App Store. Several of Zynga's title-celebrated milestones, including the second anniversary of Harry Potter Puzzles & Spells, the tenth anniversary of Farmville and the 15th anniversary of Zynga Poker. Each of these anniversaries was supported with an array of in-game events and unique content offerings.", "Zynga unveiled several high-profile brand integrations, including Social Point's partnership with AMC Networks' the Walking Dead and Dragon City and Monster Legends; CSR2's debut Pagani's new multimillion dollar, Utopia Hypercar, and Game of Thrones Slots Casino launched a new in-game event, Week of the Dragon, in conjunction with HBO's new hit fantasy series, \"House of the Dragon.\" Turning to our outlook. We now expect to deliver net bookings of $5.4 billion to $5.5 billion in fiscal 2023. Our reduced forecast reflects shifts in our pipeline, fluctuations in FX rates, and a more cautious view of the current macroeconomic backdrop, particularly in mobile. Lainie will provide more detail on our outlook shortly.", "Despite these headwinds and their effect on our guidance for the year, we remain highly confident in our diverse and extensive development pipeline that we expect will deliver a sequential growth and record performance over the next several years. Take-Two has a proven strategy, a consistent track record of success, driven by our core tenets. We aspire to be the most creative, the most innovative, the most efficient entertainment company in the world. As we strive to capitalize on the numerous opportunities ahead of us, we're committed to creating significant, long-term value for our shareholders.", "I'll now turn the call over to Karl." ] }, { "name": "Karl Slatoff", "speech": [ "Thanks, Strauss. I'd like to begin by thanking our teams for delivering another strong quarter, which reflects our ability to captivate and engage audiences consistently by delivering the highest-quality entertainment experiences across all platforms. And I'll discuss our recent releases. On October 14, 2K and HB Studios launched PGA Tour 2K23, the latest entry in our golf simulation franchise, a positive community sentiment, and great critical acclaim, including GameSpot coining the title the Best Simulation Golf Game Ever Made.", "PGA Tour 2K23 features golf icon and all-time sports great Tiger Woods, and celebrates his legacy by introducing him as both the playbook in-game pro and an executive director who advised the games development team. The game features several new additions and improvements, including an enhanced roster of male and female pros, the ability to play NBA legends' Michael Jordan and Steph Curry, a top golf mode, a deeper array of personalization options and gear, license courses, and the ability to design original courses and multiplayer offerings. HB Studios will continue to support the game with additional pros and courses, as well as seasonal updates in the Club House pass. On October 21, 2K and Gearbox Software released new tales from the Borderlands, a choice-based narrative adventure game that is a successor to the beloved Telltale Games title.", "The franchise has always been an incredible canvas for storytelling, and we are pleased to add this new offering to the portfolio. On November 2, Private Division and Roll7 released Finding the Flowzone, the second and final DLC expansion for the critically acclaimed skateboarding action platform of OlliOlli World. The release has received praise from critics, including Eurogamer, who commended Finding the Flowzone as a fun to this magnificent game and stating that the expansion is completely rad. Now I will discuss our announced offering for the balance of fiscal 2023 and beyond.", "On December 2, 2K and Firaxis Games will launch Marvel Midnight Suns on Windows PC, Xbox Series X and S, and PlayStation 5. The X\|S1, PlayStation 4, and Nintendo Switch version will follow at a later date. In support of the upcoming launch, 2K has produced five short videos that are being released weekly on Marvel Entertainment's YouTube channel, which provide the backstory to how the game's lead character Lillis became the mother of demons and how superheroes like Blade, Magic, Ghostrider, and Nico Minoru came together to form the young core of the Midnight Suns. 2K will have more to share on the game in the coming weeks.", "During the fourth quarter, 2K and Visual Concepts will launch WWE 2K23. Building upon the success of 2K22, which had nearly 450 million matches played and 10 million hours of game content viewed on Twitch, fans can look forward to the series of, once again, redefining interactive entertainment within the squared circle. We are grateful to have such a supportive and collaborative partnership with WWE, and 2K will have more to share about WWE 2K23 in the coming months. On February 24, Private Division and Intercept Games will launch Kerbal Space Program 2, the sequel to the beloved rocket-building sim.", "An early access for PC on Steam, Epic Games Store, and other digital storefronts. KSP2 will bring an array of content at the launch of early access, making this the most digitally impressive KSP game yet. The game will also feature improved tutorials and user onboarding to provide players with the necessary knowledge to excel at space flight. Built from the ground up, KSP2 will also introduce the ability to customize and paint vehicles, leading to deeper personalization and expression in every build.", "Those who purchased KSP2 and early access will help inform the future development of the game by providing feedback directly to Intercept Games leading up to the full launch of the title. We can't wait for the incredibly passionate KSP community to take flight in this new entry to the series. Throughout the balance of the fiscal year, Rockstar Games will continue to support Grand Theft Auto Online with additional major content updates alongside popular annual seasonal theme offerings and more. In mobile, Zynga's Wallet Studio will continue to release a consistent cadence of titles, while the label of other studios remains hard at work on a variety of offerings, including several titles that are currently in soft launch and expected to release in fiscal year 2024.", "Turning to eSports. The NBA 2K League is currently gearing up for its sixth season, which will tip off in spring 2023. Last month, the League announced a landmark agreement with Australia's National Basketball League to launch an expansion team, NLB Oz Gaming. Not only is this the first time an Australian professional sports league has joined a global sports league but it also marks our third expansion team from outside of North America.", "We remain very excited about the continued growth and success of the NBA 2K League. In closing, we believe that Take-Two is home to the best talent in our industry across all segments of interactive entertainment. With an expanding portfolio of the most exciting and commercially successful owned intellectual property and the ability to deliver deeply engaging and captivating entertainment experiences to a broad array of audiences around the world, we believe that we are well-positioned to deliver long-term value for our shareholders. I'll now turn the call over to Lainie." ] }, { "name": "Lainie Goldstein", "speech": [ "Thanks, Karl, and good afternoon, everyone. Today, I'll discuss the key highlights from our second quarter before reviewing our guidance for fiscal year 2023 and our third quarter. Please note that our second quarter results include our combination with Zynga, which affects the comparability of our results relative to last year. Additional details regarding our actual results and outlook are contained in our press release.", "As Strauss mentioned, our combination with Zynga is tracking very well, from the progress we are making against our integration milestones with the net bookings and cost synergy realization that we are working toward and our highly complementary company cultures. We have great confidence that over the long term, our portfolio is poised to benefit from the significant expected growth in mobile gaming, evolving player dynamics toward more immersive mobile content, and our massive combined scale, which will enable our teams to cross-promote titles and build stronger tools to connect with new users. During the quarter, we identified additional cost savings opportunities, and we now feel confident that we can deliver over $100 million of annual synergies within the first two years post close. We're also evaluating other efficiencies across our core businesses while ensuring that we have the appropriate resources to deliver on our significant growth prospects.", "Our second quarter results were solid and we delivered net bookings of $1.5 billion, which was within our prior guidance range. Movement in foreign currency exchange rates negatively affected our net bookings by approximately 1%. With consumers navigating ongoing macroeconomic uncertainties, we believe that our financial performance truly demonstrates the incredible quality of our games and the significant value that our interactive entertainment experiences provide to our players. During the period, recurrent consumer spending rose 76% and accounted for 80% of net bookings.", "NBA 2K and Rollic's hypercasual mobile portfolio outperformed our plans, while we experienced some softness across other parts of our portfolio as the interactive entertainment industry face continued headwinds. Digitally delivered net bookings increased 62% and accounted for 94% of the total. During the quarter, 73% of console game sales were delivered digitally, up from 65% last year. GAAP net revenue increased 62% to $1.4 billion, and cost of revenue increased 56% to $714 million.", "Operating expenses increased by 144% to $932 million, primarily driven by the addition of Zynga, business acquisition, and higher personnel costs, which was partly offset by lower console and PC marketing expenses. And GAAP net loss was $257 million or $1.54 per share, which was impacted by $320 million of amortization of acquired intangibles and $37 million of business acquisition costs. Our management tax rate for the third was 18% as compared to 16% in the prior year as a result of our combination with Zynga. We ended the quarter with over $1.3 billion of cash and short-term investments and $3.3 billion of debt.", "Turning to our guidance, I'll begin with our full fiscal year expectations. As Strauss mentioned, we are revising our guidance. We now expect to deliver net bookings of $5.4 billion to $5.5 billion. Approximately 70% of the downward revision reflects lower expectations for our mobile business and shifts in our release slate, while the balance reflects an updated view for the rest of our portfolio based on current business trends across the interactive entertainment industry.", "Our guidance reflects $50 million of FX headwinds. The largest contributors to net bookings are expected to be NBA 2K, Grand Theft Auto Online and Grand Theft Auto V, Empires & Puzzles, Rollic's hypercasual mobile portfolio, Toon Blast, and Red Dead Redemption 2 and Red Dead Online. We expect the net bookings breakdown from our label to be 45% Zynga, which includes our former TTWO mobile titles, 36% 2K, 18% Rockstar Games, and 1% Private Division. We forecast our geographic net booking split to be about 60% United States and 40% international.", "We now expect recurrent consumer spending to grow by approximately 90% and represent 77% of total net bookings. Our digitally delivered net bookings are expected to grow by approximately 70% and represent 96% of the total. Our forecast assumes that 75% of console game sales will be delivered digitally, up from 68% last year. We expect to generate more than $650 million in non-GAAP adjusted unrestricted operating cash flow.", "And we're expected to deploy approximately $150 million for capital expenditures. We expect GAAP net revenue to range from $5.41 billion to $5.51 billion and cost of revenue to range from $2.61 billion to $2.64 billion, which includes approximately $694 million of amortization of acquired intangibles. Total operating expenses are expected to range from $3.4 billion to $3.42 billion as compared to $1.5 billion last year. This increase reflects the inclusion of Zynga, business acquisition costs, and higher personnel marketing and IT expenses, which we anticipate will be slightly offset by our expected cost synergies.", "In light of the current economic backdrop, we continue to monitor our costs prudently to find potential areas of savings this year while being mindful of the resources we need to support a robust multiyear release schedule. And we expect the GAAP net loss ranging from $631 million to $674 million or $3.95 to $4.22 per share, which assumes a basic share count of 159.8 million shares. Our revised forecast includes an increase in amortization for intangible assets acquired from Zynga based on updated valuation estimates. We expect the management tax rate to be 18% throughout the year.", "Now moving to our guidance for the fiscal third quarter. We project net bookings to range from $1.41 billion to $1.46 billion compared to $866 million in the third quarter last year. The largest contributors to net bookings are expected to be NBA 2K, Grand Theft Auto Online and Grand Theft Auto V, Empires & Puzzles, Rollic's hypercasual mobile portfolio, and Toon Blast. We project recurrent consumer spending to grow approximately 125% and digitally delivered net bookings to increase approximately 80%.", "Our forecast assumes that 72% of console game sales will be delivered digitally, up from 63% last year. We expect GAAP net revenue to range $1.43 billion to $1.48 billion and cost of revenue to range from $690 million to $710 million, which includes approximately $198 million of amortization of acquired intangibles. Operating expenses are expected to range from $897 million to $907 million. At the midpoint, this represents a 126% increase over last year.", "This increase reflects the inclusion of Zynga, business acquisition costs, and higher marketing, which we believe will be slightly offset by the realization of some of our anticipated cost synergies and cost-saving efforts. And GAAP net loss is expected to range from $142 million to $160 million or $0.85 to $0.95 per share, which assumes a basic share count of 167.7 million shares. In closing, we continue to focus on our execution against an uncertain economic backdrop, and we are highly optimistic about our future growth trajectory. Our long-term development pipeline is stronger than ever, and we're excited to deliver a high profile of sequels and engaging new properties that have the potential to enhance our financial profile even further.", "At the same time, we are confident in our ability to create significant shareholder value as we continue our integration of Zynga by collaborating on new creative projects, leveraging our combined scale, unlocking greater potential from their mobile platform, and entering new business models and geographies. Thank you. I'll now turn the call back to Strauss." ] }, { "name": "Strauss Zelnick", "speech": [ "Thanks, Lainie and Karl. On behalf of our entire management team, I'd like to thank our colleagues for delivering another solid quarter. And to our shareholders, I want to express our appreciation for your continued support. We'll now take your questions.", "Operator?" ] } ]	[ { "name": "Operator", "speech": [ "Thank you. And at this time, we'll be conducting our question-and-answer session. [Operator instructions] Our first question comes from Eric Handler with MKM Partners. Please go ahead." ] }, { "name": "Eric Handler", "speech": [ "Good afternoon and thanks for the questions. Wonder if you could just give us a little bit of insight into the mobile business. Do you feel like we're sort of close to a stabilization for that business? And we've been hearing everything -- a lot of different things about what's going on in mobile now, specifically top games are doing well, it's the smaller games that are having some problems. Are you seeing issues with maintaining DAUs or is it spending? Any insight you can give would be greatly appreciated." ] }, { "name": "Strauss Zelnick", "speech": [ "Look, engagement is very stable. We got a lot of terrific hit titles at Zynga. It's what we like about the company. Unlike many mobile businesses of this kind of scale, our bookings are not concentrated in two or three titles.", "We have more than 10 big titles and more coming. So, engagement is incredibly solid. We are seeing some pressure on in-game spending. We also have a great story in advertising bookings because our advertising bookings are up mid-double digits year over year.", "And so, there are plenty of bright spots in the business as well. The most important spot, people love mobile games. They love our mobile games, they continue to play them. And we're seeing no significant change in engagement across our titles.", "In terms of what I expect to change, look, it's very hard to say. I think that's -- it's anyone's guess what the economy will do. My own opinion, and it's really just one person's opinion, as we're looking -- we should be looking at six to six more months of downward pressure. And I expect by the end of '23, we'll be in good shape." ] }, { "name": "Eric Handler", "speech": [ "Great. That's helpful. I wonder, just as a follow-up, it looks like just going between your company presentations, it looks like your pipeline of games from fiscal '23 to fiscal '25 is unchanged. Is that a pretty fair assessment?" ] }, { "name": "Strauss Zelnick", "speech": [ "It is. We have 87 titles coming across mobile, PC, and console. And it's the most robust pipeline we've ever had certainly and one would argue, one of the most robust pipelines in the industry." ] }, { "name": "Eric Handler", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from Andrew Uerkwitz with Jefferies. Please go ahead." ] }, { "name": "Andrew Uerkwitz", "speech": [ "Yeah. Thanks for taking my question. I guess there's a lot of frustration. You had the S-4 out earlier in the year.", "We've gotten two cuts here. And the move in the pipeline around is part of the blame. What -- is there anything you guys can share that gives you confidence that there's going to be growth next year, especially in the core Take-Two? It looks like part of the cut is half 2K, if I'm doing my math right. So just curious, what is giving you that confidence or anything you can share that gives us the confidence to go along with it here? Thanks." ] }, { "name": "Strauss Zelnick", "speech": [ "It's driven by the pipeline, of course. So, we know what the release schedule is and we feel really good about it. And if we didn't, we wouldn't call for a sequential growth and record results in the next three years. But I understand the frustration.", "And look, we call it as we see it and I think we're known for that. Had we expected where we were right now, then we wouldn't be guiding down. We're guiding down because things have materialized in a way that's different than our expectations. Some of that is related to pipeline, but frankly, not most of it.", "Most of it's related to mobile, significant amount of FX as well. But there have been some modest pipeline shifts. So, the good news is those titles are, of course, coming." ] }, { "name": "Andrew Uerkwitz", "speech": [ "Got it. And then if I could just throw one follow-on there. You guys are known for quality and I'm sure a lot of the delays or shifts are related to polish. But is there something you guys are seeing that's -- it's just too much going on? Just kind of just walk us through kind of the thought process behind it.", "It just seems like -- was COVID a bigger impact? This will be, I think, two or three years now with record pipeline and so far, just we're all being patient here." ] }, { "name": "Strauss Zelnick", "speech": [ "I understand the concern and I understand the question as well. No, we're not seeing any productivity issues, for example. We definitely have very high-quality expectations in the bands, and that's reflected in the fact that we're performing across the board. So, this company is a hit factory.", "We haven't had a disappointing release in as long as I can remember. And that's honestly the most important thing. So, we would much rather -- if you have to choose, I'd much rather have the situation we're in, which is we've had some delays and we have had to revise down guidance. I'll choose that any day over taking some flops.", "That's really the key in this business. We've had issues -- I mean, we've been around here long enough to remember them. Where in the past, we had delays in titles and it was ultimately always worth waiting for because when we got to the other side, the results were delivered, and the small amount of the time delay didn't ultimately matter in the context of the results that we were able to deliver. I'm hopeful that will be the case here as well." ] }, { "name": "Andrew Uerkwitz", "speech": [ "Thank you. Appreciate the color. Thank you," ] }, { "name": "Operator", "speech": [ "Our next question comes from Eric Sheridan with Goldman Sachs. Please go ahead." ] }, { "name": "Eric Sheridan", "speech": [ "Thanks so much for taking the question. Maybe I could just go back to the mobile business for a minute. In terms of what you've learned about the mobile business over the last 12, 15 months, some of before the close and since the close in Zynga, how do you think about what you need to build for the long term versus some of the elements of change that you can see on some of the distribution platforms from Apple and Google, and how that might impact what you need to build and scale on either the acquisition front or the monetization front for the long term? Thanks so much." ] }, { "name": "Karl Slatoff", "speech": [ "Hi. It's Karl. So really, what it means to us, what we're working on building is Zynga and this is what's happening obviously well before we merged with the company. as we're working on building the mobile platform.", "And one of the most exciting things and obviously, Zynga has got some amazing forever franchises and some great IPs and some good titles and some great titles coming out. But a huge part of the value is that platform and the ability to manage the customer life cycle very effectively. And you can see the company investing in that over time and we continue to invest that. And as we bring together the databases across our entire company, that power of data management, particularly in the context of IDFA and some of the challenges that privacy rules may sent to us, the better your data, the broader your data set, and the better the bigger and broader your platform and the more capabilities you have in your platform will enable you to mitigate those effects.", "And we're already seeing some of that. And that's been a focus for Zynga for quite some time, and we're going to continue to invest in that. You saw it with the acquisition of, the acquisition of Storemaven, but also bringing all of the Zynga portfolio and the new Take-Two portfolio onto the centralized Zynga platform is going to yield significant results for us." ] }, { "name": "Eric Sheridan", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Matthew Thornton with Truist Securities. Please go ahead." ] }, { "name": "Matthew Thornton", "speech": [ "Good afternoon. Maybe two, if I could. One for Strauss. Strauss, you talked about sequential years of growth and a record performance.", "I guess the question there is, what are you alluding to? Is that EBITDA, earnings per share, margins? Any meat you can kind of put on that would be helpful. And then just second one for Lainie. Lainie, I think you called out $50 million in -- I interpreted that as incremental currency headwind impacting the full year guide, but you also alluded to pipeline moving around. Could you quantify what that impact is and kind of what that is for the year?" ] }, { "name": "Strauss Zelnick", "speech": [ "Yeah. What I was referring to is top and bottom line so net bookings and income, however you describe EBITDA as a handy measure." ] }, { "name": "Lainie Goldstein", "speech": [ "Yeah. And for the full year, I mentioned that about 70% of the downward revision is the mobile business and the release slate together, and about $50 million is for the FX currency headwinds." ] }, { "name": "Matthew Thornton", "speech": [ "OK. And is there any color on what slipped in the pipeline? And I'm sorry if I missed that." ] }, { "name": "Lainie Goldstein", "speech": [ "Sure. For -- the changes in release schedule, there are several changes that happened during the quarter. So, there was one mobile title from 2K that moved, and Gen 8 and Switch versions of the Marvel's Midnight Suns moved into fiscal '24. And also, KSP2 has now shifted to early access this year.", "So those are the major changes in the release schedule." ] }, { "name": "Matthew Thornton", "speech": [ "Perfect. Great. Thanks, everyone." ] }, { "name": "Operator", "speech": [ "Our next question comes from Matthew Cost with Morgan Stanley. Please go ahead." ] }, { "name": "Matthew Cost", "speech": [ "Hi, everyone. Thanks for taking the questions. Just on the PC console business, are you seeing a divergence between the performance of Grand Theft Auto and NBA 2K, specifically where NBA 2K RCS is outperforming Grand Theft Auto? And if so, can you give any more color on the player and consumption dynamics you're seeing in GTA? And then on the mobile side, you highlighted how the advertising business is hanging in there and growing a fair bit better than in-app purchases. Do you expect the advertising to materially outperform in-app purchases over the next couple of quarters? The reason I ask is because presumably, a lot of those ad dollars are coming from other game companies.", "And then I wonder if eventually, that feels the pain from in-app purchases across the industry going down. Thank you." ] }, { "name": "Strauss Zelnick", "speech": [ "Yeah. Thanks for your questions. Look, GTA Online and NBA 2K are very different animals. GTA Online has been around for nearly 10 years.", "It's beloved by a massive audience. GTA V, the underlying title has sold in more than 170 million units. NBA 2K is an annualized release, and so we get an annual snapshot of how virtual currency is doing. Engagement is very high indeed.", "Virtual currency is up in NBA 2K23. The mobile advertising business, look, these are two different businesses and the vast majority of our net bookings at Zynga comes from in-app purchases still. So yes, we expect the growth rate in advertising probably to exceed the growth rate in in-app purchases, certainly for the next year. Beyond that, I think it's too early to say." ] }, { "name": "Matthew Cost", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Drew Crum with Stifel. Please go ahead." ] }, { "name": "Drew Crum", "speech": [ "Hey, guys. Good afternoon. Maybe just taking back off the last question, asking more broadly. With your guidance update and the impact from more cautious macro backdrop, if you isolate your console PC business, can you discuss it in any way you change your view on RCS for this part of the business, so excluding multiple? And then separately, can you talk about the decision to close Playdots? And is this, in any way, factors into that $100 million-plus of cost synergies that accompanied the Zynga transaction? Thanks." ] }, { "name": "Lainie Goldstein", "speech": [ "So for RCS, we did lower our expectations. Most of it was for mobile since our prior guidance assumed that mobile would experience some improvement in the second half of the year. But we no longer expect that since the current data for the industry and our real-time performance has shown that we think it will lower in the second half of the year. But we are also assuming some softer performance for several of our large nonmobile titles that are meaningful contributors to RCS.", "So that's why our expectations for RCS are to come down in the second half of the year." ] }, { "name": "Strauss Zelnick", "speech": [ "And with regard to Playdots, we've relocated the operations of our successful game, Two Dots to another studio. And yes, that was driven by the integration benefits that we felt we could achieve." ] }, { "name": "Drew Crum", "speech": [ "OK. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from Mario Lu with Barclays. Please go ahead." ] }, { "name": "Mario Lu", "speech": [ "Thanks for taking the questions. Wanted to ask about mobile. With the full year guidance, 70% of it coming from mobile but Rollic outperformed in the second quarter. So is there some main factors you can point to that separate Rollic from the rest of the mobile portfolio? Is it being kind of immune to IDFA? Is it competition? And then lastly, just curious to hear your thoughts on potentially leveraging the success of Rollic with perhaps cross-promotion to other mobile games.", "Thanks." ] }, { "name": "Lainie Goldstein", "speech": [ "So, Mario, 70% is mobile and the movement in the release schedule, so it's a combination of both of those two items. So it's not only mobile. But you're right, Rollic did outperform in Q2 so that business is doing really well." ] }, { "name": "Karl Slatoff", "speech": [ "And some of the reasons, because the Rollic is doing well, is obviously, it's an advertising-driven business, and we've had some success from an advertising perspective, both in terms of efficiency and inventory availability. And also, it's just given the nature of the hypercasual business, it's not necessarily reliant as much on targeted advertising. So it's a little bit easier to grow your UA in that context because -- where you have situations like IDFA doesn't necessarily Rollic business or the hypercasual business in the same way that it would in the normal bubble business. I'm sorry, I missed the second question.", "What was that, about cross-promotion?" ] }, { "name": "Mario Lu", "speech": [ "Yeah, the question was, your thoughts on potentially leveraging the success of Rollic to cross-promotion or view that as an acquisition channel to other mobile --" ] }, { "name": "Karl Slatoff", "speech": [ "Yes, there are certainly opportunities to do that. You can make an argument that it's a different kind of a customer. I think there's obviously overlap. There may be some differences.", "But the fact that you've got a large funnel of players coming into your database always going to be something that's going to help your UA strategy across your entire enterprise and specifically on the mobile side of the business." ] }, { "name": "Mario Lu", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from David Karnovsky with J.P. Morgan. Please state your question." ] }, { "name": "David Karnovsky", "speech": [ "All right. Thanks for the question. Just regarding the $500 million of revenue synergies with Zynga, which you reiterated, any early opportunities you're seeing across your portfolio to execute on this? And then Lainie, you mentioned other potential cost opportunities that could come up. Is that something that's factored into your guide or would that be incremental to it?" ] }, { "name": "Strauss Zelnick", "speech": [ "Yeah. On the first question, yes, there are a number of early opportunities that we've identified, including our approach directly to the consumer on the mobile business, which is pretty exciting and could generate material benefits. And we're working on a number of properties as well. It will take longer to bring some titles to market but that's super exciting." ] }, { "name": "Lainie Goldstein", "speech": [ "And in terms of the operating expense synergies, we do have some of the synergies with Zynga included in our guide. But in terms of the other areas of efficiencies, we don't have those in our guide yet. We have some ideas that we're looking at. So, like on a multiyear basis, we're evaluating our real estate footprint as we adopt flexible work policies.", "We're also looking at identifying some core functions that we can centralize across our labels, determining the necessity of some opening to hire positions, and also negotiating some vendor contracts more effectively across the company. So those are additional opportunities that we're seeing in our cost structure. So, we'll be looking at achieving those in the next year or so." ] }, { "name": "Operator", "speech": [ "Our next question comes from Doug Creutz with Cowen. Please state your question." ] }, { "name": "Doug Creutz", "speech": [ "Hey, thank you. Just to tie a couple of things that have already been said together. You mentioned that you've been assuming that mobile would improve in the back half of the year and now you're not assuming that. Is it simply to say that you thought it would get better isn't or that it's actually continued to deteriorate since the last call?" ] }, { "name": "Strauss Zelnick", "speech": [ "It's the former." ] }, { "name": "Doug Creutz", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Martin Yang with Oppenheimer. Please go ahead." ] }, { "name": "Martin Yang", "speech": [ "Good afternoon. Thanks for taking my question. My first question is on NBA 2K's ASP trends. You mentioned there's some year-over-year improvement.", "Can you maybe dig into details on what contributed to the ASP improvement?" ] }, { "name": "Karl Slatoff", "speech": [ "Yeah, it's basically we came out with a Championship Edition this year. Every year, we do different marketing packages or different SKUs. We had a particularly successful one this year that features some very prominent basketball players, and that carries a much higher average selling price and that's affecting the ASP. So it really is just sort of -- it's the SKU mix of the title." ] }, { "name": "Martin Yang", "speech": [ "Got it. And then a follow-up question regarding your mobile synergy. Is there any milestones you could share with us updating where the teams are at? Are new teams being formed to build mobile game space on your core IP? Is there any games in aviation phase or any other milestones will be appreciated. Thank you." ] }, { "name": "Karl Slatoff", "speech": [ "Yeah. We don't have anything specific to announce right now. And I assume your question is really related, as it relates to releasing Take-Two IP or games, yes. Because obviously, there's a lot of other smaller things we can do with leads, etc., and also just the efficiencies about bringing the companies together, T2 mobile and Zynga -- the acquired Zynga component.", "But yeah, there are a lot of conversations going on. There are a lot of ideas flowing back and forth. We don't have anything to announce right now, but those conversations are going very well and they're exciting. When it materializes, it's difficult to assess.", "The creative process is a very specific process and some of them take longer than others. And the most important thing is that we have game concepts that make sense from a commercial perspective but also from a brand perspective. So, the teams are having those conversations for now. So, stay tuned." ] }, { "name": "Martin Yang", "speech": [ "Thanks, Karl." ] }, { "name": "Operator", "speech": [ "Our next question comes from Matti Littunen with Bernstein. Please go ahead with your question." ] }, { "name": "Matti Littunen", "speech": [ "Hello. Good evening. First question on NBA units. So it sounds like, if I heard correctly, that the unit number so far is very similar to what you said a year ago.", "So could you just confirm, has it been broadly similar? Has there been any slight growth or decline on that? And then on the live services revenue, could you give us any color in terms of how that revenue is currently split between MyCAREER and MyTEAM and maybe how that's trending over time? Thank you." ] }, { "name": "Strauss Zelnick", "speech": [ "Yeah. It's roughly the same number of units year over year and virtual currency spending is up. And we don't split out the spending in the different modes for the purpose of this call." ] }, { "name": "Matti Littunen", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from Brian Fitzgerald with Wells Fargo. Please go ahead." ] }, { "name": "Brian Fitzgerald", "speech": [ "Thanks. Lainie, you talked to this a little bit. But in terms of labor, how do you think about things improving as the market cools off a bit for tech employees? And how are you thinking about headcount growth and retention from here? Does the cooling labor market give you any leverage in terms of getting developers back to the office? Does that help things? Any color there would be great." ] }, { "name": "Strauss Zelnick", "speech": [ "Well, we don't really look at our relations with our colleagues as one of leverage, so we probably wouldn't describe it through that lens. I do think that it's probably going to become easier to hire people when a lot of tech businesses are laying people off. We don't expect a rip and we don't have a hiring freeze. We're always judicious about the people we bring on board.", "We pride ourselves on being highly efficient, and we believe we are highly efficient now. So, I do think that this may make it somewhat easier to hire really talented people, but we wouldn't use these times to apply leverage. We believe that we have great relationships with our workforce and those are terribly important to us." ] }, { "name": "Brian Fitzgerald", "speech": [ "Thank you, Strauss." ] }, { "name": "Operator", "speech": [ "Our next question comes from Omar Dessouky with Bank of America. Please state your question." ] }, { "name": "Omar Dessouky`", "speech": [ "Hi. Thanks for taking the question. My question is about mobile advertising efficiency. How has mobile advertising efficiency in the September quarter trended versus the March and the June quarters, especially at Zynga? And what are your go-forward assumptions for the December and March quarter? And what I mean by advertising efficiency is the kind of in-app purchase bookings divided by the advertising spend." ] }, { "name": "Karl Slatoff", "speech": [ "Yeah. Just to be clear, you define advertising efficiency as in-app purchases divided by advertising spend?" ] }, { "name": "Omar Dessouky", "speech": [ "Yeah, or the reciprocal of that. So, like the total advertising spend as a percentage of bookings. Sorry, I should have said it that way." ] }, { "name": "Karl Slatoff", "speech": [ "Right. So, I think, look, we don't break -- we're not necessarily breaking that out specifically and I'm not sure that I would characterize that as efficiency, but it certainly would be an interesting measure to look at. And as we said before, we've experienced pretty strong growth in our advertising business and we've had some pressure on in-app purchases. So, it stands to reason that, that ratio would probably be going more in favor of the advertising business versus in-app purchases.", "That isn't necessarily a long-term trend. That's just something that we're seeing in the short run. We fully expect in-app purchases to come back at one point in the future. As Strauss said before, a little hard to gauge that when that may happen, but that is our expectation.", "So those ratios, I don't believe are necessarily going to be fixed over time or necessarily moving in a specific direction, again, depending on what happens in the broader market." ] }, { "name": "Omar Dessouky", "speech": [ "OK. And just a follow-up on that would be, have you changed which channels you're using for user acquisition for mobile, specifically for Zynga? Or how do you, for example, concentrate your spend in specific channels? Has that changed at all?" ] }, { "name": "Karl Slatoff", "speech": [ "Yeah, I don't think the mix in terms of where we're spending concentrating has changed dramatically based on anything that we've seen in the market. You can certainly expect that day-to-day, quarter-to-quarter, month-to-month, you're going to see variations depending on where media opportunities exist. So I'm sure you're going to see some variation depending on what happens in specific media outlets. But I don't see a broader trend that's pushing us toward any particular asset versus another." ] }, { "name": "Omar Dessouky", "speech": [ "OK. Thanks a lot." ] }, { "name": "Operator", "speech": [ "Our next question comes from Mike Hickey with Benchmark. Please state your question." ] }, { "name": "Mike Hickey", "speech": [ "Hey, Strauss. You guys are good. Thanks for taking my questions. The first one is on your guidance for '23.", "I mean, obviously, a couple of revisions here. Do you feel like you're sort of being conservative enough? Obviously, a lot of uncertainty on the macro mobile, but is there still downside risk and where would that be? And then on '24, you said growth sequentially. You've given us some data on the S-4 and I think on your presentation with Zynga. Street's looking for $8 billion in revenue, 759 in ETFs.", "Obviously, that's a pretty big step-up. Guessing it's coming from premium as mobile is slowing here. Obviously, live service is not great. Is it just one, two, three titles on premium or any sort of granularity, I guess, on the '24 growth would be great? And then the second question is on the very unfortunate GTA leak.", "Just curious how you and your teams are sort of managing through that impact, if you feel that there's a residual advantage or not, and how you sort of move forward and think about timing." ] }, { "name": "Lainie Goldstein", "speech": [ "So, in terms of the guidance for '23 on being conservative or still downside risk, we always guide based on what we know at the time that we know it. So, I wouldn't say they're conservative or a risk either way. I feel like we gave the best information that we have at the time that we have it. So, it's what we know right now.", "And hopefully, the -- it gets better, but that's what we feel the numbers are at this time. And in terms of the CAGR and the fiscal -- the numbers that were in the S-4, we generally do not provide long-term growth targets in our normal course of business. We only did that previously because of the pending combination with Zynga. And as you know, the in our business because of the changes in the shifts in the release slate can happen, it really doesn't make sense for us to give long-term numbers on a regular basis.", "So, we've never really done that in the past. But we're really continuing to be very excited about our pipeline of the strong titles that we have, and we have many large-scale projects underway. So, the potential of the titles in the pipeline, that has not changed at all. We remain highly confident that they're going to deliver us sequential years of growth and record performance in the next few years.", "So that hasn't changed. So, we really feel great about our numbers in the next few years, as we said." ] }, { "name": "Strauss Zelnick", "speech": [ "And with regard to the leak, it was terribly unfortunate, and we take those sorts of incidents very seriously indeed. There's no evidence that any material assets were taken, which is a good thing. And certainly, the leak won't have any influence on development or anything of the sort. But it is terribly disappointing and causes us to be ever more vigilant on matters relating to cybersecurity." ] }, { "name": "Mike Hickey", "speech": [ "Thanks, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from Clay Griffin with MoffettNathanson. Please state your question." ] }, { "name": "Clay Griffin", "speech": [ "Hi. Good evening. Thanks for taking the question. I guess two.", "I guess two. It seems like the legacy Take-Two mobile games are holding in a bit better than the legacy Zynga. I guess, what would you attribute that to? Is it just kind of a life cycle of where those titles are relative to kind of when IDFA ATT dropped? And then secondly, just curious, Strauss, I think Phil Spencer was talking about Game Pass and essentially implying that they were nearing saturation, I guess, relative to kind of where the Xbox console installed bases. Just curious if your thoughts about subscription models relative to the traditional premium window have changed over time.", "I think his comments generally, I think, could be characterized as lining up maybe what your view of the value proposition for a subscription product." ] }, { "name": "Karl Slatoff", "speech": [ "So, in terms of the legacy Take-Two mobile business versus the Zynga business, I wouldn't necessarily -- I mean, again, we don't really disclose that so I don't think there's any really way try to see that behavior. But I can tell you that we wouldn't look at it that way because there are certain games within the Take-Two legacy portfolio and the games in the Zynga portfolio, some are doing better than others and some are doing great, some are not doing as well. So, there's a lot of variation within the portfolio itself. So, I wouldn't necessarily characterize it as the T2 mobile businesses are doing better than Zynga or vice versa.", "It's not really how we look at the business anymore." ] }, { "name": "Strauss Zelnick", "speech": [ "It's all one, it's all Zynga. It's managed by the Zynga team and we have a lot of great titles." ] }, { "name": "Karl Slatoff", "speech": [ "Yeah. And we're specifically hoping that with the T2 mobile titles, and we're starting to see some of this collaboration happening that we're going to be -- they're going to be able to benefit from the power of the Zynga mobile platform, which has some really interesting opportunities for us to be more efficient and opportunistic in the consumer life cycle management." ] }, { "name": "Strauss Zelnick", "speech": [ "And on the subscription side, look, we've been very cooperative with both Sony and Microsoft on their subscription offerings when it makes sense for us. And my own views have not changed at all since I first started talking about subscription, which is now, I want to say, probably four years ago. The interactive entertainment business is very different than the linear entertainment business. People consume far fewer hours of interactive entertainment in a given month than they do of linear entertainment.", "And within that consumption, there are far fewer titles consumed in interactive entertainment than there are with linear entertainment. So, I, at least, pose the question as to whether subscription makes as much sense for interactive entertainment as it does for linear entertainment and registered some skepticism, which I still hold. I think the second area of skepticism was whether it made sense, and this is a rhetorical question because I think the answer is no, to offer frontline titles day and day with titles on a subscription service. I don't think that ever made sense.", "I still don't think it makes sense. And I believe that it's now becoming obvious that it doesn't make sense. It's just a lost opportunity for the publisher. So, I wouldn't want to speak for my friend, Phil, but our views remain unchanged.", "There probably is a subscription business. It's a catalog business. It's probably best aimed at very avid consumers because those are the consumers who are interested in playing catalog titles, implying a whole bunch of different titles in a given month. But I don't think it's a mass market service that supplants the interactive entertainment business as we know it at all.", "And I don't think there's any evidence to the contrary so far." ] }, { "name": "Clay Griffin", "speech": [ "OK. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. [Operator instructions] We have a follow-up question from Matthew Thornton with Truist. Please go ahead." ] }, { "name": "Matthew Thornton", "speech": [ "Thanks, guys. Maybe two quick follow-ups. First one on coming back to mobile, again. Maybe this is for Strauss.", "How do you think about what's currently going on from a macro perspective as opposed to just a user acquisition perspective, given what's going on in the iOS environment, in particular? Is there a way to tease apart what percentage of the pressure is from one versus the other? And relatedly, what's your level of confidence that we come out of? I mean, macro will resolve itself. But from a UA perspective, from an ecosystem perspective, what's your level of confidence that you can kind of control coming out of this doldrum? That's the first question. The second one is a really easy one. Given where the stock price is, I'm kind of curious your appetite around buybacks.", "I know you guys have been fairly opportunistic in the past. Obviously, we've taken on some leverage with Zynga, but I'm kind of curious how you're thinking about that, given where the share price is. Thanks, again." ] }, { "name": "Strauss Zelnick", "speech": [ "Yeah. In terms of mobile, from a macro perspective, I think that you're right. There's a difference between user acquisition and retention and conversion. And on user acquisition, I think we and everyone else is just going to be a bit more selective to drive efficiency.", "And in terms of retention and conversion, that's a reflection of people just not having to spend mobile. You can enjoy a title without spending in-game. Ninety-plus percent of consumers do not spend in-game. And so, at times when consumers are feeling the pressure of higher prices for fuel and food, for example, they may be less likely to spend money on entertainment, especially when you can have the experience anyhow.", "So, in terms of our expectations, I think this is -- it's a moment where we will, in fact, tune up our UA spend to become more efficient. That's a good thing. And yeah, we will probably see some pressure on in-game purchases for a period of time. As I said earlier in the call, not that I think you can underwrite to this because it's just one person's opinion, I think there'll be pressure for three to six months at least that's driven by the economy and geopolitical factors.", "And I'm hoping that by the end of '23 -- I believe that by the end of '23, things will normalize and will be on an upward swing again. And Lainie will take the question about buybacks." ] }, { "name": "Lainie Goldstein", "speech": [ "So we continue to believe in returning value to the shareholders and via share buyback, but we'll only do so when the conditions are right. And obviously, we believe that there is deep value in our market price currently. But in order to do a share repurchase, we would need to do it in an open trading window and also have the optimal capital structure that supports the purchases. So, we'll see when it makes sense for us to do it.", "So that's how we see it." ] }, { "name": "Matthew Thornton", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Martin Yang with Oppenheimer. Please go ahead." ] }, { "name": "Martin Yang", "speech": [ "This is a question referring to your earlier definition of Take-Two entity is a hit factory. I want to know if you hold a similar view over your mobile game portfolio. Do you feel there's a need for a portfolio review on mobile games based on the quality and future potentials? Thank you." ] }, { "name": "Strauss Zelnick", "speech": [ "Yeah. At any given time, we're always reviewing our portfolio, both in terms of the performance of the current titles and the potential for new titles that we're working on. And Frank and his team are very focused on making sure to optimize the current title lineup and to make sure that our development for new titles is as effective and poised for success as it possibly can be. Good news is we have a terrific lineup of great titles and our mobile titles all make money." ] }, { "name": "Martin Yang", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Omar Dessouky with Bank of America. Please go ahead." ] }, { "name": "Omar Dessouky", "speech": [ "Hi. Thanks. I'm just going to sneak a quick one in here. And apologies if Karl had already answered this by saying that you don't have the details.", "But in terms of part of your synergies may come from applying PC console IP to the casual mobile market using the Zynga development resources, I think when I've spoken with you in the past, you called out an example of like a Red Dead Redemption poker game, for example. Are these mobile games you're envisioning targeted toward fans of the existing PC console franchises like Red Dead or toward mobile-first casual gamers that would play -- that would otherwise play games like Zynga Poker or Empires & Puzzles?" ] }, { "name": "Strauss Zelnick", "speech": [ "I think it's a great question, thank you. And I think the bottom line is you're probably not going to convert a console player to become a mobile player. You have to appeal to a mobile player. And we believe that legacy IP, when properly developed as a great title, can do just that.", "But it's not a slam dunk by any means. It's still got to be a great game. But you're not going to convince someone who never plays a mobile title to play a mobile title just because it's based on console IP." ] }, { "name": "Omar Dessouky", "speech": [ "Thank you, Strauss." ] }, { "name": "Operator", "speech": [ "Thank you. There are no further questions at this time. I'll hand the floor back to management." ] }, { "name": "Strauss Zelnick", "speech": [ "I want to thank everyone for joining us today. I want to say thanks, particularly to our dedicated team of colleagues all around the world who continue to do a great job. While it would be nice always to have the best possible news in an upward-sloping curve, this is a business that occasionally does present us with challenges. This team is well suited to challenges.", "We have a great pipeline. We have a great team. We have the ability to deliver. And we wish you all a great holiday season.", "Thank you for joining us, and thank you for your support." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2020-11-18	[ { "description": "Vice President of Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Dave Denton", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Elizabeth Suzuki", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies third-quarter 2020 earnings conference call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, vice president of investor relations." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you and good morning, everyone. Here with me today are Marvin Ellison, our president and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president, stores; and Dave Denton, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2020.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the Risk Factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release and on our investor relations website.", "Before we discuss our third-quarter results, I would like to announce that we will be hosting a virtual investor update on Wednesday, December 9, from 8 to 10 a.m. Eastern Time. Marvin will discuss several growth opportunities that are expected to facilitate further market share gains. Dave will discuss our opportunities to drive operating efficiencies and sustainable shareholder value, and he will also provide an update on our financial targets.", "After our prepared remarks, we will host a Q&A session. We look forward to speaking with you again soon. With that, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Good morning, everyone. I'd like to start out by taking a moment to extend my thoughts and prayers to all the individuals and communities impacted by the many wildfires, hurricanes and other natural disasters, as well as the COVID-19 pandemic. There is no doubt that this has been a very challenging year for many of us. Although our Lowe's associates are dealing with the same challenges facing the rest of the country, I continue to be inspired by their commitment to serve our customers and communities while juggling a multitude of pressures and obstacles at home.", "Throughout all the uncertainty we face, we continue to be guided by three key priorities. First, our highest priority as a company will always be protecting the health and safety of our associates and customers through a safe store environment and shopping experience. And we believe that our strict in-store safety and social distancing protocols implemented in a consistent, uniform manner has built trust with our customers. Our second priority remains providing support for our community, including healthcare providers and first responders.", "And our third priority is financially supporting our associates during this challenging time. In support of these priorities, we've invested an incremental $245 million in the third quarter to support our associates. We've now invested more than $1.1 billion in COVID-related support for our associates, store safety initiatives and communities through the first nine months of this year. Now turning to our results.", "For the quarter, we delivered total company comparable sales growth of 30.1% over the prior year and 40% growth in adjusted diluted earnings per share to $1.98. At the same time, we're also making critical investments across our operations to position the company for long-term growth. Our U.S. home improvement comps was 30.4% driven by consistent and strong project demand from both DIY and Pro customers throughout the quarter.", "In a continuation of trends from Q2, growth was broad-based across channels, product categories and geographies. In fact, growth exceeded 15% across all merchandising departments, 20% across all geographic regions and triple digits on Lowes.com. DIY comps again outpaced Pro comps in the quarter driven by a consumer mindset that remain focused on the redesigning the functionality of their home. Consistent with the redefinition, in the third quarter, customers continued to shop at Lowe's as they took steps to shift their home to serve three primary purposes: a home school, a home office and their primary location for recreation and entertainment.", "We're pleased that customers continue to choose Lowe's as a retail of choice for these very important projects. Our Pro business remained strong in the third quarter with comps exceeding 20%. Our investments to improve our product and service offerings and overall customer experience is resonating with the Pro customers. We're seeing a significant number of new Pro customers rediscover Lowe's, and we're seeing them come back to buy from us over and over again.", "We're well positioned to continue to attract new Pro customers while also growing share of wallet with existing Pro customers. We launched a significant merchandising investment in the third quarter to reset the footprint of our U.S. stores, shifting to a project-focused versus a product-focused store layout. We believe these changes will create a more intuitive shopping experience for our customers, especially to Pro.", "And we redesigned the layout of our stores to improve product adjacencies and bay productivity with the goal of increasing sales per square foot. Bill will provide more detail on this very important reset initiative in a moment. From a geographic perspective, we had broad-based growth with positive comparable sales growth exceeding 20% across all 15 geographic regions and all three U.S. divisions.", "Regions that outperformed the total company comps were Atlanta, Houston, Los Angeles and New York. We also continued to see strong sales trends in urban areas. In fact, comp sales in our urban markets outperformed remote or rural markets by over 500 basis points. Our strength in our urban markets reflects the improvements we've made to our product and service offerings for the Pro customer, as well as enhanced omnichannel capabilities to serve customers increasingly shopping online.", "On Lowes.com, sales grew 106% as we continue to see an increase in both DIY and Pro customer demand for contactless shopping options. We have made tremendous progress over the last two years with the right investments to improve our omnichannel retailing capabilities, enabling us to meet the ever-increasing expectations of customers to shop whatever way they choose. And we continue to invest in our supply chain network as we opened new cross-dock delivery terminals, bulk distribution centers and e-commerce fulfillment centers to expand our fulfillment capabilities. And while we've seen exponential online growth this year, we still have tremendous growth runway in front of us as Lowes.com business is meaningfully underpenetrated, with online representing only 7% of our sales.", "Supported by our modern cloud-based platform, our talented dot-com and technology team has a detailed road map toward becoming a best-in-class omnichannel retailer. Turning to Canada. We posted positive comps that exceeded 25%, supported by strong Pro and DIY demand, as well as early success implementing our retail fundamentals playbook to improve operating efficiency while driving sales. This was a very important quarter for us as we drove strong top line results while continuing to make significant investments across merchandising, Lowes.com, store operations and supply chain that will enable us to capitalize on current trends and will position us as a company to drive sustainable growth.", "2020 has demonstrated to all of us how quickly shopping behaviors can change. And I'm proud of the agility that we've shown to adjust our business model to serve an unprecedented number of customers in store and on Lowes.com. We also understand that agility will be important as we hopefully pivot to a post-COVID retail environment later in 2021. However, we understand that creating an efficient and world-class omnichannel experience will determine retail winners and retail losers in the future.", "Therefore, we're pleased with the current development of our omnichannel strategy thus far and remain committed to making the necessary investments to provide our customers with choices to shop any way they choose. And over the near term, our investment thesis will remain laser-focused on enhancing the growth and profitability of our core retail business. Before I close, I'd like to again express my sincere appreciation for the tremendous efforts of our associates to support our customers and communities when they need us most. The country continues to face significant challenges presented by COVID-19, and this is still a very unpredictable business environment.", "However, our No.1 priority as an essential business will always be supporting the health and safety of our associates and our customers. I look forward to speaking with you again at our investor update on December 9th with a discussion focused on the market share growth opportunities that lie ahead of us. With that, I'll now turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. As Marvin mentioned, we posted U.S. home improvement comparable sales growth of 30.4% in the third quarter. Our continued strong execution, combined with elevated brand and product offerings, enabled us to effectively serve the sustained increase in customer demand driven by the increased importance that customers are placing on their homes.", "Similar to the second quarter, growth was broad-based across both DIY and Pro customers, in-store and online, and across all merchandising departments. In fact, all 15 merchandising departments generated positive comps exceeded 15%. Lumber led the way, again driven by strong unit demand across Pro and DIY customers, supported by our continued investments in job lot quantities, and the strength of our merchants and our supply chain teams in sourcing these high-demand products. In addition to lumber, we delivered above-average comps in decor, lawn and garden, and seasonal and outdoor living.", "Within decor, our growth was driven largely by the strength in furniture, including accent furniture and accessories, along with the strong results in home organization, as customers continue to update and create new spaces for home offices and remote schooling. In lawn and garden, there was broad-based strength across the business, though most notably within live goods and landscape products, as customers actively engaged in outdoor landscaping and other fall exterior projects. Our seasonal and outdoor living team also delivered comps above the company average this quarter driven by customers looking to extend their outdoor entertaining space, with fire pits and patio heaters being the accelerated product category for this fall. We continue to strengthen our position as the No.1 destination for outdoor power equipment with the recent addition of EGO, which is the top-selling brand in battery-powered outdoor power equipment, to our all-star lineup, which includes John Deere, CRAFTSMAN, Husqvarna, Honda and the Ariens brands.", "And we continue to leverage our other powerhouse brands like Weber and Char-Broil, which continues to be the top two brands in outdoor grilling. Now turning to our online results. As Marvin mentioned, we delivered sales growth of 106% on Lowes.com. With the replatforming of Lowes.com to the cloud, we have been rapidly deploying enhancements to deliver a better customer experience, including enhanced online delivery scheduling, so that customers can more efficiently self-serve and select the delivery time that is most convenient for them or easily reschedule as the need arises.", "We also made it easier to shop by product collection with over 500 collections and growing. So customers can now purchase a patio set without it involving a time-consuming search for each individual item. I'm also excited that we now have the capability to ship products that require special handling, items like lithium-ion batteries. This capability now enables us to handle online orders of EGO, Kobalt and Skill battery-powered products, along with other products powered by lithium batteries or items that may require care in shipping and handling.", "And as Marvin covered in his opening remarks, we are resetting the footprint of the store, so that's more intuitive shopping experience for our customers, especially for the Pro. For example, the reflow of our rough plumbing and electrical aisles are two key areas for the Pro that needed to reflect how the Pro shops. We are now placing all of the relevant products adjacent to each other, such as pipe cement next to pipe and the necessary fittings next to their respective pipe category. We are also eliminating merchandising bays without planograms.", "We call these junk bays, thus opening up space for higher-velocity, higher-demand items and categories that will better reflect the local market. We are on track to have the reset complete for over 90% of our stores by fiscal year-end. And as part of this store reset, there'll be two other noticeable changes. First, we are adding a Pro-Flex area, similar to what we did earlier this year in our seasonal areas, making it easier for the Pro to grab and go.", "And then second, we are moving the cleaning category to the main or the first aisle of our stores. This is just another example of ways we are working to improve the productivity in this highly visible area of the store. And as we look to close out the year, we are building on our momentum around the holiday season that began with our first-ever drive-through, curbside trick-or-treating event at our stores, where we gave away candy and pumpkins to hundreds of thousands of families who are excited about the holidays but may not have had the same door-to-door trick or treating available in their neighborhoods as in years past. And we feel that this will be a holiday season like no other, when our customers will no doubt be spending much more time at home.", "And because of that, we're helping our customers invest in the time and memories that they're creating at home. And we're planning to deliver a season of savings for the holidays over an extended period to avoid creating congestion in our stores. Consistent with our approach throughout 2020, we continue to expect reduced promotional activity compared to the prior year. Overall, we've delivered outstanding results this year, and I can't say enough about the unbelievable efforts of our vendor partners and our merchants who have worked extremely hard to keep up with the unprecedented demand.", "Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Bill, and good morning, everyone. This year, we faced operational challenges unlike anything I've encountered in my career, whether it's in response to a hurricane, flood, tornado or global health crisis, Lowe's associates take pride in the role they play to keep families safe in their homes and businesses running in challenging times. Our associates have also remained steadfast in their commitment to providing a safe shopping experience in our stores so our customers feel comfortable returning for another shopping trip to Lowe's. In recognition of the outstanding efforts of our team, we have provided financial support to our hourly associates with two additional $100 million bonuses this quarter.", "Full-time associates received $300 and part-time associates received $150 in each payment, while Lowe's covered the cost of the tax gross-up again. This brings our total COVID-related financial assistance to our associates to over $800 million this year. And I'm thrilled to announce that for the third quarter in a row, 100% of our stores have earned their \"Winning Together\" profit-sharing bonus totaling $104 million. Once again, their efforts exceeded expectations, so this represents an incremental $31 million over the target payment level.", "I was also really pleased to see the strong frontline associate morale, reflected in their impressive level of engagement in our recent annual associate survey. Our associates indicated that they feel supported by the company during this challenging year and that they are energized by their work. And we're supporting our communities through hiring as we're bringing on 20,000 associates across our U.S. stores and distribution centers this holiday season to support elevated levels of customer demand.", "This year, we've hired over 155,000 associates through our seasonal hiring programs, and many of these seasonal hires have transitioned to a more permanent role within the company. The pandemic has changed the way we all live, work and shop. This is evident in our increased customer demand for contactless shopping options this year. This quarter, we began adding touchless BOPIS lockers to our stores to complement our curbside pickup and BOPIS pickup at checkout.", "We're focused on rolling out these lockers to our major metro markets by Thanksgiving. And we are standing up dedicated fulfillment teams at our stores who are already improving speed of service and customer satisfaction with their consistent focus on this important function. We're also raising our game with the Pro as we expand our brand and product offerings to meet their unique needs. We are adding to our Eaton electrical product assortment, which is a go-to solution for the Pro working on a home remodeling project.", "And we are now the largest distribution partner for SharkBite, which provides push-to-connect plumbing products that make projects fast and easy, a must-have for any plumbing project. Combined with the power of Simpson Strong-Tie, DEWALT, Spyder and Bosch brands, this broader offering in Eaton and SharkBite builds out our arsenal to ensure that we have a competitive offering that meets the needs of our Pros across the variety of projects that they handle. And we kicked off a multiyear national rollout of our tool rental program to increase our relevance with the Pro, as over 70% of Pros rent tools at least once a year. In August, we celebrated the grand opening of our first tool rental location in Charlotte, where we provide high-quality tools for both Pros, DIYs and weekend warriors through a convenient online platform that allows customers to reserve their tools ahead of time.", "We are encouraged by the early results and the strong feedback from our most frequent Pro customers in the Charlotte area. Looking at our third-quarter results. I'm really pleased with the comps exceeding 20% that the Pro team delivered. We are consistently meeting the needs of our Pro customers with job lot quantities that are available every week, efficient service focused on getting them back on the job site quickly and the products they're looking for.", "We're winning new Pro customers, and they're coming back to our stores again and again. And we continue to drive efficiency by streamlining our store operations as we leverage technology to improve customer service and alleviate the task and responsibilities for our Red Vest associates. This quarter, we leveraged the new intuitive touchscreen POS at our registers to easily cross-train other associates on the cashier position. These new touchscreen registers not only speed up cashier training from the old green screens, they also provide our customers with a faster checkout experience.", "This is consistent with our store simplification approach, which leverages new technology to make our associates more productive while also improving customer service at the same time. With all these store technology processes and improvements under our belt, we are well on our way to hit our target of 60% service and 40% tasking by the end of the year. And it's paying off with high customer satisfaction scores as we acquire new customers who keep coming back to shop at Lowe's. Thank you, and I will now turn the call over to Dave." ] }, { "name": "Dave Denton", "speech": [ "Thank you, Joe, and good morning, everyone. I'll begin this morning outlining the company's strong capital allocation program. In the first nine months of 2020, we generated $10.3 billion in free cash flow driven by very strong operating performance. In the third quarter alone, we paid $416 million in dividends.", "We also announced a dividend of $0.60 per share, a 9% increase that will be paid in the fourth quarter of this year. During the quarter, we reinstated our share repurchase program and repurchased 3.6 million shares in the open market for $621 million. I continue to expect our share repurchase program to be a significant contributor to long-term shareholder value creation. We incurred capital expenditures of $462 million as we invest in the business to support our strategic initiatives, including our omnichannel capabilities.", "In October, we took advantage of a favorable interest rate environment to reduce our interest expense through a cash tender offer for $3 billion of our higher coupon bonds. As a result, we recognized a loss of $1.1 billion on the extinguishment of debt. To fund the tender offer, we issued $4 billion of unsecured notes. This issuance consisted of seven-, 10- and 30-year notes with a weighted average interest rate of 2.17%, which is a record low in the company's history.", "These efforts further strengthen our capital position by lowering our interest expense over the longer term. We now have $8.2 billion of cash and cash equivalents on the balance sheet. And combined with $3 billion in undrawn capacity on our revolving credit facilities, we have immediate access to $11.2 billion in funds, which we are confident is more than enough liquidity to navigate any uncertainty. At the end of Q3, our adjusted debt-to-EBITDA ratio stands at 2.3 times. Now turning to the income statement.", "In Q3, we generated GAAP diluted earnings per share of $0.91 compared to $1.36 last year, a decrease of 33%. And as I just mentioned, the company incurred a $1.1 billion loss on debt extinguishment this quarter. Now my comments from this point forward will include certain non-GAAP comparisons, where applicable. In Q3, we delivered adjusted diluted earnings per share of $1.98 per share, an increase of 40% compared to the prior year.", "These results were driven by higher-than-expected sales volume, as well as our strong execution to meet elevated customer demands. Q3 sales were $22.3 billion, an increase of 30.1% on a comparable basis versus the prior year. This is driven by transaction growth of 16.4% and comparable sales average ticket growth of 13.7%. We continue to see strong repeat rates from both new and existing customers.", "Commodity inflation drove a benefit of approximately 340 basis points to comps in the quarter. U.S. comp sales were up 30.4% in the quarter, with continued strength from both DIY and Pro customers and broad-based demand across geographies, merchandising departments and selling channels. Our U.S.", "monthly comps were consistently strong throughout the quarter with 28.9% in August, 31.8% in September and 30% in October despite a significant reduction in promotional activity versus LY. Gross margin was 32.7% of sales in the quarter, an increase of 28 basis points compared to the third quarter of '19. Product gross margin rate improved 65 basis points driven by continued improvements from our pricing, cost management and promotional strategies. Favorable product mix drove approximately 35 basis points of benefit.", "These benefits were offset by 30 basis points of headwind from lower credit revenue, 25 basis points of pressure from inventory shrink and 20 basis points of pressure from supply chain cost. And consistent with our long-term strategy, we are investing in our supply chain as we expand our network to stand up market-level delivery model for big and bulky products. We further expanded capacity for parcel shipments with the opening of a new direct fulfillment center on the West Coast. SG&A was 21.4% of sales in Q3, a 31 basis point improvement compared to LY.", "As we anticipated, we incurred $290 million of COVID-related expenses. These investments included $230 million in financial assistance for our frontline associates and approximately $55 million related to both cleaning and other safety-related programs, and approximately $5 million in charitable contributions. These $290 million of COVID-related expenses negatively impacted SG&A leverage by 130 basis points. We also incurred approximately $100 million in a large-scale strategic merchandising reset of our U.S.", "stores, which negatively impacted SG&A leverage by 45 basis points. These incremental costs were partially offset by payroll leverage of 90 basis points related to higher sales volume and improved store operating efficiencies, occupancy leverage of 35 basis points, 35 basis points of leverage in employee benefits and advertising leverage of 25 basis points. Adjusted operating income margin increased 55 basis points to 9.81% of sales. The adjusted effective tax rate of 23.9% was in line with the prior year.", "Now Q3 benefited from a $0.02 timing shift into Q3 at the expense of Q4. At $15.7 billion, inventory was higher compared to the prior-year levels as we stocked up on product to meet elevated customer demand throughout the quarter. Also, lumber inflation increased inventory values by approximately $250 million. I'd now like to spend just a few minutes discussing our outlook for the fourth quarter.", "While the operating environment remains uncertain and we still have limited visibility into the longer-term trends, I'd like to share my perspectives about how we are planning the business in Q4. We expect that our top line growth will moderate from Q3 levels as outperformance in seasonal categories abates in the fourth quarter. This is consistent with natural demand patterns of the home improvement sector. For the quarter, we expect total and comparable sales growth of between 15 and 20%. Consistent with the prior two quarters, we anticipate that we will incur ongoing COVID-related operating expenses of approximately $75 million to support safety and cleanliness in our stores.", "In Q4, we will continue to evaluate the operating environment and assess any potential incremental associate financial assistance. We expect to incur approximately $150 million in expenses associated with the merchandising investment in our stores as we expect to complete the reset activity for over 90% of our U.S. stores by the end of the fourth quarter. Additionally, we will continue to invest in expanding our supply chain network.", "These significant investments, coupled with our fourth quarter typically being our smallest revenue quarter, should result in adjusted operating margin performance essentially flat to prior-year levels. The effective tax rate is expected to be over 27%. Continuing our commitment to return capital to shareholders through value-enhancing share repurchases, our guidance assumes approximately $3 billion in share repurchases in the fourth quarter. We expect GAAP and adjusted diluted earnings per share of $1.10 to $1.20 a share.", "For adjusted EPS, this represents 22% growth at the midpoint over the prior year. We are now planning for approximately $1.7 billion in capital expenditures for the year with a continued focus on our omnichannel investments. In closing, I'm extremely pleased with our outstanding results for the first nine months of the year. In an unprecedented operating environment, we remain focused on serving our customers and our communities, which led to an opportunity to grow market share earlier than we expected.", "I remain confident that we are making the right investments to drive sustainable growth. We have a strong balance sheet and we are committed to a disciplined capital allocation program, which will lead to a longer-term shareholder value creation. I look forward to speaking with you again soon at our investor update meeting on December 9th. So with that, I thank you.", "We are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] And your first question comes from the line of Simeon Gutman with Morgan Stanley." ] }, { "name": "Simeon Gutman", "speech": [ "Hey, good morning everyone. I have a question, Marvin, if you step back and look at the transformation so far since you've gotten there and your ability to get to 12% margins and beyond. I know the stock is down a little bit this morning, and I think it's reflecting maybe a mismatch in timing of some investments and flow-through. But it doesn't look like much has changed with your goals and the path you're on, but I wanted to ask you if there's anything that you can be critical of that's something that's not playing out.", "Or is your reaction that things should only be stronger for Lowe's than what you envisioned when you got to Lowe's?" ] }, { "name": "Marvin Ellison", "speech": [ "Simeon, this is a very good question. We actually feel great about the transformation. I mean, obviously, we don't have perfect visibility to the future and we had no idea, as no one did, that we'd be dealing with a global pandemic in the year 2020. But when I think about how far we've progressed in two years, when you look at the digital platform and our online business, the last two quarters growing 135%; last quarter, 106%.", "In the third quarter, we were at levels that we could not have even imagined just 12 to 16 months ago, merchandising initiatives, supply chain. I think the key for us is that we're not really concerned about the short term. We know this is a great brand, we have a strong balance sheet and we're trying to make the right investments in the future. When I look around at the accomplishments of the team, I'm exceptionally proud because we're a little bit ahead of schedule, as Dave mentioned. And we think that we're going to start to lean into taking market share.", "And at the December 9th investor update, we're going to be a lot more specific about kind of where we are in this transformation and how we see the out-years and where we believe that we can really start to pick up additional market share. But overall, I couldn't be more pleased with the progress of this team." ] }, { "name": "Simeon Gutman", "speech": [ "OK. And a quick follow-up is, I think year-to-date, we've incurred about $1.1 billion of COVID associate benefits and additional costs. How do we think about that into the fourth quarter and into 2021?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, I'll take the first part and see if Dave has any additional context. Dave mentioned that we're committed to fundamental expenses relative to cleaning and providing a safe environment for our associates and customers in our physical stores. And so that is something that we are committed to continuing to execute. We're going to just monitor all other aspects of the needs of our associates and determine what, if any, additional investments need to be made in the fourth quarter.", "We've actually followed that philosophy for the last couple of quarters, and the fourth quarter won't be any different. I don't know if Dave has anything to add." ] }, { "name": "Dave Denton", "speech": [ "Yes. Simeon, this is Dave. The only thing I would add to that is that, obviously, in November, the associates will receive incremental compensation. And then in December, our \"Winning Together\" program kicks into play.", "And just given how the stores are performing, the vast majority if not almost all the stores are at max payout from that. So we're leaning into areas to compensate our associates tied to their needs but also tied to performance." ] }, { "name": "Simeon Gutman", "speech": [ "OK, thanks. Good luck." ] }, { "name": "Operator", "speech": [ "The next question comes from the line of Kate McShane with Goldman Sachs." ] }, { "name": "Kate McShane", "speech": [ "Hi, good morning. Thanks for taking my question. I wondered if I could ask about Pro versus DIY, just if you saw a narrowing of the gap in performance between the two this quarter versus last quarter. And how should we be thinking about the Pro penetration in sales next year once you reset the store and leverage some of the initiatives that you've put in place the last year or two?" ] }, { "name": "Marvin Ellison", "speech": [ "Kate, it's really difficult for us to give you a very specific forecast on that. Obviously, this is the most difficult environment for any kind of a financial forecast. But I think at a high level, we anticipate that you're going to see that gap continue to close and the Pros will start to gain more of a penetration as we start to have less of the nesting effect when we get to this post-COVID environment. One of the reasons we're making all of these investments in the Pro, and as Joe and I both mentioned, I mean we grew the business over 20% in the third quarter, is because we're anticipating this post-COVID retail environment and we know this customer is very important for us.", "So we expect that gap to continue to close as we get into 2021. The question is when and that's going to be, in large part, based on COVID and how the nesting effect of the DIY starts to minimize over time." ] }, { "name": "Dave Denton", "speech": [ "And Kate, this is Dave. I'd just add that if we step back and think about the financial algorithm of this company over the next several years, as we've said many times, we real strength in the DIY customer. You're seeing that in our numbers today. The opportunity over time is to really penetrate and grow our Pro business.", "And I think the investments we're making both in Q3 and Q4, and really as we cycle into next year, is really bolstering our business model around the Pro. And so it's not going to be like a light switch that we're going to just turn on and the Pro is going to just elevate significantly, but this is each week and each month and each quarter kind of continue to push and grind ourselves out to grow that Pro business. And that's the objective we have here." ] }, { "name": "Kate McShane", "speech": [ "OK. And if I could just ask a quick unrelated follow-up, just with the news in the MRO space this week. I just wondered if you could remind us how you're thinking about your competitive positioning within the MRO segment. And does that change this week change anything when you think about supply chain investment for Lowe's?" ] }, { "name": "Marvin Ellison", "speech": [ "Kate, it does not. I made the comment earlier in my prepared comments that we're committed to the core retail business. When we look at our investment thesis and we evaluate where we can gain the greatest return, it is in our core business. Now we're going to continue to target the MRO segment in our current Pro strategy with our outside sales reps, but those reps are connected to the store and connected to our MSH model.", "And we feel like that that model has the ability to scale. But our investment thesis, our focus, is improving our core business. And our core business is defined as our brick-and-mortar stores, our dot-com platform, our supply chain and all the other operational components that tie that together. And that's our omnichannel philosophy.", "We feel like we're in a good position, and we're going to continue to make those investments. And over time, that thesis may change. But in the short term and near term, we're just laser-focused on our core business." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "The next question comes from the line of Scot Ciccarelli with RBC Capital Markets. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning everyone. Another expense-related question. I guess looking for some clarity, just in terms of kind of the way to think about the cadence. So pre-pandemic, the Lowe's story was very heavily centered on productivity improvements, SG&A leverage.", "Obviously, as COVID hit, you've incurred a lot of incremental expenses, COVID assistance for your associates, obviously, extra labor because of sales growth. How should we think about SG&A growth on, let's call it, a per-store basis? Or how are you going to frame it for '21, just in terms of the way we should think about those overall levels?" ] }, { "name": "Dave Denton", "speech": [ "Yes. It's probably a little early to talk specifically about '21. But just in general, I think what you're seeing is we have a very focused effort around store productivity and managing both labor and costs within our stores. Couple that with the investments that we're making in supply chain, which is ultimately creating a market-based delivery model, that will ultimately put pressure a little bit on gross margin as we take delivery out of the stores, move it into the market, but relieve the stores of that burden from an SG&A perspective.", "So you'll see incremental flow-through as that model gets built out. That's probably a 12-, 18-, 24-month process before that happens. But I think we're well on our way to continue to make investments, both from a technology perspective and an operational improvement perspective to drive productivity. So you should see us continue to get better, absent the effect of COVID.", "The one thing that is going to go forward is probably in the neighborhood of $70 million or so per quarter on incremental costs associated with safety and cleanliness. And I think that is here to stay for some period of time." ] }, { "name": "Marvin Ellison", "speech": [ "Scot, I'm going to let Joe McFarland talk a little bit about our productivity initiatives. I mean we're extremely proud of the fact that 18-plus months ago when we did an evaluation of our payroll spend in the stores, roughly 60% of all of our spend was going toward task and noncustomer-facing activity. And Joe has absolutely flipped that equation with the stores. I'm going to let him talk about that for a second." ] }, { "name": "Joe McFarland", "speech": [ "Yes. Thanks, Marvin. Scot, we're -- we've been very pleased with the progress we're making on our 60-40 transition. As I mentioned in my prepared remarks, we're well ahead of that schedule.", "We'll hit the 60% service, 40% task by the end of this year. But that also allows us to continue to make investments in things like our fulfillment teams, the supervisors that we've added to the Pro area of the business and the incremental expense that we incurred there. So we're very pleased with the productivity, and we'll continue on that productivity march." ] }, { "name": "Scot Ciccarelli", "speech": [ "Thanks a lot guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. So as you've gone through this transformation, you mentioned you're ahead of schedule in realizing some of the productivity or cost savings that you expected like the split between task and service, and yet now we're seeing maybe a bit of an acceleration in some of the investments of the business. So are you entering a new phase of this transformation, where some of the low-hanging fruit has already been harvested in terms of the cost, and at the same time, investments are increasing, which could occur at a time where this wallet share shift that is benefiting the home improvement category, all of these come together such that we do see a bit of a retrenchment or some margin degradation in your P&L over the next few quarters?" ] }, { "name": "Marvin Ellison", "speech": [ "Michael, this is Marvin. So as Dave mentioned, we're going to have a little bit more specificity on the December 9th investor update. But here's what I will tell you, we don't believe we're going to get entrenched, and we believe that there's still a large amount of opportunity in front of us to drive productivity. We have a multiyear time line where we've mapped out initiatives from a merchandising perspective, operational perspective, supply chain, etc.", "We see productivity gains over the next couple of years, if we can. Obviously, those initiatives vary in size and scale, but we believe we still have enormous opportunity. And to put it in perspective of your comments, we've made the decision to accelerate this U.S. stores reset initiative because early tests gave us confidence that this would tremendously benefit our Pro customers, and it would create a much more intuitive shopping experience for our DIY customers.", "And so we took on $100 million of expense in the third quarter, and we're taking on roughly $150 million of expense, and that's going to get roughly 90% of our stores completed. That is an example of us not running this business quarter to quarter. We want to make sure that we're making the right investments that will have long-term benefits and create long-term productivity gains. And we believe that we're doing that, and that's going to be our focus.", "And when we update you all in December, we'll provide some perspective on how we see revenue and operational performance, as well as profitability in 2021. But we feel really good about our progress, and we feel good about being in a position now to transition to a market share focus ahead of schedule." ] }, { "name": "Dave Denton", "speech": [ "And Michael, I'll just add that -- Marvin said something very important there, he said we decided to accelerate the program. This was not an incremental program that we didn't have on our road map. This was on our road map consistently over the last couple of years since we've been here. This is -- now we're taking the opportunity to lean into it.", "So I think that the original thesis of all the investments that we put forth, I think are very valid. We see a lot of runway to continue to fund those investments and drive performance going forward." ] }, { "name": "Michael Lasser", "speech": [ "So David, if I could just clarify that and add one unrelated question. Does that mean that some of those pull-forward of investments will come from next year, such that you will get a return on those dollars and you can be in better position to lever your SG&A even in a tougher macro environment? And then my follow-up question is the big change in the cadence of the P&L this quarter was the discussion around lower credit revenue and shrink. How long are those going to be issues that weigh on the gross margin? And what has caused those to pop up suddenly?" ] }, { "name": "Dave Denton", "speech": [ "Michael, just as you think about the investments we are making, yes, we're making these investments to improve our productivity in the years to come. So I won't speak specifically to '21. But yes, the things that we're doing today will benefit us going forward. And then secondly, I'll talk a bit about credit revenue and I'll speak -- have Joe McFarland talk about the actions we've taken from a shrink perspective.", "On the credit revenue side of the house, yes, we're having a little bit of pressure there. And there's really two things that are happening. One is we are seeing a tender shift as the U.S. consumer has kind of pulled back on debt and your saving rate has increased.", "So we've seen a tender shift away from our private-level -- private-label credit a little bit into PIN debit. So that puts pressure on that line. And then secondly, we are forecasting some higher credit risk going forward just given the macro economy in the future. So a little bit of both of those things are driving that pressure.", "And then from a strength perspective, I'll let Marvin and Joe comment on that." ] }, { "name": "Marvin Ellison", "speech": [ "So Michael, I'll hand it to Joe to talk about two things, give a little bit of an explanation on shrink, our trends and some of the initiatives to reduce it; but also to give another example of a pull-forward initiative that we are in the midst of executing. So Joe, you can go ahead and cover those two things." ] }, { "name": "Joe McFarland", "speech": [ "All right. Thanks, Marvin. So as far as the investments, I'll give you a quick example, discussed rolling out of the buy online pickup in store dedicated lockers. And so this was originally on the road map.", "This was approximately $30 million pull in expense to this year that we had from last year. This will allow us to continue to leverage our payroll expense and continue to drive our omni business. In addition, we have the new dedicated fulfillment team. So we feel very good about the investments we continue to make in the business.", "In regards to shrink, we have been experiencing shrink pressures over the last several quarters. We have a good sense of where that lies. We understand the challenges. We have been making significant investments from a loss prevention standpoint, from a safety standpoint.", "And so we feel good about the trajectory. There were some challenges with being an essential retailer, being some of the only retailers open during the onset of the pandemic. I believe we're cycling some of that today. But again, as we continue to invest in market-level intelligence, in loss prevention and safety programs, we're confident in the payback." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much and have a nice holiday." ] }, { "name": "Operator", "speech": [ "Our next question come from the line of Chris Horvers with JP Morgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning guys. I'm surprised we've gotten this far into the call without the quarter to -- obligatory quarter-to-date question. I'll phrase it a little bit differently.", "You talked about seasonal mix being a driver of why you're expecting 15 to 20% comps in the fourth quarter. You did post the 30% in October. Are you just simply mix adjusting for seasonal mix and that drives you into the 15 or 20 -- 15 and 20%? Or are you assuming moderation in other categories?" ] }, { "name": "Marvin Ellison", "speech": [ "So look, I'll take this, Chris, and I'll let either Bill or Dave jump in if they have additional comments. To say this is the most difficult environment to forecast in would be an understatement. What I can tell you is we feel great about our early trends in November. We feel very good about our ability to meet demand if it exceeds our 15 to 20% guidance.", "We'll have a much better perspective on Q4 when we speak to you and the other investors on December 9th. But this is just our way of trying to frame up our best guess of where we think the business is headed in obviously the most difficult and complex forecasting environment that any of us have worked in. And again, I'll leave it at that. And if we have more context and more detail on December 9th, we'll be more than happy to share.", "But the key is we feel really good about the trajectory of our business, but this is our best estimate based on what we know today." ] }, { "name": "Chris Horvers", "speech": [ "Understood. And then a question on, I guess, the medium- to long-term gross margin outlook. Previously, you had talked about mid- to high-32% range in the existed sort of -- existing sort of algorithm and so forth. Does '21 revert back down to this prior target? And if so, what are the drivers? Because year-to-date, you're performing very nicely in that regard.", "And so is it supply chain investments that causes some near-term pressures? Is it mix? Some promotional normalization? And then longer term, how do you think about the opportunity to get into that 33 to 34% range given your largest peer does have a higher gross margin? Understood there's probably some efficiencies given scale, but at the same time, just trying to think about structurally the differences given all the work that you're doing in the box and around the supply chain." ] }, { "name": "Dave Denton", "speech": [ "No. We feel very strongly that the opportunity is ahead of us from a gross margin perspective. We're not going to give this back specifically. I will say there is some, I'll say, geographies on the P&L.", "We continue to push very hard in improving what I would consider our product-level gross margin performance. And part of this is just being very efficient from a promotional standpoint, being very efficient from a cost management perspective. At the same time, we are investing in supply chain, and that's going to put pressure on gross margin, but it's going to relieve operating expense within our stores. The flow-through of that is very accretive to op inc.", "So I think you'll see some geography shifts there, but there's nothing that's going to revert back. It's not our anticipation that we would revert back to where we were prior to this year." ] }, { "name": "Chris Horvers", "speech": [ "Understood, thank you. Best of luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your questions." ] }, { "name": "Seth Sigman", "speech": [ "Thanks, morning everybody. Thanks for taking the question. Nice quarter. I think investors are trying to understand the magnitude and sort of the net impact from the investments you're talking about and the pull-forward.", "So the question is, and I know it's been asked a couple of different ways today, but if comps are positive and you can sort of manage through next year from a top line perspective, can you continue to expand margin rate in FY '21?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, Seth, we're not commenting in detail on 2021 at that -- at this time. As we've mentioned a couple -- on a couple of different occasions, we're going to be updating you all on December 9, and we're going to have a little bit of perspective. And we're going to spend the majority of that presentation talking about the initiatives and actions we're going to be implementing to improve and take market share. And at that time, we'll have better perspective on '21, and we'll be able to provide a lot more context on what we're doing today." ] }, { "name": "Dave Denton", "speech": [ "And Seth, I'll just add, let's not get hung up on where we end '20 and where we end '21. The reality here is we set a target of 12% operating income flow-through. I think we're very focused on delivering upon that objective. I think we have very good line of sight to getting to that level and using that as just a stopping point to actually potentially go further after that.", "So I think our -- the investments that we're making, the focus that we have today is really on improving that flow-through over time. And we still see a very strong line of sight to that." ] }, { "name": "Marvin Ellison", "speech": [ "And Seth, this is Marvin again. The only other comment I'll make is, we were actually questioned earlier about the MRO space and if we are going to make any strategic changes based on actions in the marketplace. And one of the reasons why we're not is because we see so much upside in our core business. And we see an incredible opportunity to drive efficiency and productivity by continuing to make the right investments in merchandising systems, supply chain, operations.", "And so to Dave's point, we see the 12% not as a pinnacle but as a milestone that we will hit, and then we will continue to drive improved productivity beyond that point. And again, we'll be able to provide more context at our investor update in December." ] }, { "name": "Seth Sigman", "speech": [ "Got it." ] }, { "name": "Dave Denton", "speech": [ "And we're going to take one more question, please." ] }, { "name": "Operator", "speech": [ "The next question is from the line of Elizabeth Suzuki from Bank of America." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Thank you. I was a little surprised to hear that the product mix was favorable to gross margin, just given that lumber sales growth was so strong and it's usually a lower-margin category. Can you talk about the categories that helped out from a product mix standpoint in the quarter?" ] }, { "name": "Dave Denton", "speech": [ "Yes. Liz, this is Dave. Actually, lumber did put some pressure on gross margin in the quarter as it typically does in an inflationary environment. Having said that, I'd say the merchandising and the finance team have done a really nice job from managing costs kind of across all the categories.", "And I'd say I can't call out just one category where we're seeing improvements because we're seeing improvements more or less up and down the P&L across all merchandising categories for the most part." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great, thank you." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2019-02-27	[ { "description": "-President and Chief Executive Officer -- President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "-Executive Vice President, Merchandising -- Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "-Executive Vice President, Stores -- Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "-Chief Financial Officer -- Chief Financial Officer", "name": "Dave Denton", "position": "Executive" }, { "description": "-J.P. Morgan -- Analyst -- J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "-Morgan Stanley -- Analyst -- Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "-UBS -- Analyst -- UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "-Oppenheimer and Company -- Analyst -- Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "-RBC Capital Markets -- Analyst -- RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "-Guggenheim Securities -- Analyst -- Guggenheim Securities -- Analyst", "name": "Steve Forbes", "position": "Analyst" }, { "description": "-Cleveland Research -- Analyst -- Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": "-Robert W. Baird and Company -- Analyst -- Robert W. Baird and Company -- Analyst", "name": "Peter Benedict", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies fourth-quarter 2018 earnings conference call. This call is being recorded. [Operator instructions] Also, supplemental reference slides are available on Lowe's investor relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call.", "During this call, management will be using certain non-GAAP financial measures. The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks, and the company can give no assurance that they will prove to be correct.", "Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission. Hosting today's conference will be Mr. Marvin Ellison, president and chief executive officer; Mr. Bill Boltz, executive vice president, merchandising; Mr.", "Joe McFarland, executive vice president, stores; and Mr. Dave Denton, chief financial officer. I will now turn the program over to Mr. Ellison for opening remarks.", "Please go ahead, sir." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Regina. Good morning, everyone. Overall, we are pleased with the progress we're making in our business and most of the intense work over the past six months to transform our company has been in preparation for an improved spring season and fiscal 2019. Therefore, we're encouraged by the customers' response to our assortment and service changes in Q4 and with the results we're seeing in early spring categories.", "This progress was evident in the improvement we saw in the paint category in the fourth quarter. As a reminder, for the past 10 consecutive quarters, paint has delivered comps below the company average. Our intense focus on retail fundamentals in this ever -- area while leveraging our exclusive partnership with Sherwin Williams, allowed us to exceed our expectations in paint during the fourth quarter and transition this business to comp above the company average. While paint is only one category, it is the first area of the business where we implemented our retail fundamentals framework of improved staffing and in-stocks while remediating issues from previous resets.", "We believe this renewed focus on retail fundamentals across multiple categories will pay dividends for our entire business in 2019. Now allow me to take a few moments to update you on our quarterly results and provide you with thoughts on fiscal 2019. For the fourth quarter, we delivered comparable sales growth of 1.7% and our U.S. comps improved by 2.4%, delivering a positive 5.8 comp in January.", "We're also very pleased with the comp progression, which we believe further reinforces that our retail fundamental focus was in place and doing well in the quarter. In the U.S., we delivered comps in 11 of 14 geographic regions. And our Tampa, Houston markets faced tough comparisons from Hurricane Irma and Harvey. The U.S.", "we delivered comps -- positive comps in eight of 11 product categories and great offers in tools and hardware to deliver a comp above the average supported by strong customer response in Craftsman products, which gained market share across every category. In addition to paint, we also achieved above-average comp performance in lawn and garden, appliances and lumber and building materials. We delivered online comp growth of 11% for the quarter. And while traffic to our website was strong, we were unable to fully capitalize on the traffic due to system challenges, such as the outages we experienced on black Friday weekend.", "These challenges are a reminder of the upside opportunity we have in our online business. However, coming out of the holiday season, it was obvious that we needed to redirect our online strategy and our focus. Therefore, in January, we made a leadership change hiring Mike Amend as our new president of online business. Mike is someone with extensive knowledge and expertise in the home improvement omnichannel space, and we're confident that Mike will work with our new chief information officer, Seemantini, to lead an aggressive transformation of Lowes.com in 2019.", "In Canada, we posted negative comp sales for the quarter as a weaker Canadian holiday market, combined with ongoing integration of Rona, exerted pressure on the business. We also recorded a $952 million noncash pre-tax goodwill impairment charge associated with our Canadian operations. We anticipate weakness in the Canadian housing market, which is exerting pressure on our outlook for that business over the near term. However, we remain confident in our market position in Canada and of the long-term potential of this business.", "We reported diluted loss per share of $1.03 for the quarter, but our adjusted diluted earnings per share were $0.80, an increase of 8.1% for the same period a year ago. Now as we transition in 2019, we remain true to our mission of delivering unrivaled improvement products with the best service and value across every channel and community that we serve. And we'll achieve this mission by winning in four key areas: driving merchandising excellence, transforming our supply chain, delivering operational efficiency and intensifying customer engagement. Note that our strategic focus hasn't changed, but we've modified the tie of our second focus area since our analyst investor conference from omnichannel to supply chain transformation.", "This better describes the initiatives beneath it, including fulfillment and delivery optimization. In fact, all four key areas deliver a better omnichannel experience for our customers. Now allow me to take a few moments to discuss 2019 in more detail. The U.S.", "home improvement industry should continue to benefit from several factors, including income growth, lower federal tax rate, gains on household formation and continued home price appreciation. This growth is further supported by an aging housing stock. As home prices are increasing, consumers are staying in their homes longer and because of their improved financial position, they are investing in their homes. All of these factors drive investments in home improvement projects.", "To capitalize on this supportive microenvironment, we will continue to improve our execution and focus on retail fundamentals. And to be transparent, we are an executive team with high expectations and we visit stores on a weekly basis. We're still seeing pockets of inconsistent execution. However, through the inconsistency, we're beginning to see improvements in key areas.", "So let me take a moment to share with you five areas where we were pleased to see signs of progress in our business. First, we're delivering better customer service. Customer satisfaction scores have improved for both DIY and pro customers. Second, our merchandise service teams, or MST, pilots showed positive results.", "Third, we're seeing improvement in performance versus expectations in key categories. In addition to the improvement we saw in paint, we're also leveraging our improved reset process to better position us for the spring selling season. Fourth, we continue to see strong customer response to Craftsman, with market share gains in each Craftsman category since introducing the brand. We're also very excited about the product launch of Craftsman outdoor power equipment this spring.", "And fifth, we're seeing positive results in our pro business, driven in part from our investment in job lot quantities. Although things are far from perfect and we still have work to do to transform the company, these five areas of progress give us confidence in our business outlook for 2019. They also demonstrate that we are focused on the right initiatives to achieve our long-term targets. Before I close, I'd like to thank our over 300,000 associates for embracing change and for their renewed competitive spirit and for their commitment to our most important initiative: serving the customer.", "With that, let me turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. We see a great opportunity ahead of us to capture more share in the home improvement market with a strong retail brand, great products, a compelling new marketing campaign and impactful new partnerships, all of which will drive customers to our stores and our website. We are very excited about our new partnership as the official home improvement retail sponsor of the National Football League. This exclusive multiyear sponsorship grants Lowe's the ability to market on a national and local level throughout the year, which will allow us to deepen our relationships with both the pro and our DIY customers.", "We are also working to deliver an outstanding customer experience in our stores and on our website. Today, Joe McFarland and I will provide you with an update on our progress. As Marvin indicated, we are in the early stages of change. And while there are still pockets of inconsistency in our system, transformative action is under way, and we are beginning to see signs of improvement.", "For example, we are seeing positive signs from our merchandising service team, or MST pilot. These teams are funded by our vendors, and they add an average of eight full-time employees per store. These teams are responsible for the day-to-day maintenance of the bay presentations in our stores, responsible for setting and maintaining end caps and helping execute off-shelf displays. The MST teams are critical to improving our execution at store level as they take these consuming tasks off the shoulders of our red vest associates so that they can be freed up to serve customers.", "Early results of our MST pilot show reduction in out of stocks, improved sales productivity and an increase in bays serviced per hour. We expect to complete the staffing of our MST teams and roll the program out nationwide in the first quarter of 2019. As we have discussed before, the pro customer will be a key focus for us in 2019. This is why, as Marvin mentioned, we took steps in the fourth quarter to improve our inventory position for the pro by investing in job lot quantities, an area that has historically been underfunded.", "We must ensure that we have inventory depth at the store level to meet the pro customer needs and enable the presentation impact on our top-selling items. In the fourth quarter, we piloted job lot quantities for select SKUs in select test markets, and we saw an increase in both pro comps and pro sales penetration. Following this successful pilot, we are now expanding our investment in job lot quantities, and we are rolling out nationwide in the first quarter. We are also leveraging our improved reset process to better position us for the spring selling season.", "We are transitioning into the season more efficiently, and we are setting our stores earlier, all of this to ensure that we have sufficient, seasonal inventory on hand and that we are positioned to capture the spring demand when the season breaks. We are pleased with early results in the south and deep south, where we are seeing strong comps in our seasonal and lawn and garden categories. Another area of excitement for spring is the continued rollout of Craftsman. Our data shows us that approximately 60% of customer -- Craftsman customers were not previously a Lowe's customer.", "So from tools to outdoor power equipment, from the garage to the garden, Craftsman is a traffic-driving, loyalty-building opportunity for us. And we are very proud to be the exclusive destination in the home center channel for this iconic brand. We have gained market share in each Craftsman category since introducing the brand, and we are excited to add Craftsman outdoor power equipment as part of our spring offering. Throughout this spring, we will also continue the roll out of mechanics' tools, hand tools, power tools and tool storage across the chain.", "In addition, for the first time this spring, Lowe's will have the top three brands in riding equipment, the John Deere, Husqvarna and Craftsman. In addition to our assortment in outdoor power equipment, we expect to drive sales this spring with compelling events like spring black Friday; exciting product offerings such as the extension of our Monrovia plant program, a home center exclusive in lawn and garden; and expanded offerings from Weber and Char-Broil, the top two brands in outdoor grilling. In fact, earlier this month at our store managers' meeting, the merchants led every store manager in the company through a product walk, displaying for them all of the new and innovative products that they could expect to see for the upcoming season. This event was well received and has built an increased excitement for the spring season.", "In the first quarter, we will also drive merchandising productivity through the rollout of our field merchandising teams. These teams will focus on meeting the needs of the customers at market level, delivering localized and relevant product assortments, helping to drive customer engagement and improving sales per square foot and inventory productivity in our stores. We will also dramatically increase our online assortment in 2019 as we work to shift slower-moving SKUs out of our stores and onto our website to improve inventory turn. We are excited about the opportunities that are ahead of us, and we're working very hard to position Lowe's for the future and to capitalize on the strong demand in a healthy sector.", "Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Bill, and good morning, everyone. I'd like to discuss the steps we are taking to improve customer service, in-stock and better optimize our labor spend. The first step to improve customer service is to streamline communication and tasks at the store level. Therefore, in the fourth quarter, we moved to a simplified weekly playbook that focuses the teams on top priorities, key metrics and critical deliverables.", "Since then, we've seen a significant increase in on-time task completion in the stores as our associates are now more focused on activities that drive sales and improve customer service. In addition, we instituted a regular pack-down process within our stores to ensure that we're consistently filling our shelves with the product we already have. Since that launch, we've seen in-stocks improve by 15% -- to assist with our supply chain replenishment algorithms and keeping pace with sales demand, we gave our store managers limited autonomy to reorder appropriate quantities of low-risk, high-velocity SKUs to improve in-stocks on key items. To improve our focus on customer service, we eliminated sales forecasting activities during the busiest hours of the day so our associates can focus solely on selling and providing excellent service.", "As a result, we've seen an increase in sales productivity and customer satisfaction scores. In the first quarter, we'll improve associate engagement by rolling out the smart model, a new customer service model, which will guide the way we hire, train, evaluate and coach associates. This program models what a great experience actually looks like and drives behaviors that deliver the kind of experience that customers want. The Smart program is a comprehensive toolkit, including a training program and mobile devices, which are designed to provide our associates with the tools they need to deliver outstanding customer service.", "In the first quarter, we will train all associates in the company on smart customer service, and we'll complement this training by rolling out smart mobile devices to our stores. No longer will associates be required to leave the sales floor to log into a terminal to determine the price, rate of sales, on-hand quantities or order status of an item. The new smart device will provide associates with real-time data at their fingertips without ever stepping off the sales floor or losing engagement with the customer. Also, in order to improve staffing and better leverage our payroll spend, in the first half, we'll roll out our new labor scheduling system.", "This system will better predict customer demand by time of day, day of week and department, allowing us to align our labor hours with peak traffic, providing better department coverage and customer service while also ensuring that we're using our labor hours efficiently and reducing payroll expense. This new system will replace the current staffing system that doesn't effectively capture and predict sales and customer traffic patterns. To further improve the customer experience, in the first quarter, we are replacing a series of non-customer-facing positions with over 600 assistant store managers and over 5,000 department supervisors. These customer-facing department supervisor roles will focus on providing better departmental coverage and expertise, as well as coaching our associates and delivering excellent service.", "One of these supervisors will be dedicated to the pro department. To improve the pro customer experience, we're also reallocating resources to add dedicated loaders so that the pro customer can consistently rely on us to help them load the bulky product they need. These new resources in pro will allow us to take full advantage of the job lot quantity investment that Marvin and Bill mentioned earlier and build out the momentum created in January when pro comps were high single digit. Though we're in the beginning stage of some change, we're excited by the early results we are seeing and committed to the work ahead to fully capitalize on the healthy demand in our sector.", "Thank you. And I will now turn the call over to Dave." ] }, { "name": "Dave Denton", "speech": [ "Thanks, Joe, and good morning, everyone. Let me begin this morning with a few housekeeping notes and review of the major charges that we incurred during the quarter. First, as a reminder, in the first quarter of fiscal 2018, we adopted the new revenue recognition accounting standard. The primary impact was the reclassification of the profit-sharing income associated with our proprietary credit program from SG&A to sales.", "The adoption of this program had no meaningful impact on operating income and no impact on comparable sales. Secondly, this quarter, we changed our accounting policy for shipping and handling costs. Costs related to the delivery of products from the company to the customers are now included in cost of sales versus SG&A and D&A. This reclassification resulted in a decrease in gross margin of $289 million in the fourth quarter, and prior periods have been restated.", "Again, this accounting policy change had no impact on operating income. Third, as described in the press release and consistent with our plan to reposition Lowe's for long-term success, we incurred $625 million of pre-tax charges related to our strategic reassessment. And finally, during Q4, we recorded a $952 million noncash pre-tax goodwill impairment charge associated with our Canadian operation. Given the softening outlook for the Canadian housing market, we determined that the book value of this business exceeded its fair value.", "This writedown essentially eliminates all goodwill associated with our Canadian operations. I'll now turn to review of our operating performance, starting with our capital allocation program. In fiscal 2018, we generated over $5 billion in free cash flow. And through a combination of both dividends and share repurchases, we returned nearly 90% of this cash to our shareholders.", "In the fourth quarter alone, we paid $387 million in dividends, and our dividend payout ratio currently stands at 35%. In November of this year, we entered into a $270 million accelerated share repurchase agreement, retiring approximately 2.9 million shares. We also repurchased approximately 2.8 million shares for $259 through the open market. So in total, we repurchased $529 million of our stock at an average price of $92.25.", "We have approximately $14 billion remaining on our share repurchase authorization. And importantly, we continue to invest in our core business, with capital expenditures of approximately $328 million in the fourth quarter and nearly $1.2 billion for the year. Now looking at the income statement. We generated a diluted loss per share of $1.03, compared to diluted earnings per share of $0.67 in the fourth quarter of LY.", "On a comparable basis, excluding the $1.6 billion in pre-tax charges we recognized in the fourth quarter, adjusted diluted earnings per share was $0.80, an 8.1% increase over last year's adjusted diluted earnings per share. Despite slightly softer sales in the quarter due to the weaker Canadian macroeconomic environment, the $0.80 of adjusted diluted earnings per share was in line with our expectations as we effectively managed expenses and drove store payroll leverage. Sales for the fourth quarter increased 1% to $15.6 billion, supported by total average ticket growth of 4.6% to $76.96, partially offset by 3.6% decline in total transactions. Comp sales were 1.7%, driven by an average ticket increase of 2.3%, partially offset by a transaction decline of 0.6%.", "Our U.S. home improvement comp was 2.4% for Q4. While comp transactions declined for the quarter, we drove sequential improvements throughout the quarter, with comp transactions down 2.1% in November, down 0.8% in December and positive 1.6% in January. During the quarter, the net effect of cycling the hurricane season was an approximate 80 basis point drag on comp sales.", "Headwinds from Hurricanes Harvey and Irma were partially offset by demand from Florence and Michael. Now looking at monthly trends. Total comps were 0.3% in November, 0.8% in December and 4.8% in January. Additionally, monthly comps for our U.S.", "home improvement business were 0.9% in November, 1.4% in December and 5.8% in January. Now my comments from this point forward will be on comparable non-GAAP basis. Adjusted gross margin for the fourth quarter was 31.5% of sales, a decrease of 56 basis points from Q4 of last year. The adoption of the new revenue recognition standard provided a 110 basis point benefit to gross margin.", "We experienced 55 basis points of pressure from substitute items that were offered over Black Friday weekend due to inventory shortages on advertised SKUs, as well as an accelerated clearance activity for holiday inventory in order to better position us for the spring selling season. We are raising the bar on serving our customers. Therefore, these two actions were necessary to mitigate inefficient planning leading into the holiday season. We also experienced 45 basis points of pressure from supply chain costs as we added new facilities to the network that are still ramping up to full capacity, coupled with ongoing increases in transportation cost and increases in customer deliveries.", "Tariffs exerted 25 basis points of pressure on gross margin, and other product costs increases exerted 15 basis points of additional pressure. We are working diligently to mitigate the pressure from tariffs through our portfolio approach. We are acting with caution and deep analytical rigor given the unprecedented size and scale of potential changes to allow us to measure the unit impact before proceeding. And finally, product mix shift had a 25 basis point negative impact on gross margins for the quarter.", "Adjusted SG&A for Q4 was 23% of sales, which delivered 77 basis points. Adoption, again, of the new revenue recognition standard resulted in 108 basis points of SG&A deleverage. This was partially offset by leverage from operational expense management. Adjusted operating income decreased 106 basis points to 6.4% of sales.", "The adjusted effective tax rate was 24.3%, compared to 31 point -- 39.1% of LY -- versus LY. The significant improvement is largely the result of the tax reform. $12.6 billion inventory increased $1.2 billion or 10.3% versus the fourth quarter of LY. This is largely driven by earlier spring buys, the anticipation of additional Craftsman resets and our investments in job lot quantities.", "These are important strategic investments to drive sales performance in the coming months. Looking ahead, I'd like to discuss our 2019 business outlook, which remains essentially unchanged from what we shared at our end of December analyst and investor conference. I'm providing the outlook today on an adjusted basis versus 2018. However, we have also provided a schedule on our investor relations website that takes this one step further and rebaselines 2018 by quarter, removing all operational impacts associated with our strategic reassessment.", "Also, as disclosed in our press release, for fiscal 2019, we will adopt a new lease accounting standard using a prospective transition approach. We estimate adoption of this standard will result in an increase in lease-related assets of between 3.2 and $3.6 billion, and an increase in lease-related liabilities of three and a half to $3.9 billion. The difference between the increases in total assets and liabilities will be recorded as an adjustment to beginning retained earnings in fiscal 2019. The standard will have no impact on our debt covenant compliance under our current agreements.", "In 2019, we expect a total sales increase of approximately 2% for the year, driven by a comp sales increase of approximately 3%. We expect adjusted operating margin increase of 85 to 95 basis points. The primary driver of operating margin expansion beyond sales growth is expected to come from SG&A deleverage. Store labor productivity, as well as reductions in advertising costs for more effective and targeted marketing programs will be the major contributors.", "The effective tax rate is expected to be approximately 24%, and we expect adjusted diluted earnings per share of $6 to $6.10 a share. We are forecasting cash flows from operations of approximately $6.5 billion and capital expenditures of approximately $1.6 billion. This leads to expected result in free cash flow of approximately $4.9 billion for 2019. And our guidance assumes approximately 6 to $7.5 billion in share repurchases for the year.", "We remain extremely excited about the future of our business and are focused on taking the necessary actions to drive returns and long-term shareholder value. So with that, operator, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question comes from the line of Christopher Horvers with JP Morgan." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, guys. Can you talk about the improvement in January? Obviously, you called that out in the press release and on the call. It's a small month.", "So was curious, have you seen in particular categories? Was it driven by particular regions? How did it look in DIY and pro? And was there any of the clearance activity that you saw pressure gross margin provided a benefit to the January comp?" ] }, { "name": "Marvin Ellison", "speech": [ "Chris, this is Marvin. Overall, we saw improvement in both pro and DIY. And really, the sequential comp improvement was driven by quite a few factors. First, we saw transaction growth in pro and DIY.", "And I think David's comments on the progression of transactions throughout the quarter reflected that. We also saw significant comp improvement in the pro business. We think that is based on the investments in job lot quantity, the supervision and staffing improvements, basic things like loading and just the broader service operation that we put in place. We also feel very good about the early set to spring.", "I think Bill mentioned it in his comments, and so did I, where we actually had stores this time last year that in the seasonal area, they were still managing through clearance holiday product. And so, the simple fact that we were able to get what would be relevant spring product in some of these warmer weather markets paid a big dividend. In addition to that, we talked about the Craftsman response by the customer was also important. I'll let Bill add any additional color, but the good news for us is it was widespread.", "It was not either DIY or pro. It was both. It was transaction-driven. It was driven across multiple categories, and the pro business improvement also drove the kind of correlated improvement in building materials and tools and categories like that.", "Bill, anything you want to add to that?" ] }, { "name": "Bill Boltz", "speech": [ "You hit on most of it, I think the comments that were made in your earlier response around paint was another one where we saw the improvement there, both for DIY and for the pro. In addition to the Deep South and the South, as I said in my prepared remarks, where just by setting these stores earlier and getting ready for spring earlier, we saw payback come from that. So we're encouraged by the early signs in that." ] }, { "name": "Marvin Ellison", "speech": [ "And Chris, the only caveat I'll provide is we're not declaring victory. We have a lot of work to do. There's still areas of the business that I mentioned that we are still seeing pockets of inconsistency. But we believe that the whole retail fundamentals focus that we all talk about is paying dividends the longer we are able to embed it in our merchandising philosophy and our operational processes.", "And that's why we believe we sequentially improved throughout the entire Q4 period." ] }, { "name": "Christopher Horvers", "speech": [ "And then as a follow-up, Dave, as you look forward, can you talk a little bit about the cadence around the quarters or the halves? Anything on the comp and the margin structure? And as you look forward, do you think the inventory's clean such that, and the stores are close, so do you think that the gross margin pressures from clearance are behind us and the accounting charges as well?" ] }, { "name": "Dave Denton", "speech": [ "Yes. So maybe keep that -- a couple of questions in there. First, from a comp perspective, as I think about 2019 as it's shaping up, I would think about that as somewhat balanced first half and second half, maybe with a slight bias a bit to the back half of the year. The first half, I think we're very nicely positioned for seasonal.", "And I think the season will drive our performance a bit in the first half as we implement our initiatives. The second half driven more specifically related to our initiatives beginning to take hold or beginning to see some progress financially from those programs. And so, I think that's the way to think about as the year shapes up. I do think, largely, our inventory liquidation work is behind us.", "As a retailer, we are always in this business. We always look at nonproductive inventory, so we will continue to focus on that. But we don't see any major program from that perspective going forward." ] }, { "name": "Christopher Horvers", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Simeon Gutman with Morgan Stanley." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, good morning. My first question is on 2019 guidance. I think it was mentioned that the guidance is essentially unchanged. Can you just help us bridge -- I think at the investor day, it was 30 basis points of pro forma adjusted margin improvement.", "Can you bridge that versus the guide and maybe the base that you're guiding off of today. Is that effectively unchanged?" ] }, { "name": "Dave Denton", "speech": [ "Yes. So think about this in two ways. One, when we gave guidance at our analyst and investor conference, we baselined it off of a rebaseline assuming a midpoint of our Q4 guidance range. Now that Q4 is done, we kind of came in closer to the high end of that guidance range.", "So we're -- so that's really the major change. Secondly, when I provided our guidance, during my prepared remarks, I reference back to our adjusted 2018 numbers not our rebaseline numbers. So if you step back and you do the compare to rebaseline numbers versus our adjusted, that would bridge that gap. So our -- essentially, our 2019 outlook has not changed as we sit here today." ] }, { "name": "Simeon Gutman", "speech": [ "OK. And my follow-up is on the Q4 gross margin. You mentioned the drivers. Can you remind us or can you share with us how much of it was unexpected versus your plan? And then if you look at the entire margin expansion guidance for 2019, that 30 basis points or so or the adjusted one that you're talking about, if you end up doing better than that, besides sales, which I would think is the more obvious lever, is there an opportunity to beat on margin? And I'm just trying to gauge the sensitivity within each of these lines, whether it's gross margin or SG&A and determine if there is high degree of any or not." ] }, { "name": "Dave Denton", "speech": [ "So I guess, I'll take the first piece, as what was somewhat unexpected in gross margin as we cycled into Q4. I don't think we fully anticipated the impact of both the substitute items on Black Friday and the requirements to do that, although it's the right thing to do from a customer perspective. And then secondly, we made, during the quarter, a proactive change to our plan to liquidate seasonal more aggressively and earlier to get ourselves better positioned from a spring perspective, we cycled into 2019. So those were probably not completely expected, but we actively manage that from our standpoint." ] }, { "name": "Marvin Ellison", "speech": [ "Simeon, this is Marvin. So the broader comment that I will make is we put a very new merchant team in place. And Bill Boltz didn't really get in the seat until basically mid-August. And so, as you know, planning for spring is well under way prior to that time frame.", "So it was a real accelerated process to understand where we were entering spring set dates and the like. And to David's point, you know, there is a traditional process that I'm accustomed to and Joe and Bill accustomed to heading into the holiday period with big ad items, that is to go through the ads and make sure that you have a degree of in-stock. And what we found out is that we didn't. And that was a traditional problem that we've had here at Lowe's.", "And so, rather than to disappoint customers, again, we decided to take the aggressive approach that we're going to substitute it, knowing that it would have margin impact. But as David stated, it's the right thing for the customer. In addition to that, as I mentioned, it was not uncommon going into week three, four and five for Lowe's to be still managing through holiday markdowns in lieu of driving spring categories. And so, obviously, we decided to take advantage of our Merchandise Service Teams and to reset these areas.", "And we're pleased with what we're seeing in areas where the sun is actually coming out. And those things exerted pressure. Bill and his team have good plans in place. We have a lot of new leaders running big businesses.", "And we think the guidance that Dave outlined for margin is something that we'll be able to deliver upon." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Michael Lasser with UBS." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my questions. Can you give us a sense for how your promotional posture is going to be in 2019? It seems like this clearance activity is taking a little bit longer than what you expected and is not only that going to extend into the upcoming year but will you also be more aggressive to reengage customers with your store?" ] }, { "name": "Marvin Ellison", "speech": [ "Michael, we don't see any material changes to our promotional cadence in '19 versus the prior years. We think we have a great brand. We're excited about products that we're bringing to market. And we think that that's going to allow us to get the traffic and do a much better job of converting that traffic." ] }, { "name": "Michael Lasser", "speech": [ "OK. Then I want to follow up on the outlook for 2019 because you did embed income tax rate that's 100 basis points below what you had previously expected. So what prompted that change? And how did that flow through the rest of the model?" ] }, { "name": "Dave Denton", "speech": [ "Yes. Clearly, we are constantly looking at our income tax status. And I think we should -- we're just continuing to tweak that as we look at our expectations for 2019. So nothing dramatic there." ] }, { "name": "Michael Lasser", "speech": [ "OK. Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Brian Nagel with Oppenheimer." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning. Thank you for taking my question. Nice quarter. First question I have, Marvin, you discussed a lot of what's happened in the stores and obviously, some initial positive results.", "How should we think about, with all -- with what you're doing in the stores, initiatives in the stores, how far into this process are you? And then also, is there a way to look at, particularly with the sales acceleration, comp sales acceleration through fiscal Q4, is there a way with that data to sort of say isolate areas where you have touched versus areas you haven't so we could see evidence of the progress you're making in the stores with some of the initiatives?" ] }, { "name": "Marvin Ellison", "speech": [ "No. That's a good question. I would say putting a measuring stick to how far we are. We still have a lot of work to do.", "I mean, if you took a poll in this room with me, Joe and Bill who spent quite a bit of our life in home improvement, we would tell you that we're going to be a lot better this spring, but we're not going to be nearly as good as we would like to be, just because we all really started with Lowe's late in the summer, and it just didn't give us the proper time to make the necessary adjustments to the categories we wanted to impact, the buys we'd like to make and the supplier relationships that we would like to formulate. Having said that, we're very proud of the work of the teams. And we're very proud of the change management acceptance that we've seen in stores, on the merchandising side and the supply chain, really across the whole organization. But we have a ways to go to be the great company that we know we can be.", "And as we think about the business we've touched, I'm going to let Bill provide a little more specifics. But I highlighted paint, and we highlighted paint because one of the first areas that were obvious, from a retail fundamental standpoint that was not working, was the paint department. We had poor staffing. We were totally out-of-stock.", "We had no accessories. We have no philosophy on attachment selling. And we were not leveraging this great supplier partner in Sherwin-Williams that we felt that we could. And so, we immediately addressed that, and we feel great about the progress that we're making.", "And we felt like that the progress was more of a microcosm of kind of what could be for other categories that we're now touching. But I'll let Bill talk about some of the other categories that we're going to be focused on going about this year trying to get the same level of improvement." ] }, { "name": "Bill Boltz", "speech": [ "Yes. So I think a couple of things. First of all, just to kind of finish the comment around paint, there's a number of things that are happening even though we're in the early stages, we've, between Joe and myself, we've worked on staffing, right? We made a lot of changes in our paint department last year, but we never addressed the staffing model. So now the staffing model is being addressed.", "We've addressed supervision for the paint department. We took an in-stock focus. So between Don Frieson's team, the store team and my team, we took a look at what's needed for the pro and for the DIY. And that includes job lot quantities in products like five-gallon paint.", "Training, we put a whole new paint department in front of our customer last year. We didn't do any training, so now we're going through training all of our associates. We're leveraging a relationship, as Marvin touched on, with Sherwin-Williams. These guys know the pro business better than anybody else.", "And so, as our partner, how do we leverage that relationship in order to make sure that collectively, we're addressing that pro painter in the way that we need to. From a marketing perspective, we've got a whole new marketing campaign coming out this spring. We're very excited about that and the work that the team's done, in addition to pricing and loyalty programs that we're testing to be able to put out there for the pro painter. And then as I touched on already in the seasonal categories, the work that we're quickly able to do at the latter part of last year between the store team, the supply chain team and the merchant teams look at spring, to look at load ins, to look at the prep needed in order to be ready for spring when the season breaks, was all efforts that we had to quickly get behind in order to make that happen.", "So again, early stages. But as I said, we're seeing pockets of where it's working. And so, that gives us little bit of encouragement in regards to the stuff that we're focused on as working. Yet, as Marvin said, we've got areas inside the store that are a longer putt for us.", "We've got to get out -- further out on and we'll see some of those improvements coming to us in the back half of this year because it's going to take longer for us to get cleaned up and to get addressed." ] }, { "name": "Joe McFarland", "speech": [ "Brian, one other thing, as you think about the -- where we're at from this recovery we've been talking about, new department supervisors in place that just happening in January. I talked about the smart training that rolls out in Q1, the mobile devices rolling out in Q1. We're early stages in pro job lot quantities. So we feel good about where we're at today and feel really good about the plans we have moving forward." ] }, { "name": "Brian Nagel", "speech": [ "That's helpful. Just may be a real quick follow-up. You obviously called out January in the 5.8% comp there. Any commentary on how the business has tracked here in February?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, I think the simple answer would be minus obvious weather challenges, we're pleased with what we're seeing. I mean, February is always an interesting month in home improvement because it's not a high volume month. And weather is very unpredictable. But as we mentioned, we've gone into stores, and we set spring early.", "And I'll just give you one anecdote, I was in a store recently, and the store was performing really well from a comp perspective. And then we have a 21-year manager that's in the building, so I pulled him aside and wanted to get his assessment of how does he feel about spring versus last year? And we were standing in the area with the new Craftsman outdoor power equipment and with the new grill assortment. And he basically said to me, \"Marvin, this time last year, we would have been surrounded by clearance holiday.\" He said so that's how I feel about the business. We're selling product that's relevant to the customer.", "And so, that's what we're seeing, Brian. So none of the things we're doing is outrageously strategic. It's retail fundamentals, setting product in the time frame that customers would like to buy it, having great brands, improving service, having product available. But the key for us for February is just the timing, meaning having the product in the store, online when customers are interested in buying it.", "And so, where the sun is shining and we can get the good points of view on category performance, we're feeling good that we're headed in the right direction." ] }, { "name": "Brian Nagel", "speech": [ "great. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Scot Ciccarelli with RBC." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys, Scot Ciccarelli. Given the improvement that you saw in the pro sales specifically in January, I guess, I'm wondering how are you guys generally thinking about pro trends for '19 as you add job lot quantities and some of the other changes that you're making. That's No. 1.", "And No. 2, related to that, do you have any feel for whether the improvement was more from bringing new customers into the Lowe's ecosystem? Or is that just a greater share of wallet from existing customers? Or is it just too early to tell?" ] }, { "name": "Marvin Ellison", "speech": [ "So Scot, I'll give a high-level answer to pro, and if Joe believes any other specifics he can jump in. But we think our pro business improved, and our actual pro comp in the month of January outperformed the total company comp. So pro really had a strong close to the quarter. But when we look at it fundamentally, it's just some basic things.", "It is getting the job lot quantities in the stores. And as both Joe and Bill mentioned, we're not yet complete, but we should have all stores with the job lot quantity investments by the end of this quarter. It's doing basic things, like adding dedicated loaders to every store. Joe mentioned the fact that we put pro department supervisors in position.", "For a business this important, we did not even have a supervisor overlooking the area. We've invested in equipment, just basic things like lift trucks and carts that were not even in the area, in addition to fundamental things like easy accessibility for parking. So, we believe we're simply servicing an existing customer better, and we're becoming a second, if not a first option, for customers that literally stopped shopping us because we didn't have adequate inventory levels. We have high expectations for pro, but we have a lot of work to do.", "We are, by no means, checking the box that we kind of solved this very important customer's issues. But we think that we have a good plan forward. And so, we're going to continue to execute on that. I don't know, Joe, if you have anything you want to add?" ] }, { "name": "Joe McFarland", "speech": [ "The only thing I'd add is we brought in a few -- two new leaders for our pro business that have depth of experience servicing the pro of both inside the store, as well as outside sales. So we've been focused on both. And focused on attracting new customers, but also focused on serving the customers and getting the larger share of wallet. So as Marvin said, we're early stages in pro, but we feel very, very good about the focus that we have." ] }, { "name": "Marvin Ellison", "speech": [ "And Scot, the I'd close with is it's too early to determine if it's new customers, existing customers, we're looking at all that data, as you can imagine. But our philosophy is very basic here. We want to improve our overall service and engagement with our DIY customers, but we want to have a more intentional focus on the pro because we know that a more intentional focus on the pro will improve transactions, it will improve ticket, and it will improve overall productivity from a sales per square foot perspective. And so, it's a balanced approach, serving both of those very important customer segments." ] }, { "name": "Scot Ciccarelli", "speech": [ "Appreciate the help. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Steve Forbes with Guggenheim Securities." ] }, { "name": "Steve Forbes", "speech": [ "Good morning. I wanted to start with the adjusted EBIT margin guidance for '19, right? You mentioned leverage within the SG&A. But can you give some color around the outlook for gross margin, specifically as it relates to a bunch of the headwinds, right, you called out impacting you in the fourth quarter? How should we think about those impacting you in '19?" ] }, { "name": "Dave Denton", "speech": [ "Yes. So Scot -- or Steve, this is Dave. I would look at gross margin, think about that as essentially flat for the year, for the most part. We're going to get operational leverage really through SG&A as we focus on both store productivity, but importantly, as we focus on advertising effectiveness.", "And I feel like that much of what we have occurred in Q4 of '18 is kind of behind us and baked into our plan going forward is essentially that flat outlook." ] }, { "name": "Steve Forbes", "speech": [ "And just a quick follow-up regarding the capital deployment plans for the year. Any color, right, regarding the anticipated timing of the activity or share repurchase activity and how much you planned to fund via just the free cash flow profile of the business versus incremental debt as we fine tune the models here?" ] }, { "name": "Dave Denton", "speech": [ "I can't give you too much on that. I -- we're taking obviously a very cautious approach to this, making sure that we understand both the macro environment and, specifically, the credit markets as we approach 2019 from a capital plan. I think that the best assumption that you should use from a modeling perspective as you think about share repurchase more or less equal throughout the year. Obviously, that will ebb and flow based on how we actually go to market, but that's probably a good starting point for you." ] }, { "name": "Steve Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Eric Bosshard with Cleveland Research." ] }, { "name": "Eric Bosshard", "speech": [ "Good morning. Two things. First of all, in terms of online, curious for your outlook in terms of when the results there start to improve. Seems like the execution at the stores is better, but online continues to lag.", "So I'm curious for the outlook for progress there. And then also, if you could explain within that changing your strategic focus, which may be a nuance, but from omnichannel to supply chain. And then secondly, if there's any quantification of the benefit in January, if it was material, of clearancing holiday out earlier." ] }, { "name": "Marvin Ellison", "speech": [ "So Eric, I'll take the first part of the online question, and I'll let Bill give some color to online. And I'll let David jump in on the question regarding clearance. With -- first and foremost, we know a modern-day retail has to be an omnichannel retailer. And for us, the classic example of our shortcomings was evident on Black Friday weekend where we had our failures from a system and service perspective.", "And so, we made the decision to just go out and recruit someone who had a specific background in this to just kind of supercharge our focus and have a much more aggressive approach. And that's Mike Amend. Mike Amend, joined us in January, as I mentioned in my prepared comments, and he's going to work with Seemantini, our new chief financial officer, who actually ran the e-commerce business for Target. And they're putting together an aggressive plan that's going to allow us to get very focused on creating a true omnichannel experience for Lowe's.", "And so, the good news for us is that we have two leaders in position, one with deep home improvement experience from an e-commerce perspective and another with broad experience on the e-commerce world that's going to allow us to really have a more aggressive focus. And the fact that it's reporting into merchandising is critical because we want the merchants to have a broad view not a store view or an online view but an omni view. So I'll let Bill talk a little bit about kind of his additional thoughts on what the expectations are in that business for 2019 and beyond." ] }, { "name": "Bill Boltz", "speech": [ "Yes. Thanks, Marvin. So a couple of things. First of all, we're not sitting still in online.", "So as we've strengthened the leadership team on the merchandising side for online underneath Mike, realigning those folks so that they're tied to the core merchandising teams so that we can pull through those strategies. But we're really looking at it focused on three separate areas. So from a customer's perspective, making sure that it's easier to shop, easier to navigate and that we have more products available on Lowes.com. And then for our associates, it's building out the muscle in the endless aisle inside of our stores.", "So utilizing Lowes.com as a tool in their toolbox and getting that rigorously as we work through the smart training that Joe was talking about. It's about being able to leverage Lowes.com as a solution for our customers inside of our stores. And then the third part of it is our vendor partners, right? Being able to get the SKU additions online, the product availability, making sure that we're forecasting and building out the rigor around those businesses just like we do inside of our store, improving the A plus content and then improving our drop ship ability and fulfillment availability that we have on Lowes.com. So that's what we're focused on.", "We've got a lot of work to do. We know that we've had some struggles there, but I think we're very confident with the leadership team that we have in place there that we'll see significant progress in our Lowes.com business in 2019." ] }, { "name": "Marvin Ellison", "speech": [ "And before I hand to David, there's just one other data point. Even with some of our challenges, today, 60% of our online orders are picked up in the store. And so, that -- so our customers are begging us to get this right. And we have some short-term and long-term plans that we think will make a true difference in this business.", "And we're pleased with the leaders we have in position, pleased with the oversight and strategic direction that Bill is providing. And we are looking forward to coming back in subsequent earnings calls to update the investor community on kind of the progress we make. I'll let Dave talk about clearance." ] }, { "name": "Dave Denton", "speech": [ "Eric, your last comment around the clearance affecting January. Clearance did not drive any material influence, or had very immaterial influence, on sales in January so that's not a driver of our performance in the month." ] }, { "name": "Eric Bosshard", "speech": [ "Great. That's helpful, thank you." ] }, { "name": "Dave Denton", "speech": [ "Thank you, your welcome. With that, we'll take one more question. Thank you." ] }, { "name": "Operator", "speech": [ "Our final question will come from the line of Peter Benedict with Baird." ] }, { "name": "Peter Benedict", "speech": [ "Hi, guys. Pressure's on here, I guess. So I'll start with a question just around supply chain transformation, Marvin, that you called out, kind of that second strategic focus. Any -- give us a sense of where you are today.", "Any milestones we should think about in terms of where you want to be 12, 24 months from now with respect to fulfillment and delivery? That's my first question." ] }, { "name": "Marvin Ellison", "speech": [ "Well, Peter, I would say where are they? We talked about it at the analyst and investor conference that we just opened our first direct fulfillment center. And that's a milestone for us because, believe it or not, we were shipping parcel -- online product from our first distribution center out of Wilkesboro. And it's very manageable, not very efficient and effective and we've transitioned from that to something that's much more state-of-the-art, with plans to open a second facility on the West Coast. What we're also focused on this year is transitioning a lot of the deliveries that take place in the store today, primarily appliances and other big bulk items, into a bulk distribution cross dock strategy that takes enormous pressure off the stores from a delivery perspective and it centralizes it and it will allow us to aggregate bulk deliveries to the customers' homes more effectively.", "At 30,000 feet, Lowe's has a supply chain that does a very good job of supplying product to the store. But in modern retailing, your supply chain must have the same ability to deliver a product to the consumer's home and to the job site. And so, in essence, what we're developing is a network of distribution centers and systems that will allow us to do store, job site and to the customer's home. And that's what we will start to build out this year.", "And that's really the short- and the long-term plan." ] }, { "name": "Peter Benedict", "speech": [ "OK. That's helpful. And my follow-up would be basically related to how you guys are working with your vendors as you execute all the stuff you've been talking about. You talked about having them pay for the MST efforts.", "Are there any other -- just give us a sense for how maybe you're working differently with vendors today that maybe Lowe's has in the last few years. And what's been the response as you've been asking these folks for more?" ] }, { "name": "Bill Boltz", "speech": [ "So I'll take that. First of all, we're being more transparent with our vendor partners, making sure that they understand what we're focused on. And then we've had some history of being inconsistent with them. So for us it's about being able to deliver on what we're working on together and being very transparent and making sure that the teams are communicating to them frequently and often.", "Marvin and I have made ourselves available for those strategic meetings where necessary to help pull those messages through. But we value our vendor partners. They're doing a great job. We've thrown a lot at them just as we've thrown a lot of change in our organization, and they've responded very favorably.", "So we're -- just like what we talked about with paint, that's a real good example of how that communication and that response has helped pull through that performance improvement in our paint business because we're collectively working together." ] }, { "name": "Marvin Ellison", "speech": [ "And Peter, the only two comments I will add is No. 1, our vendor partners are eager and willing to work with us. They want to win, and they want Lowe's to win because we are true partners in each of our entities' success. And secondly it's a ton of value to have Bill Boltz here as someone who was a vendor to Lowe's.", "So not only does Bill bring very specific and a deep understanding of home improvement product and category knowledge, he also brings a perspective of a former supplier working with Lowe's to help us understand how it feels to be in that position. And so, we have work to do, but as Bill noted, we've made ourselves available, have had quite a few strategic meetings. We've had some very positive and very impactful discussions. And we think it's going to bear more fruit in the long run than it has thus far." ] }, { "name": "Peter Benedict", "speech": [ "OK, great. Thanks so much, guys. Good luck." ] }, { "name": "Dave Denton", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] }, { "name": "Peter Benedict --Robert W. Baird and Company -- Analyst", "speech": [ "More LOW analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
LOW	2020-05-20	[ { "description": "Vice President of Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin R. Ellison", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joseph M. McFarland III", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "William P. Boltz", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "David M. Denton", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": "Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "JPMorgan & Co. -- Analyst", "name": "Christopher Horvers", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning everyone and welcome to the Lowe's Companies' First Quarter 2020 Earnings Conference Call. My name is Michelle and I will be your operator for today's call. As a reminder, this conference is being recorded.", "I will now turn the call over to Kate Pearlman, Vice President of Investor Relations. Thank you. You may begin." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning, everyone. Here with me today are Marvin Ellison, our President and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President Stores; and Dave Denton, our Executive Vice President and Chief Financial Officer.", "I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2020. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the Risk Factors, MD&A and other sections of our Annual Report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to US GAAP can be found in this morning's press release and on our Investor Relations website.", "With that, I'll turn the call over to Marvin." ] }, { "name": "Marvin R. Ellison", "speech": [ "Good morning, everyone. This is an unprecedented time as we all navigate the ongoing global economic social and health impacts of COVID-19. I'd like to start-out by extending my best wishes for the health and safety to you and to your family. Like most retailers, we began the first quarter focused on meeting our internal financial plan, while executing our Q1 retail strategy. However, due to the global health crisis caused by COVID-19, everything changed in late February. And we immediately pivoted by establishing a cross-functional COVID-19 task force, opening a companywide Command Center and reprioritizing our Q1 objective.", "As a company, our focus shifted from running a business to achieve our financial plan to functioning as an essential retailer operating in a pandemic with three key priorities; first, creating a safe store environment for our associates and our customers; second, providing support for our community, including healthcare providers and first responders and third, financially, supporting our associates during this unprecedented time. As a result of these new priorities in the first quarter, we invested $340 million to support our associates, healthcare workers, first responders and community. In addition, we committed $50 million of charitable contribution for our communities to do our part in this time of need.", "I'd like to begin by highlighting a few of the operational actions that we took in response to COVID-19. And later in the call, Joe will provide more details on these efforts. In early March, we shortened our store operating hours by closing three hours earlier, each day at 7:00 p.m, so we could increase third-party cleaning routines and restock shelves. During the hours that our stores were opened, we implemented several operational changes to ensure the safety of our associates and our customers. Including the garden centers, our stores averaged 144,000 square feet of space. To develop our social distancing safety procedures, our team took a strategic data-driven approach, tracking historical customer traffic patterns and identifying areas where customers tend to congregate.", "Based on this analysis, we implemented additional safety and social distancing protocols in three distinct areas; point of sale checkout, outside garden and the paint desk. Our store team was so effective in implementing and executing the enhanced safety guidelines that our customer service scores improved 200 basis points year-over-year in the first quarter. This is truly an incredible accomplishment and a reflection of our commitment to customer service even in this unprecedented environment. Also to provide our valued associates with a much-deserved day off to spend with their families and their loved ones, we closed all stores and distribution centers on Easter Sunday. This decision negatively impacted sales and operating income, but it was absolutely the right thing to do for our associates.", "We have a unique and a resilient business model that operates well when our communities need us most. While there's a hurricane, flood, tornado or global health crisis, we are committed to being there for our customers. And I am pleased that over the past 18 months, we've established the agility to provide our customers with the essential products they need to keep their homes safe and functional and their businesses running. None of our success in the first quarter would have been possible without the outstanding commitment of our store associates working under unprecedented conditions. Our field leaders also distinguished themselves during the quarter. Division Presidents, Regional Vice Presidents, District Managers and Field Merchants abandoned their normal routines and spent time each week visiting stores to provide leadership support and guidance for our store managers and front-line leaders. As someone who started out their retail career as a $4.35 an hour part-time store associate, I understand the importance of seeing the leaders of the company out on the front-lines during the crisis.", "Let me now turn to our first quarter results, which reflect the benefits of our retail fundamental strategy, the improvement in our overall execution and the strength of our home improvement business model. For the first quarter, we delivered strong sales growth with total company comp sales growing 11.2%. Our US home improvement comps was 12.3% due to strong demand from both DIY and pro customer. Overall demand strengthened as we moved through the quarter and net sales momentum has continued into the month of May. For the quarter, DIY comps slightly outpaced pro comp and the uptick in DIY demand was partly driven by the arrival of spring weather in many Western and Southern geographies, as well as a customer mindset that was heavily concentrated on the home.", "We serve broad-based project activity, ranging from outdoor landscaping and other beautification projects to essential indoor, repair and maintenance work and long-deferred home projects to the to-do list that customers previously tackle given their busy schedule. Comp sales for pro were strong supported by our focus on retail fundamentals, including job lot quantities, more flexible delivery and the improved service model that we put in place in 2019. And as you would expect, we saw increased demand in COVID-related product, such as cleaning suppliers and appliances like refrigerators and freezers. Partly offsetting these gains were softness in heavy indoor installation categories such as kitchen and bath as customers were reluctant to invite people into their homes.", "In total, we estimate that the net impact of COVID-related sales contributed approximately 850 basis points to our total company comp growth, which includes 80 basis points of cleaning products, 70 basis points of refrigerator and freezer sales and 700 basis points in acceleration of projects, primarily for the DIY customers.", "As we move through the quarter, there was also a sharp uptick in sales on Lowes.com. As customers began to shop more and more online, our investments in online infrastructure and progress to-date with the Google cloud migration greatly improved site stability and allowed us to effectively handle the increased traffic. For the quarter Lowes.com sales were up 80% overall, with even stronger growth rates for our pro customers. Online penetration increased to 8% of total sales.", "From a geographic perspective, we had broad-based growth with positive comps in all 15 geographic regions and all three US divisions. Regions that outperformed the total Company comps were Atlanta, Charlotte, Dallas, Houston, Nashville, Los Angeles, St. Louis, and Seattle. And once again, the West was our top-performing geographic division. The geographic footprint of our stores in the US also played a role in our strong sales performance in Q1. The COVID-19 crisis created less disruption in rural areas of the country where approximately one-quarter of our store base is located. Our rural stores outperformed the company comp in Q1 by over 250 basis points. Conversely, on average, our urban stores experienced more demand disruption from the COVID-19 crisis. Approximately 10% of our US store base is classified as urban and this subset of stores under-performed the company comp by more than 400 basis points.", "In Canada, we posted negative comp sales as performance was adversely impacted by store closures and other regulatory related operating restrictions. We have initiatives in place to improve performance and remain confident in the long-term potential of our Canadian business. During the quarter, we shifted our marketing efforts by dramatically limiting our promotional messaging and instead highlighting our commitment to our communities and our appreciation for our front-line associates. In fact as the presenting sponsor on ESPN for the NFL Draft, which posted record setting viewership, we ran a campaign of spotlight and thank our sources and how they support their communities and the first responders in a time of crisis.", "Although actions like closing on Easter, reducing promotions, closing stores two hours early each day and limiting customer access to key areas like paint and garden limited our sales in the quarter, they are a reflection of our culture and to the fundamental commitment to the safety of our sources and our customer. Our Q1 results also showed a while consumers were sheltering in place this quarter, they had an opportunity to rediscover Lowe's both in-store and online and improvements we made in our business over the last 18 months allowed us to meet the customer demand.", "I'm also pleased that during this time of high levels of unemployment in our country, Lowe's has hired over 100,000 stores associates for the spring season. In addition, to this other retailers on operating safely in this exceptionally challenging environment, we shared our best practices with the Retail Industry Leaders Association. In fact, the only competitive threat we're focused on right now is the COVID-19 virus. Although our current and future environment is unpredictable, I am confident in our ability to execute and continue to provide the essential products and services that our communities need.", "And in closing, I am tremendously proud of our associates and would like to again express my heartfelt appreciation for their hard work and their dedication. And also want to thank our vendor partners for their great efforts to step up to the challenges that this pandemic as presented.", "And with that, I will turn the call over to Joe to discuss the actions that we've taken to support our customers operate effectively and keep our sources safe." ] }, { "name": "Joseph M. McFarland III", "speech": [ "Thanks, Marvin, and good morning, everyone. I'd like to begin by echoing Marvin's appreciation for the tremendous work that our associates have done during this crisis across our stores and distribution network. As always, our highest priority is the health and safety of our associates and customers.", "I'll now take a moment to review the operational changes that we implemented this quarter in response to COVID-19. To begin with an immediate assessment of how to best facilitate social distancing in our operations and then quickly acted to implement the following, additional signage and floor markers, adding social distancing ambassadors to manage customer traffic flow, leveraging new technology available on handheld smart devices to monitor store traffic, helping store managers limit customers based on the store footprint in line with regulatory requirements and removing product from our stores to help free-up additional space for our customers, especially in high traffic areas.", "As Marvin mentioned, on average our stores are 144,000 square feet in size, including the garden center. Therefore, we also deployed a data-driven process to implement additional safety measures in areas where customers tend to congregate, such as our point-of-sale registers, the garden center and the paint desks. For example, in our garden centers, we utilized our merchandising services teams or MSTs to remove shelving and product to encourage customers to spread out. And at the garden center entrants, we set up one-way traffic flows and limited the number of customers entering at any one-time. To ensure clean, safe operating environment, we implemented more stringent cleaning procedures, added more hours for our third-party cleaning service and closed our stores three hours early at 7:00 PM to allow for increased cleaning and restocking activities. We also determined at keeping our stores open until 7:00 PM, allowed for enough operating hours during the day to minimize concentrations of customer traffic. Lowe's is one of the first retailers to install plexiglass shields at the point-of-sale areas in all stores. We also distributed gloves and masks to our associates to wear during their shifts.", "As a reflection of our commitment to our associates, we provided them with additional financial assistance, totaling $290 million in incremental investment in the first quarter. We made two special payments to hourly associates to help with unexpected expenses, one in March and one in May, with each payment consisting of $300 for full-time and $150 for part-time and seasonal associates. And for the month of April, we instituted a temporary wage increase of $2 per hour for all hourly associates.", "To further protect the health of our associates and those around them, we offered 14 days of emergency paid leave for all associates who needed it. And for those at higher risk for severe illness from COVID-19, we offered emergency paid leave of up to four weeks. And to show our support to our dedicated front-line managers, we have provided them with an additional two weeks of paid vacation to recharge and spend time with their families. We also extended telemedicine services to all associates and their families whether or not,they were enrolled in Lowe's medical plans. And to do our part in protecting front-line medical workers and first responders, we committed $50 million of support to our communities this year, including approximately $10 million worth of essential protective products including N95 masks.", "And as online demand increased, smart devices allowed associates to buy online, pickup at store and parcel shipping orders more efficiently. In fact, this quarter, we rolled out curbside pickup in a matter of days. This rapid response would not have been possible with the technology we deployed in 2019. Our new customer-centric scheduling system and scheduling effectiveness tools also allowed us to monitor store traffic versus associates availability and deliver customized tiered sets of priorities for stores based on their capacity level. As we look forward, we remain committed to our retail fundamental strategy and investing for future growth.", "In closing, I'm incredibly proud of how our associates responded and adapted to this challenging environment. They served our customers and communities in a time of tremendous need and we remain committed to supporting them as our most valuable asset. I'm really pleased to announce that 100% of our stores earned their winning together profit-sharing bonuses this quarter, totaling $87 million. Based on stronger than expected store performance, this represents an incremental $24 million payment to our front-line associates above the target payment level.", "Thank you. And I will now turn the call over to Bill." ] }, { "name": "William P. Boltz", "speech": [ "Thanks, Joe, and good morning everyone. As Marvin mentioned, we posted US home improvement comparable sales growth of 12.3% in the first quarter driven by outperformance in essential DIY and pro categories. 14 of 15 merchandising departments generated positive comps with weakness limited to installation heavy product in kitchens and bath. We saw very strong COVID-related demand for essential cleaning products along with other home necessities such as refrigerators, freezers, and DIY home repair products. As customers are isolated in their homes this quarter, they engaged in a variety of projects, which drove double-digit comps in core spring-related categories, paint and other critical repair and maintenance categories. During the quarter, we posted double-digit comps in lumber, which benefited from strong unit demand from both Pro and DIY customers, but continues to be driven by our improved investments in job lot quantities.", "Core pro categories also performed well with double-digit comps in rough plumbing, hardware and tools. Within rough plumbing, we delivered double-digit growth in pipe and fittings as our expansion of job lot quantities in this area continues to pay-off along with growth in other essential categories like air filtration, pumps, and water filtration. Our hardware business benefited from the strength in fasteners and our general hardware categories, supported by the addition of pro brands like FastenMaster, GRK and Power Pro One, as these product categories are the critical project completers for both the Pro and the DIY customer.", "In tools, we continue to see a strong customer response to our CRAFTSMAN program, but we also saw strength from the launch of our new Kobalt XTR 24-Volt Power Tool platform, as both the heavy DIY and Pro customer are quickly recognizing the quality and performance of this great product. Within our key Pro tool brands such as DEWALT, the number one power tool brand in the industry. We continue to see nice growth across all segments and we are pleased with the results we are seeing through the addition of our exclusive DEWALT 12-Volt compact line of power tools.", "Lastly, we continue to showcase new and innovative tool products from Bosch, Lufkin, Spyder and Metabo HPT, along with Kobalt to build on the strength of our tools business. These brands combined with our investment in job lot quantities and our improved Pro service model are driving new customer trial and increasing our share of wallet with our existing Pro customers.", "As Marvin and Joe indicated, the progress we made on our strategic initiatives in 2019 positioned us to execute well this quarter. For example, having our merchants in place for the entire year allowed us to fully plan for the spring season and respond to the rapidly changing operating requirements we are currently facing. I'm also proud of our vendor partnerships and our recent brand introductions, both of which have allowed us to better meet the customer demand. I'd like to take a moment to mention just a few of the suppliers, who made an extraordinary effort to keep our stores well-stocked this quarter, despite their own challenging operating environments.", "Within our building products categories, some of our suppliers that deserve a special shout-out are Charlotte Pipe, ECMD, SharkBite and Idaho Forest Group. In home decor, 3M, Manati [Phonetic] and Samsung were true standouts and in our hardlines business, Hillman, Bonnie, Oldcastle and MTD products went above and beyond in their responsiveness. And finally, I'd be remiss if I didn't give a big thank you to the efforts put forth by Zep cleaning products, Safety Zone and Medline as these three suppliers went above and beyond to provide us with hand sanitizer and gloves for our front-line associates.", "Turning back to our associates, our field merchandising teams played a critical role in helping our stores adjust to the changing environment along with being on the ground to respond to 10 tornadoes and two earthquakes that impacted parts of the US during the quarter. And our merchandising Service Teams or MST also went above and beyond as they were ready to do whatever was needed during the quarter to help our stores respond to significant increases in demand. This quarter our MSTs were key in our ability to quickly reconfigure our stores to support social distancing. The support of these teams is invaluable because they are the boots on the ground, focused on taking the time consuming tasks off the shoulders of our red vest associates.", "And looking ahead, we continue to make investments to drive future growth. And in the second quarter, we are excited about our roll-out of Simpson Strong-Tie framing hardware and fasteners. These trusted Pro products will be available in stores nationwide with an expanded assortment on Lowe's.com, helping pros to fulfill all their hardware needs in one place, saving them time and money. And spring has now arrived across the country, we will continue to leverage our position as the number one destination for outdoor power equipment in the US with our leading brands such as John Deere, Honda, Husqvarna, Ariens and CRAFTSMAN to provide customers with an outstanding selection of products, to help them complete their outdoor projects. At the same time, we're proud to offer our customers the top two brands in grilling, Weber and Char-Broil.", "As we've discussed previously, we remain focused on completing our Google cloud migration in the second quarter to ensure that we build a strong infrastructure for Lowe's.com and the teams are working quickly to add capabilities to Lowe's.com over the next three quarters that will further enhance the customer experience and to continue to grow sales on this digital platform.", "In closing, we remain committed to the work ahead to serve our customers and our communities as they navigate the public health challenge of COVID -19 while building capabilities to serve them even better in the future.", "Thank you. And I'll now turn the call over to Dave." ] }, { "name": "David M. Denton", "speech": [ "Thank you, Bill, and good morning, everyone. I'll begin this morning by reviewing the liquidity actions that we took during the quarter and provide an update on our capital allocation priorities.", "Given the uncertain economic outlook, we decided to bolster our liquidity to plan for any unforeseen disruptions. In Q1, we raised $4 billion in senior notes and increase the capacity of our revolving credit facility by $770 million. After repaying $500 million of senior notes due in April of 2020, we now have $6 billion of cash and cash equivalents on the balance sheet as well as $3 billion in undrawn capacity on our revolving credit facility, which can be made available for any unanticipated needs and liquidity. We believe that we have more than adequate liquidity to manage through any of the potential scenarios that we could be facing. During the quarter, we also decided to halt our share repurchases program. Furthermore, we do not anticipate doing any more share repurchases this year beyond what we executed in the quarter. In Q1, we repurchased 9.6 million shares for $947 million at an average price of $98.45 per share. We remain committed to returning capital to shareholders through our dividend program. And as always, we look for ways to drive shareholder value over the long-term.", "Also consistent with our capital allocation framework, we are continuing to prioritize investments in the business for future growth. In the quarter, capital expenditures totaled $328 million and we are still planning for a total of $1.6 billion in capital expenditures through this year. In certain cases, we have reprioritized some capital project to focus on the near-term need to improve our omnichannel capabilities, but our expectations for the total spend in 2020 remains unchanged.", "I'll now turn to review of our operating performance beginning with the income statement. In Q1, we generated GAAP diluted earnings per share of $1.76 per share compared to $1.31 in the first quarter of LY, an increase of 35%. In the quarter, there was a very modest impact on operating income related to the previously announced Canadian restructuring.", "My comments from this point forward will include certain Non-GAAP comparisons where applicable. In Q1, we delivered adjusted diluted earnings per share of $1.77, an increase of 45% compared to the prior year. These results exceeded our expectations largely due to stronger than expected sales and gross margin rate, particularly in the latter half of the quarter. Sales for the first quarter were $19.7 billion, an increase of 11.2% on a comparable basis versus the prior year period. With total average ticket growth of 9.7%, our transactions grew by 1.2%.", "US comp sales were up 12.3% in the quarter and we were encouraged to see strength in our performance across both DIY and Pro customers and across all geographies. Our US monthly comps increased as we moved through the quarter, with 5.1% in February, 8.9% in March and 20.4% in April. February's financial performance was largely in line with our expectations, but beginning in March, we saw sales impacted by COVID related prep activities and customers working on long-delayed projects as they sheltered in place. Also Lowes.com sales ticked up meaningfully in March as more customers increasingly utilized online shopping options. Sales continue to accelerate into April with a large step-up mid-month. Lowes.com sales also increased significantly with comps of over 150% in a month while our installed sales declined approximately 50%, as many customers were unwilling to allow installation work in their homes. The strong broad-based trends that we saw in April have continued into May with strength across both DIY and Pro and across nearly all merchandising categories and all geographies. For May month to-date, US comp sales have been trending at or above April results with strong double-digit comps across all geographic regions.", "Gross margin was 33.1% of sales in the first quarter, an increase of 164 basis points compared to Q1 of LY. Gross margin rate improved 110 basis points, driven both by the actions that we took last year to lower product cost and improve our pricing and promotional performance, as well as a 40 basis point benefit from lower promotional activities throughout the quarter. As Marvin mentioned, the Company pulled back on promotional marketing in an effort to limit non-essential traffic, given the stay at home orders across the nation. Gross margin also benefited from approximately 55 basis points related to favorable product mix.", "SG&A for Q1 was 21.3% of sales, an improvement of 45 basis points over the prior year. This included $320 million of COVID-related expenses incurred during the quarter with $275 million in financial assistance to our front-line associates, approximately $35 million related to cleaning and other pandemic related operating expenses and approximately $10 million in charitable contributions. While the $320 million of COVID-related expenses resulted in SG&A deleverage of 160 basis points, the impact was more than offset by payroll leverage of 105 basis points driven by higher sales and improved store efficiencies, advertising leverage of 40 basis points and employee insurance leverage of 25 basis points.", "Adjusted operating income margin increased 208 basis points to 10.16% of sales. Note that COVID-related expenses are not excluded from our adjusted results. The effective tax rate was 25.1% compared to 16.6% last year. The prior year quarter benefited from the change in approach related to the exit of our Mexico operations. The adjusted effective tax rate was 25% above the prior year rate of 22.9%. At $14.3 billion, inventory is slightly lower than the prior year level.", "Now before I close, let me address our 2020 business outlook. Despite our solid performance this quarter and strong sales momentum continuing into May, we are withdrawing our prior guidance for the full year 2020 sales, operating income and earnings per share. In this unprecedented operating environment, we, like other companies, have limited visibility into future business trends, which result in an unusually wide range of potential outcomes for our 2020 financial performance. However, going forward, we would like to provide additional transparency regarding our performance. So it is my expectation that we'll be giving more frequent periodic updates on our results throughout the second quarter.", "In closing, we remain confident about the future of our business and our ability to continue to drive sustainable long-term shareholder value. Finally, I'd like to extend my appreciation to the associates at Lowe's across the world who have risen to meet the challenges of this global health crisis.", "Operator, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We are now ready for questions. [Operator Instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning, everyone. My first question is on sustainability of comps. I know it's an impossible question to really answer and you're not going to provide much guidance, but from a planning perspective, right, there is a surge right now. Your inventory position looks pretty reasonable. So what are your expectations, if you can share how you're thinking about the surge and then leveling off? And then what should be a recession theoretically now and into the back half of the year?" ] }, { "name": "Marvin R. Ellison", "speech": [ "This is Marvin. I'll take the first part and I'll let Dave take the second piece. You're right. This is a very unique and unprecedented environment that we're in. But what we can tell you is that we had very strong sales in April. And as Dave mentioned in his prepared comments, that momentum has continued into May. That includes triple-digit comps in Lowe's.com that also transitioned from April into May. We don't anticipate we're going to see negative comps, but we do anticipate that we're going to see sales start to moderate at some point in the latter part of this quarter and in the back half of the year. What's interesting about this environment is that this is not a housing recession. You go back to 2008-2009, you are in housing recession and so the home Improvement business was directly impacted. This is obviously different and we're seeing still sustained strength from our homeowners, because they're sheltering in place and they're finding those projects around the house.", "Having said that, like every other company out there, we have very limited visibility to what's going to happen in the out-months and out-quarters, but we do feel as though even in this unprecedented environment, we have a really good execution plan and we think the results in Q1 reflected this.", "I'll let Dave add any additional." ] }, { "name": "David M. Denton", "speech": [ "Yeah. Simeon, I just add kind of a couple of points. One, real-time, we're tactically responding and managing to the increased demand for consumers for these essential products that you're seeing in our stores. So one, real-time we're working on that.", "Secondly, importantly, we're still running our long-term playbook. We're making investments to-date and drive long-term shareholder value in the out-years. So we have not deviated from that playbook.", "And three, we have developed a variety of I guess plans that can allow us to flex both from a merchandising perspective to lean into more non-discretionary type items over the back half if required. And secondly, we enabled with all the tools we put in place operationally to be able to flex our labor and operating expense profile to manage in a slightly softer demand environment." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. And then my follow up is there -- I doubt with plus 20 type of comp, it sounds like that's what you're running. Anything in DIY yellow flag, and it sounds like the Pro is also pacing the DIY customer at the moment. Can you talk about anything you're hearing as far as the type of job and if their pipeline or backlog is starting to refill up?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Well, I think what's interesting is the strength remains in DIY, but for us, the Pro customer remains healthy and that customer has transitioned primarily to outside project. Also as a reminder, our Pro customer is the smaller what we call it a pickup truck Pro. That Pro was less impacted in this worst downturn than the larger more industrial Pro. So even though Pro was not as robust as DIY, our Pro growth is still really strong in the quarter and that strength continues and their pipeline is more delayed and not canceled and now you're starting to see those jobs pick up.", "Another interesting data point is in the states that are beginning to reopen, we are seeing our stores outperform the total company comp in those locations, which to us is a data point, but it's a glimmer of hope that we're able to sustain our performance even when there is a broader competitive landscape out there. But again, Simeon, there is a lot we don't know, there is a lot of uncertainty. But as Dave said, we have a lot of levers that we can pull from an expense management perspective and Bill Boltz and Joe McFarland have really detailed playbooks from the 2008-2009 period when we had to transition in our old life to a more repair maintenance type of strategy. We know how to do that. So if that is a requirement, we have a very experienced team of merchants and operators that could make that pivot." ] }, { "name": "Simeon Gutman", "speech": [ "Great. Thanks. Good luck." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. Marvin, I know you're not expecting negative comps, but should we look at that 850 basis points of COVID-related sales are simply pulling forward demand from future periods. And if that's the case, why wouldn't comps go negative?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Well, Mark, we don't see this pull forward, because these were projects that were on the customers' to-do list that they simply didn't have time to get to. I mean, as a reminder, I mean we are in the central retail business and two-thirds of what we sell is non-discretionary. And what we saw a lot of customers coming in and fixing things that they had just delayed. So we don't see it as a pull forward at all. Look, we're blessed to be open. We're very thankful that we're open, but this is what I question the most challenging environment any of us I've ever worked in and when we look at what the customers are buying, we look at the sustainability of it, we don't see what occurred in Q1, we don't see what occurred in April as a pull forward, we see it as a unique demand shift based on the competitive landscape and based on customers sheltering in place." ] }, { "name": "Michael Lasser", "speech": [ "Understood. And then a quick two-parter for Dave. First part is, if we strip out the benefit in the gross margin you saw from favorable mix and from advertising less promotions, it looks like you still haven't recouped everything that you lost in the first quarter of last year. At what point, will you be able to recoup everything that you lost in the gross margin or is it just going to be structurally lower?", "And your commentary around share repurchases indicated that you're not going to do it for this year. What happens if there is a V-shape recovery or the business continues to perform very well, under what conditions will you resume the share repurchases? Thank you very much." ] }, { "name": "David M. Denton", "speech": [ "Yeah. Hi, Michael. Listen, it's our expectations that we would recover by the end of the year, our gross margin to the baseline rate that we've talked about, that was our prior guidance. And we're largely working on that day-in and day-out. I'd say there is a combined team between really merchandising and finance, focused against that effort. And I'm actually really pleased with the progress we made and we continue to push forward. So I feel like we're in really good stead there and we're kind of making the right investments to improve our performance.", "And then secondly from a share repurchase perspective, listen, we'll wait and see. I think the good news is at the moment, our cash flow is very robust, very strong, we've shored up our balance sheet from a liquidity perspective. Let's just kind of watch and see just given the dynamic nature of this market and see where we stand and we'll watch it carefully as we go through the balance of this year." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much and good luck." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Hey, guys. Good morning. Thanks for taking the question. I want to talk a little bit on SG&A. Obviously, very good leverage in the quarter, you discussed an incremental cost obviously, but you had some offsets. I'm just wondering, if you can elaborate on some of those positive offsets in the quarter. How sustainable are those as you look into the second quarter? And then just regarding the $320 million of incremental costs, how should we be thinking about that bucket as well? Thanks." ] }, { "name": "Marvin R. Ellison", "speech": [ "So Seth, I'll take the first part and then hand it over to Joe McFarland. I think the key to our ability to have the leverage performance was the new scheduling in labor management system. Timing is everything and our associates have been incredibly heroic during this time, but the ability to make sure we could look at the demands of the business by location, by department of the store to schedule effectively was in large parts.", "I'll let Joe McFarland talk about what we were able to benefit from the labor scheduling system in addition to some other expense related initiatives that they drove in operations." ] }, { "name": "Joseph M. McFarland III", "speech": [ "Yeah. Thanks, Seth. This is Joe. So as we've been working on 60-40, again that is to shift our labor productivity from tasking to selling. We are well on our way in our 60-40 transition. And so if you think about things that Marvin mentioned, the customer-centric schedule, we were able to really dial-in our associate staffing based on departments that we're lifting, reallocate labor in the areas of the store that we're suffering and also the smartphones, the ability for -- the associates to be able to sustain a 150% comps in dot-com in the month of April and 80% for the quarter would not have been doable if we've not done things like our Pick app in the smartphone applications that really allowed the associates to set up curbside delivery. And so Seth, there are a number of things throughout the quarter, the operational initiatives that we continued to stay focused on, our centralized receiving, so a lot of things allowed us to gain that leverage." ] }, { "name": "David M. Denton", "speech": [ "Yeah. Seth, I'll just add -- give a shout out to all the ops team to really be very focused and really drive a lot of efficiencies this quarter. However, there will be additional costs that we will incur as the new operating model goes forward. We incurred incremental costs for cleaning, we put in social distancing ambassadors in our stores to manage the queues and flow through from a traffic perspective. So some of those costs which we incurred about $35 million in the first quarter are probably ongoing for the balance of this year." ] }, { "name": "Seth Sigman", "speech": [ "And what about the $275 million, how much of that is ongoing past the first quarter?" ] }, { "name": "Marvin R. Ellison", "speech": [ "So Seth, I mean, our goal is to take care of our associates. I mean, we are really proud that in Q1, we invested roughly $340 million in our associates and our customers and communities. We're going to continue to make sure that we take care of our associates as this pandemic continues to drive a unique environment in our stores. Like anything else, it's difficult for us to project when that's going to be, but as an example, we paid out $80 million in special payments in the month of March, $2 wage increase for all the associates in the month of April, another $80 million plus in special payments for the month of May. Joe talked about the winning together payment that we're going to make over and above the target for the month of June. And so we've looked at the needs of our associate and we'll make the appropriate decision based on what we think is in their best interest." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Thank you for that. Just a follow-up here on that May quarter to-date trend, are you seeing the composition of growth change at all between DIY and Pro and are you seeing a pick up in some of those weaker installation heavy categories like kitchen and bath, any signs that those are starting to improve more as the restrictions are using here? Thank you." ] }, { "name": "Marvin R. Ellison", "speech": [ "So I'll take the first part and let Joe talk about the installed piece. The short answer is yes. DIY remains very, very strong. Pro is improving. And remember, what I said because our Pro is that smaller pickup truck Pro, that Pro tends to be less impacted by macroeconomic factors. And so that Pro was healthy, but they're getting even more healthy as the weeks and days progresses throughout the year. And as I mentioned, and states that are reopening, we see strength in our business, but we also see strength in these urban store locations. You remember, I mentioned in the first quarter, our remote stores dramatically outperformed urban stores by almost 650 basis points. We're starting to see those urban markets start to improve as well and so as Dave mentioned, as a broad geographic positive double-digit performance that we're seeing.", "And Joe can talk a little bit about the installed piece." ] }, { "name": "Joseph M. McFarland III", "speech": [ "Yeah. So from the installed piece, Marvin mentioned that our installed heavy-related categories for the quarter were significantly down as referenced in negative comps in kitchen and bath. As we have progressed through the quarter and looked week by week, we have a really robust dashboard that we look at that includes things like future leads. And so on the exterior installation projects, we're really seeing that business come back very, very quickly. So we're very pleased there. We are making progress on the interior projects, but that will be slow and I will be tempered as our consumers feel more and more comfortable allowing our pros in their home and our installers in their home." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Thanks, guys. Best of luck." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Greg Melich with Evercore ISI. Please proceed with your question." ] }, { "name": "Greg Melich", "speech": [ "Hi, thanks. I have a follow-up for Dave and then on strategy, Marvin, I had one. Dave, just the $340 million that you did or $320 million on COVID, is any of that accrual that something that basically might get paid out later this year like extra vacation or was that basically costs in the quarter? And then Marvin, I had a follow-up." ] }, { "name": "David M. Denton", "speech": [ "It's largely costs in the quarter. There is always some accruals based on when things actually get paid, but largely this is expenses that are incurred in Q1." ] }, { "name": "Greg Melich", "speech": [ "Perfect. And it sounds like you're comfortable with the leverage ratio falls from 2.7 down to 2, if results are strong, you wanted to be more conservative on the balance sheet?" ] }, { "name": "David M. Denton", "speech": [ "That's correct. If you look at our leverage ratio as we sit today, we're probably a little bit over 2.8 at this point in time, but if you net the cash that we have on our balance sheet, we're well below that. And I think just given the unprecedented environment we're operating in, we're just going to be conservative here for a while until we kind of see how this plays out for the balance of the year." ] }, { "name": "Greg Melich", "speech": [ "Makes total sense. And Marvin, you're talking about the digital surge and also how it's happening by geography and by even customer. Could you give us some more about the changes and improvements you're making in the multi-channel experience and just any metrics around the customers that are using it that might be new or now behaving differently or more frequently since they use Lowes.com." ] }, { "name": "Marvin R. Ellison", "speech": [ "Well, what I can tell you, Greg, is that we're just pleased that the work that we put into stabilizing and modernizing Lowes.com starting to pay dividends. As we mentioned the last couple of calls back last year, the entire dot-com site was on a decade-old platform. And so we're in a process of transition that to Google Cloud will be complete this quarter, but that allowed us to take on the demand and what we're seeing is that customers simply want to shop the way that they choose to. And in the past, we couldn't accommodate that. Joe mentioned his prepared comments, when we started to get requests from customers for curbside, we put that up and going in three days. I mean, this time last year, it would've been impossible to do that because we don't have the infrastructure. Bill Boltz and the merchant team has also done a really nice job of adding additional SKUs.", "And I'll let Bill talk about some the work the merchants have done that has allowed us to drive the dot-com business and some of the future work that we have in place to drive dot-com for the balance of the year." ] }, { "name": "William P. Boltz", "speech": [ "Yeah. This is Bill. So just a lot of work from the online team as well as the core merchants to get relevant SKUs online, relevant categories of product in addition to being able to support the operations work that goes on inside the store. But along that, as I mentioned in my opening comments, the capabilities that the team is continuing to work on to enhance delivery operations, to schedule deliveries, to be able to ship from any of our locations, all of that we're continuing to go and to be put in place through the balance of the year. So just lots of improvement and that will continue to go on in Lowes.com." ] }, { "name": "Marvin R. Ellison", "speech": [ "And Greg, the other point I make, I mean, I would say roughly 90% of our dot-com sales are fulfilled or picked up at a store. And for us that's significant because any time the customer can pick it up at a store that helps us to defer the cost of operating in that platform. The good news is Lowes.com will only get better for the balance of the year. And as I mentioned, we're triple-digit growth in April, we're triple-digit growth month-to-date, and we can sustain that and we're having improved functionality for the customer each and every week and that's something that we're excited about the future." ] }, { "name": "Greg Melich", "speech": [ "Great job, guys. Good luck." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Eric Bosshard with Cleveland Research. Please proceed with your question." ] }, { "name": "Eric Bosshard", "speech": [ "Two things. First of all, in terms of online, the pick-up in-store fulfilled at store, I know you said that fulfilled from the store, but how much of this is getting delivered in the mail and how much of it is getting picked up at the store? Could you just give us what that number was in the quarter?" ] }, { "name": "Joseph M. McFarland III", "speech": [ "Yeah. So Greg, it's Joe. So just over 60% of our orders are picked-up in-store and then the incremental is fulfilled primarily through store." ] }, { "name": "Eric Bosshard", "speech": [ "Okay. And then secondly in terms of the promotion and merchandising strategy for 2Q. I guess a question for Bill, the strategy around promotions and events for Memorial Day and 4th of July, how are you planning on that? And then, curious as you look back to how you manage to bring Black Friday, the reduced effort to drive traffic, did you end-up seeing or how material was the negative impact on sales from that and then bridge that to how you think about Memorial Day and July 4th, as well?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Hey Eric, this is Marvin. I'll take the spring Black Friday and I'll let Bill talk about Memorial Day and Q2. So when we look at spring Black Friday, we received minimal incremental sales benefit from the event. Due to the distribution process of print media, we were unsuccessful in pulling the tap from distribution. But when we look at all other forms of media, all other traffic drive and mechanisms for the event was pulled. So from that, the sales were minimal. And let me make sure just for the broader audience, I define how we look at print media. Print is the least effective marketing medium that we have and total sales contribution generated by print for Lowe's is 0.7%.", "So I know there was a lot of discussion that spring Black Friday was a benefit to us in the quarter. But as I said, it was incrementally minimal at best. In addition to that, we closed for Easter and we were forecasting Easter to be a plus $200 million day. And when Dave Denton, Joe McFarland and Bill Boltz and I sat down and made that decision to close, we had no idea at that time how we will make the sales up, but we felt like it was in the best interest of our associates and their families to give them a day off and we would just take the financial hit for lack of a better term for that decision, but we felt like that it was simply culturally the right thing to do. So when we take then close to Easter, when we take pulling all other traffic driving mechanisms for spring Black Friday, both events turned into a negative environment from a sales perspective for us. So that kind of summarizes Easter and spring Black Friday.", "And looking in the rearview mirror, I'll let Bill talk about Q2." ] }, { "name": "William P. Boltz", "speech": [ "Yeah. Hi, Eric. In regards to the pricing strategy, as we've shared with you before, our intention has always been to change the pricing strategy at Lowe's and get to be more of an everyday competitive price program and so that we really started a year ago, it continues into 2020. So as we look at Memorial Day, Memorial Day can be very consistent in how we operated in Q1. And as we get into the back half of Q2, with July 4th and Father's Day, we'll get again trying to implement the pieces in the place that the pricing strategy more of a normal cadence from being relevant for dad and being relevant for the holiday on July 4th. So that's how we're going to approach the quarter." ] }, { "name": "Marvin R. Ellison", "speech": [ "And Eric, the last point I'll make it, and I think Dave will close with a comment is, I mean, at the end of the day, we want to be a value-oriented retailer, but we don't want to be promotional. I think that's what -- just the point that Bill has said from his very first day here. So you may not see us using traffic-driving media to get incremental footsteps in the store in this unique environment that we're operating in, but when the customers come in, we want them to see a value on the shelf, because if there is a time that you ever needed a value for customers, this is one of those times. But we will be very cognizant and conscious of not driving traffic in an environment where that may put people at risk, something that we're going to balance really well.", "Dave?" ] }, { "name": "David M. Denton", "speech": [ "Yeah. And to Marvin's point, obviously, there is a lot of value in our stores, the items that we sell. And if you just look in the rearview mirror and you look at the number of items that we promoted this year versus the number of items that we sold on promotion last year were down about 24%." ] }, { "name": "Eric Bosshard", "speech": [ "Okay. That's helpful. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Kate McShane with Goldman Sachs. Please proceed with your question." ] }, { "name": "Kate McShane", "speech": [ "Hi, good morning. Thanks for taking my question. I just wondered with regards to customer acquisition, do you have an idea of how any newly acquired customers broke down between DIY and Pro during the first quarter? And have you seen repeat purchasing from these customers?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Kate, this is Marvin. That's really good question. What I will tell you is that this was such a unique quarter and we were so focused on first and foremost, making sure that we were looking into the health and safety of our associates and our customers, that is not a data set that we spent a ton of time looking at. Candidly, as I said in my prepared comments, the moment we started to address the challenges of COVID-19 for our associates and customers, we became less focused on the financial performance of the company and became more focused on trying to provide the essential products that our customers and communities needed. I'm sure we can get that data and we can probably share and I'm sure the Investor Relations team can get it for you, but we were just so focused on just trying to run this business, serve our customer, serve our communities and keep our associates safe. There are a lot of data sets we didn't pay a lot of attention to this quarter." ] }, { "name": "Kate McShane", "speech": [ "Okay. And just as a follow-up and unrelated. I realized comps are very, very strong, but are you still seeing the stronger trend in the better and best categories versus the good categories and have there any signs of trade down by the Pro?" ] }, { "name": "Marvin R. Ellison", "speech": [ "No. Average ticket remains strong. We have seen no trade down. Our customers' segment has been surprisingly resilient. And as I stated earlier, customers have rediscovered Lowe's. We know that for a fact, but again, patterns have been strong. They have been very consistent and we're continuing, as you can imagine to track it on a day-by-day, hour-by-hour basis, so we can make the necessary adjustment." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "David M. Denton", "speech": [ "Michelle, we're going to take one more question, please." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Christopher Horvers with JPMorgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning. So two margin questions. First, Dave, on the gross margin, up 150 year-over-year. When you think about the lower promotions and the mix benefit, how did the underlying expansion play out relative to your plan?", "And then in an environment hypothetically, where the category goes flat or let's say down low-single digits in the back half of the year, because the recession lingers longer. How do you think about SG&A dollar growth or payroll deleverage in that sort of environment, given the strong flexibility that you've shown over the past 18 months? Thank you." ] }, { "name": "David M. Denton", "speech": [ "Sure. So I'll take gross margin and I'll flip to Joe talk a bit about SG&A. I think obviously from a gross margin perspective, in my prepared comments, we made really nice progress. I think maybe the best way to look at it is in February. So when we entered the year, we were actively running our playbook, we had worked between finance and merchandising to improve our cost complement and partner more deeply with vendors to manage our promotional cadence more effectively. And I think we're largely hitting our plan if not, probably a little bit in advance of our plan is we went into February. Obviously, we got turbocharged a bit from a gross margin expansion perspective due to COVID in the back half of the quarter. But I feel like the underlying elements that we put in place are driving really solid performance there. We still have work to do, we're not done. This is a marathon, not a sprint. But I think we have the right pieces together to play out and improve our margin performance both in the short-term, but the long term.", "And maybe I'll flip it to Joe to talk a bit about SG&A." ] }, { "name": "Joseph M. McFarland III", "speech": [ "Yeah. Thanks, Chris. So from an SG&A standpoint, the team did a really nice job in Q1. Obviously, as Dave had mentioned. And as we look forward with the continued strong sales, we have a rule of thumb based on sales outperformance and payroll leverage. But in addition, the hard work that the ops team has done, putting new engineered labor standards in, the labor engine that the team built, the mix between ticket and transactions and we're very confident in our ability to continue to leverage on SG&A." ] }, { "name": "Marvin R. Ellison", "speech": [ "Great. Thank you very much for calling in today in and talking about Lowe's. Please stay safe and healthy." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
LOW	2023-05-23	[ { "description": "Vice President, Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "Brandon Sink", "position": "Executive" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Jonathan Matuszewski", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steven Forbes", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies first quarter 2023 earnings conference call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I'll now turn the call over to Kate Pearlman, vice president of investor relations and treasurer." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you and good morning. Here with me today are Marvin Ellison, chairman and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president, stores; and Brandon Sink, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we'll be making comments that are forward-looking, including our expectations for fiscal 2023.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties, and important factors, including those discussed in the risk factors, MD&A, and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found on the quarterly earnings section of our investor relations website.", "Now, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate, and good morning, everyone. In the first quarter, our comparable sales declined 4.3%, driven by approximately 350 basis points of lumber deflation, unfavorable weather, and lower DIY discretionary sales. We continue to build momentum with the Pro through our MVPs Pro Rewards Program and our expanded assortment of Pro national brands. Lumber deflation disproportionately impacted Pro sales by approximately 800 basis points of comp pressure.", "And despite this pressure, comparable Pro sales were slightly positive in Q1 with broad-based strength across multiple categories. This positive comp in Pro builds on top of a 22% U.S. Pro comp in the first quarter of last year. DIY sales were pressured by delayed spring and lower-than-expected discretionary demand, although we are encouraged to see better trends in periods of favorable weather.", "A late start to spring disproportionately impacts do-it-yourself customers who represent 75% of our business given many seasonal categories are heavily concentrated in DIY. As the weather improves, we're optimistic that customers will reengage with spring projects, and we are ready to support the increased demand with our best in-stock position and staffing levels in three years, coupled with improved omnichannel and fulfillment capabilities. However, we are expecting a pullback in discretionary consumer spending over the near term. Given these trends, we're updating our full year outlook this morning.", "Despite market pressures, we are pleased to see market share gains this quarter, and we expect to continue to outpace the market as we execute against the growth initiatives of our Total Home strategy. We're also confident in our ability to drive continued productivity through our perpetual productivity improvement initiatives or PPI. This operational discipline and agility helped us to offset the impact of lower sales and higher wage costs in Q1. Adjusted operating margin expanded 47 basis points in the first quarter, leading to adjusted diluted earnings per share of $3.67, a 5% increase compared to last year.", "While we can't control commodity deflation, weather, or macroeconomic uncertainty, we can control how effectively we operate our business and adapt to a changing environment. A key component of our transformation that is often overlooked is the culture of continuous improvement we've introduced at Lowe's, which is the foundation of our perpetual productivity improvement initiatives. And although our PPI initiatives originated in store operations, we're now focused on driving productivity across all areas of the company. And we see tremendous runway ahead for continued productivity across the business, including dozens of PPI work streams in merchandising, store operations, supply chain, and corporate support functions.", "As an example, we're replacing our 30-year-old operating system with a modern omnichannel architecture that will enable a seamless, intuitive customer experience while removing complexity for associates. This project has been underway for four years, and we are pleased that we are on track to retire all legacy green screens by the end of this year. This new modern operating system will allow us to unlock a significant amount of labor productivity and deploy new capabilities, including enabling more seamless omnichannel selling from within our stores. In addition to our new operating system, our penetration of rural stores gives us an opportunity to drive sustainable profit growth due to the much lower expense base that's required to operate these stores.", "As an example, what we spend to operate our store in Philadelphia, Mississippi is significantly less than the cost to operate one of our stores in Philadelphia, Pennsylvania. While in years past, our penetration of rural and remote stores was viewed as a competitive disadvantage, we now expect that these stores will be a key component of our operating profit growth over the next three to five years. Given our confidence in this trajectory, we set long-term targets of $1.5 billion to $2 billion in incremental productivity gains at our December Analyst and Investor Conference. And we are tracking our progress against those initiatives on a monthly, if not a weekly basis.", "In addition to our disciplined focus on productivity, this quarter, we also continue to make strides with our Total Home strategy. And in Pro, our growth was fueled by continued acceleration of our MVPs Pro Rewards Program and CRM tool, coupled with our improved Pro assortment, inventory depth, and omnichannel capabilities. These initiatives have enabled us to continue to gain traction with our core Pro customer, which is a small- to medium-sized Pro. Joe will discuss some of the exciting new Pro initiatives later in the call.", "Online sales also accelerated this quarter with 6% comparable sales growth, representing more than a 10% sales penetration. Online growth was supported by an increase in Pro sales as we continue to upgrade our Pro digital experience with new tools and personalization. We also continue to enhance our DIY online experience by making home improvement projects easier for consumers to visualize, estimate, and shop. And these investments are paying off with higher online conversions and attachment rates.", "In supply chain, we continue to roll out our market delivery model, bringing us to 12 geographic regions across the country, supporting more than 1,100 stores. And we're pleased that this more efficient model of delivering big and bulky products is already enabling us to accelerate our market share gains in appliances and will enable future growth in other big and bulky product categories. And we remain on schedule to have market delivery rolled out by the end of 2023. And despite the macroeconomic environment with mixed signals creating near-term pressures, we remain optimistic about the future of home improvement.", "And once we navigate through this uncertainty, we remain bullish on the long-term outlook for our industry due to the unique convergence of structural drivers and demographic trends that are supportive of home improvement demand. And we feel fortunate to operate in such a favorable sector of retail where two-thirds of our sales remain nondiscretionary. And as we navigate this near-term pressure, we will continue to monitor trends closely, and we are confident that we have the agility needed to quickly adapt to any scenario. In closing, I'd like to thank our front-line associates for their continued hard work and dedication to supporting our customers and our communities.", "And with that, I'll turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. During the first quarter, five of our 14 merchandising categories were positive: building materials, rough plumbing, paint, hardware, and appliances. We continue to see broad-based Pro strength across all three merchandising divisions. In home decor, paint and appliances delivered the strongest comps this quarter.", "Our momentum in appliances continues to build as we drove higher unit sales and work to continue to take market share by leveraging our improved omnichannel shopping experience, enhanced market delivery capabilities, and expanded assortment. Appliances are a great example of an omnichannel category where customers often compare options online, then visit our showroom to see products in person, and then get their questions answered by one of our appliance specialists. And with our improved online capabilities like easy scheduling and order tracking, we continue to see more and more of our customers getting comfortable completing their purchases online. In the U.S., we estimate that roughly 100,000 appliances break every day.", "So, our investments in fast appliance delivery and a seamless omnichannel shopping experience positions us well as the go-to destination for these urgent and often nondiscretionary needs. We are also seeing increased demand in paint, especially from our pros who paint as they take advantage of our paint job site delivery, our MVPs Paint Rewards Program, and our improved product assortment. This quarter, we took the next step in catering to these important customers by launching Spec Right Interior Paint in partnership with Sherwin-Williams. This is our first exclusive line of tintable paint formulated specifically for pros.", "Within decor, we recently launched new closet organization solutions across four private brands to meet a range of storage needs and budgets. This includes modular, easy-to-install wood or wire closet systems that are modern, customizable, and a far better value than the competition. Our private brand strategy allows us to deliver value to DIY customers who are looking for high-quality, on-trend products at more affordable price points, which enables us to provide differentiation, loyalty, and profitability. Turning to building products.", "Building materials and rough plumbing led the way. In building materials, we saw broad-based strength, reflecting the investments we made to improve our Pro offering through an enhanced assortment. You may remember, last year when we announced a new 10-foot fiberglass rebar known as PINKBAR by Owens Corning. This product exceeded our sales expectation given its strength, lightweight materials, and corrosion resistance.", "This year, we're building on that success with the new 20-foot PINKBAR product designed to help pros reinforce bigger structures using fewer connections, ultimately saving them time and money on material costs. Rough plumbing was driven by strength in water heaters, HVAC, plumbing repair, and pipe and fittings as we continue to strengthen our offering for the Pro and the DIY consumer in these categories. And while lumber comps were pressured by steep year-over-year lumber deflation, the category had the highest unit comp in the company this quarter, reflecting strong Pro demand. We are pleased with our continued enhancements to our strong assortment of Pro products from trusted brands like Bosch, DeWalt, Eaton, Estwing, FastenMaster, FLEX, GRK, Hubbell, ITW, Klein Tools, Lesco, Little Giant, Lufkin, Mansfield, Marshalltown, Metabo, SharkBite, Simpson Strong-Tie, SPAX, Spyder, and Werner.", "In hard lines, our performance was pressured by the delayed spring, some volatile weather in the West, and softer discretionary spending. However, we did see higher demand during periods where weather improved. In lawn and garden, we proactively partnered with our live goods vendors to increase our agility in responding to changing weather patterns, which was critical in a season marked by erratic weather. Our live good vendors play a key role each spring as we continue to refine our local offerings, in addition to the timing of when product arrives to our stores.", "This year, they help support our new Green Vest program, where our merchandising service team, or MST associates, along with support from our vendors, now provide service to our garden centers, taking the task off the shoulders of our Red Vest associates to allow them to focus on serving the customer. We also continue to expand our private brand offering, including a full lineup of new and innovative lawn fertilizers and grass seed products through our Sta-Green brand, which is already exceeding our expectations. And in hardware, in addition to delivering a positive comp, we also saw strong attachment rates, alongside the higher lumber unit sales and strength in building materials, powered by the improved assortments of the key fastening brands like SPAX, GRK, FastenMaster, ITW, and PowerPro One. As we continue to enhance our assortments at a national level, we also continue to advance our localization work.", "This is a key pillar of our Total Home strategy, with the goal of expanding market share, increasing inventory productivity, and protecting our margins. We have been piloting a localized framework for a few common market categories like rural and urban stores. Today, I'm excited to announce we are now scaling our rural framework to as many as 300 additional stores by year-end, with a wider offering of farm, ranch, and outdoor products that positions Lowe's as a one-stop shop to make it convenient for rural customers to get what they need in one shopping trip. Our rural format includes broader product offerings and categories such as pet, livestock, trailers, fencing, utility vehicles, specialized hardware, and our new Carhartt apparel, all designed to meet the unique needs and preferences of rural homeowners who work and play outdoors.", "Given our rural store footprint and long-standing relationships in these communities, we see this as a natural opportunity for our business and one that will simplify the shopping experience for these very valuable customers. And as Marvin mentioned, we see the productivity improvements in these stores as a key component to delivering sustainable growth in our operating profit. We also remain focused on our many merchandising PPI initiatives, including leveraging our modernized cost optimization tools to negotiate costs with vendors. And we're getting more strategic and surgical in our inventory planning to focus on more high-velocity core inventory items with low markdown risk like Pro replenishment and fewer slow-velocity SKUs.", "From a technology standpoint, in the first quarter, we completed the rollout of new dedicated Zebra smartphones for all MST associates ahead of schedule. These devices are equipped with the new MST app, designed to optimize their time, with technology that leapfrogs the competition. The system automatically prioritize planogram changes, pricing updates, base service, and other projects to optimize associates' time on the most efficient, highest-value next task. And it also gives associates step-by-step instructions to maximize productivity and minimize the learning curve for new associates.", "This app was built internally to seamlessly integrate with our other mobile apps. For example, each time an MST associate resets a bay, the product location automatically updates in our associate product app and our customer mobile app, so both associates and customers can quickly find what they're looking for. As I close, I'd like to again extend my appreciation to our vendors and our merchants for their partnership, hard work, innovation, and continued support. Thank you.", "And I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thank you, Bill, and good morning, everyone. At Lowe's, we are committed to being the employer of choice in retail, where associates choose to build their careers. As a reflection of this commitment, over the last three years, we have increased the hourly rate for our store associates by 20%. And since 2018, we have invested over $3 billion in incremental wage and share-based compensation for our front-line associates.", "As a result of our consistent and ongoing commitment to our hourly associates, we are seeing our best staffing levels in three years, improved retention, and the highest customer satisfaction scores in our company's history. In addition to compensation, we are also taking other steps to show appreciation to our associates, including simple initiatives like lowering the prices of the food in our store break rooms and closing our stores on Easter for the fourth consecutive year. These expressions of appreciation may not sound overly complex, but to our hourly associates, they matter. As a former hourly associate, one way I measure improved associate engagement is by tracking the number of people who transition their jobs into careers.", "More than 85% of leadership roles are now filled from within, up nearly 700 basis points over the last two years. Our front-line associates deserve all the credit for the transformation of our company, and I would like to personally thank all of our associates for everything they do to support each other, our customers, and our communities. Now, let me transition to Pro, one of the highlights in the first quarter. I'm excited to announce that we just launched new Pro online Business Tools, the latest enhancement to our MVPs Pro Rewards Program, which is designed to make pros of all sizes feel like MVPs at Lowe's.", "Through our surveys, we learned pros would welcome time-saving tools that help them shop quickly and minimize time away from the job site. At the same time, we learned our Pro associates spend a lot of time building quotes and checking order status, tasks that take them away from serving customers in their stores. To solve for both needs, we launched a suite of tools on lowes.com and our mobile app that make it easy for pros to manage their orders from anywhere, whether that's on the job site, at home, or out of town. Rather than having to drive to our stores to get a quote, pros can now build and update online quotes in minutes.", "It automatically applies their volume savings pricing and discounts and lets them quickly download a PDF quote for their customers. They can also use order tracking to track the status of the order throughout the fulfillment process. Pros tell us they love how easy and simple these tools are. In one pro's words, he appreciates the convenience of being able to get a price, get it ordered, and get it done.", "While these tools just launched in April, we are already seeing better-than-expected adoption rate and sales growth and expect results to accelerate as more pros discover the new features. Our traction with pros online is just one example of the momentum we are seeing in our MVPs Pro Rewards Program and one of the reasons we delivered a positive sales comp in Pro for Q1. Pros enrolled in our loyalty program continue to shop more frequently and buy more per trip and spend more overall. As our CRM tool matures, we are using data insights to identify trends that can improve our marketing and sales strategy, including tailoring our offerings by trade and by tier.", "These improved Pro capabilities and offerings are reflected in our Pro customer satisfaction scores, which are up 200 basis points over last year. In our April survey, over 75% of pros continue to say their backlogs are healthy. While the Pro backlogs remain consistent with recent quarters, pros did report a shift to smaller project sizes. Moving on to productivity.", "We continue to scale a series of perpetual productivity improvement initiatives or PPI. First, we remain laser-focused on technology modernization across all areas of our stores, including rapidly replacing legacy self-checkout systems with our proprietary self-checkout registers. We are encouraged to see higher customer adoption, throughput, labor productivity, and customer satisfaction on these registers, and we'll complete all remaining stores later this year. We've also matured our new store inventory management system, or SIMs, which continues to improve our inventory visibility and operational efficiency.", "It also fully integrates with the mobile apps Bill just mentioned, reducing the time both associates and customers spend searching for product. We also continue to enhance our pickup-in-store experience to streamline processes and enhance technology. These improvements drove faster fulfillment and a 400-basis-point increase in pickup-in-store customer satisfaction scores in the first quarter. As we approach Memorial Day, I'd like to thank any veterans listening in for their service.", "As a Marine who served combat tours in the Gulf War and Desert Storm, I'm proud of Lowe's long-standing history of giving back to our military community, including a 10% military discount. And we are proud to support these customers who have given so much to our country. As I close, I would like to thank all our store leaders and associates once again for their hard work to serve customers, drive results, and improve this business each and every day. And with that, I'll turn the call over to Brandon." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Joe. Beginning with our Q1 results. We generated GAAP diluted earnings per share of $3.77, compared to $3.51 last year. Now, my comments from this point forward will include certain non-GAAP comparisons, where applicable.", "Non-GAAP measures have been adjusted to exclude the gain associated with the sale of our Canadian retail business. In the quarter, we recognized a net pre-tax gain of 63 million on deferred consideration associated with the sale of our Canadian retail business. Excluding this benefit, we delivered adjusted diluted earnings per share of $3.67, an increase of 5% compared to prior year. Q1 sales were 22.3 billion, which includes approximately 735 million related to a shift in our fiscal calendar as we cycle over a 53-week year.", "Also, as a reminder, prior-year sales included $1.2 billion generated in our Canadian retail business. As Marvin mentioned, comparable sales were down 4.3%, partly driven by a later start to spring and a more cautious consumer. This also includes approximately 350 basis points of lumber deflation. Please note that comparable sales are calculated based on weeks two through 14 in fiscal 2022.", "Comparable average ticket was down 0.3%, largely driven by lumber deflation as ticket increased in the majority of our other merchandise divisions. Comp transactions declined 4% due to the delayed start of spring and lower-than-expected DIY discretionary sales. Our monthly comps were down 3% in February. With unfavorable weather patterns across the country in March and April, comps declined 5.4% and 3.9%, respectively.", "Lower sales in seasonal categories pressured sales by approximately 400 million in the quarter or approximately 175 basis points. Gross margin was 33.7% of sales in the first quarter, down 35 basis points from last year. Gross margin benefited from a favorable product mix, offset by costs associated with the expansion of our supply chain network. There was no meaningful impact from shrink or credit revenue in the quarter.", "Also, keep in mind that product margin in the prior-year quarter reflected a timing benefit driven by product cost inflation. Adjusted SG&A of 17.4% of sales leveraged 79 basis points. As Marvin mentioned, this performance reflects an enterprisewide disciplined focus on PPI that helped offset pressure from lower sales and wage investments. It also includes the benefit of a one-time legal settlement.", "Adjusted operating margin rate of 14.4% of sales leveraged 47 basis points. The adjusted effective tax rate was 23.6%, in line with prior year. Inventory ended the quarter at 19.5 billion, down 0.7 billion compared to Q1 of last year. As a reminder, prior-year inventory levels includes our Canadian retail business.", "U.S. inventory units finished the quarter slightly down to last year. Now, turning to our 2023 financial outlook. Given the higher-than-expected pullback we've seen in home improvement spending, we are now expecting our relevant market, which reflects our 75% DIY, 25% Pro mix, to be down mid-single digits this year.", "But while we are seeing lower-than-expected DIY discretionary demand, we are also driving better-than-expected results in Pro and continued strength in our online sales and core categories like appliances and paint. This reinforces our confidence that we will continue to take market share and outperform the broader market. We are now expecting 2023 sales of 87 billion to 89 billion, with comparable sales expected to range from down 2% to down 4%. Please note that the updated outlook also reflects the impact of lower-than-expected lumber prices.", "This creates an incremental 50 basis points of pressure on full year sales as compared to our original expectations. We continue to expect Pro to outpace DIY for the year as Pro backlogs are healthy and demand for Pro services remains strong. We now expect adjusted operating margin in the range of 13.4% to 13.6% for the full year, driven by PPI initiatives across the company, partly offset by planned wage investments and lower sales volumes. We expect capital expenditures of up to 2 billion this year.", "And with our planned share repurchases, we expect to reach our 2.75 times leverage target by the end of the year while maintaining our BBB+ credit rating. Finally, we are also updating our outlook for adjusted earnings per share in a range of $13.20 to $13.60. Keep in mind that our outlook for operating margin and diluted earnings per share are now adjusted to exclude the gain associated with the sale of our Canadian retail business that we recorded in the first quarter. To assist you with your modeling, I would like to spend a moment discussing our expectations for the second quarter.", "We're expecting an approximately $400 million headwind to sales due to the timing shift in our fiscal calendar. We also expect lumber deflation to pressure Q2 sales by approximately 150 basis points. Finally, we expect 250 million benefit to sales from the delayed spring. Taking all of this into account, we are expecting Q2 sales toward the higher end of our full year guide.", "We are also expecting adjusted operating margins slightly above prior-year results, partly due to the impact of the shift in our fiscal calendar, as well as the timing of several productivity initiatives that are already in flight. Turning to our capital allocation strategy. During the quarter, the company generated 1.7 billion in free cash flow. We repurchased 10.6 million shares for $2.1 billion and paid $633 million in dividends at $1.05 per share, returning $2.8 billion to our shareholders.", "Capital expenditures totaled 380 million in the quarter as we continue to invest in our strategic growth initiatives. We ended Q1 with 3 billion of cash and cash equivalents, which includes proceeds from our 3 billion notes offering in March. We ended Q1 at 2.62 times adjusted debt to EBITDAR. Finally, we delivered return on invested capital of 28%, inclusive of a 725-basis-point impact related to transaction costs associated with the sale of our Canadian retail business and the discrete gain in Q1.", "In closing, we are confident in our ability to execute our Total Home strategy while navigating near-term market uncertainty, and we remain committed to our best-in-class capital allocation strategy, centered around delivering sustainable shareholder value. And with that, we will open it up for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We are now ready for questions. [Operator instructions] Our first question is from the line of Liz Suzuki with Bank of America. Please proceed with your questions." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you. So, I think, previously, we had heard a lot of focus on higher sales per square foot as the main driver of operating margin improvement. Now, I think you guys are talking more about the benefits of operating in lower-cost markets like the more rural stores.", "So, presumably, those stores have lower sales per square foot than your stores in more densely populated markets. So, how are you thinking about geographic mix and potential for store expansion going forward if those more rural areas are now looking more attractive?" ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Liz. This is Marvin. I think it's more in tune with what Bill talked about with some of the investments we're making in those rural stores. As we surveyed those customers, they gave us a list of things they wish they could purchase in one shopping occasion.", "And some of those types of things like Carhartt apparel, farm and ranch types of items and categories as part of our expansion opportunity. And we think by doing those types of initiatives, we're going to see sales per square foot actually improve. As a matter of fact, when we look at the pilot stores where we've been very diligent on going after those specific categories, we actually saw that within the pilot locations. And so, that is leading us into this, you know, roughly 300 store expansion of these extended categories.", "And we just see this as a unique opportunity. I've mentioned that the expense base is lower, but as you said, if you can have a lower expense base, then you can improve sales per square footage. That and in combination of all the other initiatives we're doing around the company, we think, will continue to drive our profit growth. And I'll let Brandon add any additional comments." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Good morning, Liz. This is Brandon. Just as we think about the capex, as Marvin mentioned, we're not necessarily looking at opening stores over the long term as really part of our core strategy.", "But we love what we're seeing with these rural stores. We initially piloted on a smaller subset of locations. We love the profit profile of these stores within these rural markets, and we've been very thoughtful around the assortments and where we're rolling out. I'm really excited to see this scale as we move through 2023 and what this can deliver from a top-line perspective beyond that." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thanks. And in those stores, just as a follow-up, are you seeing online penetration that's similar to your overall company average or is it a little bit lower or is it higher? Just curious if there's any difference in the online mix." ] }, { "name": "Marvin Ellison", "speech": [ "Liz, it's about the same. But, you know, I mentioned in my prepared comments that we're retiring this old legacy operating system. And by retiring this system, it opens up the ability to have really true omnichannel selling in the store. So, we see omnichannel and e-commerce growth only accelerating with the ability of our 300-plus thousand associates having the ability to more easily transact in the store, thus connecting physical and digital in a more seamless way." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Christopher Horvers with J.P. Morgan. Please proceed with your questions. Christopher Horvers, your line is open for questions, Mr.", "Horvers. Perhaps you're muted. OK. Now, I'm going to move on to our next question, which is coming from the line of Simeon Gutman with Morgan Stanley." ] }, { "name": "Simeon Gutman", "speech": [ "Hey. Good morning, everyone. Can you hear me?" ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. We can, Simeon." ] }, { "name": "Simeon Gutman", "speech": [ "OK. Good. My question is, first, I'm trying to sort out the guidance. If you take the Q2 through Q4, what's embedded both for sales and margin, is that roughly the same as what it was, call it, when you guided the year, or has anything changed?" ] }, { "name": "Brandon Sink", "speech": [ "Simeon, thanks for the question. This is Brandon. Let me just kind of speak a little bit to the curve, specifically. When we look at Q2, as I mentioned in the prepared remarks, expecting Q2 sales toward the higher end of the full year guide.", "That's inclusive of the $250 million delayed spring benefit, offset by the 150 basis points lumber deflation and then the $400 million week shift drag. As we start to transition and look at the second half, we do expect the Pro business is going to continue to outperform and drive our growth. We mentioned that backlogs remained healthy, and we expect that business to continue to outpace DIY. The lumber inflation is -- or deflation is going to moderate as we start to look at the second half and we cycle over more normal pricing over the balance of the year and then continued strength in what we're seeing with the online business and in core DIY businesses like appliances and paint.", "So, taking all that into account, when we look at the second half, we're looking at that in line with the full year guide." ] }, { "name": "Simeon Gutman", "speech": [ "That's helpful. Thanks. And then maybe to follow up, sticking with the guidance. If you look at whether it was the weak or even the moderate cases beforehand, margins were going to hold up reasonably well for a couple of reasons, a lot of it your internal initiatives.", "Those drivers that were holding up margin, are those the same? Are you on a faster trajectory? Are you pivoting? Are you prioritizing some over the other? If you could share some of that, please?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Simeon, largely the same. Roughly flat is what we've spoken to as it relates to gross margin over the course of the year. The puts and takes that we've talked through are still relatively consistent: the headwinds from the supply chain expansion and investments in the Pro growth initiatives; the benefits, and Bill covered this when he talked through merch productivity; higher private brands penetration; lower commodity transportation costs; and then the pricing initiatives that we're working through.", "So, those largely are going to drive the outputs. And then just from an SG&A standpoint, that's where we're going to see the bulk of the leverage, 40 basis points to 60 basis points reflected in the new guide that's going to offset the planned wage increases in the strategic investments. And then on the lower sales, just the change from the previous guide, it's mainly volume related." ] }, { "name": "Simeon Gutman", "speech": [ "OK. Thanks, everyone. Good luck." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Simeon." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Steven Zaccone with Citigroup. Please proceed with your questions." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Good morning. Thank you for taking my question. I wanted to focus specifically on the second quarter guidance, just since weather has been so volatile.", "Is there any more detail you can provide about how the business is trending thus far in May would be helpful." ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Steven. This is Marvin. I'll take that. So, Steven, we would basically describe it as in line with our current guidance.", "The good news is as we've seen periods of more sustained seasonal weather, we've seen those seasonal categories respond in line to that. And that's geographically specific around west, south, north, and east. But May is performing basically at our current guidance." ] }, { "name": "Steven Zaccone", "speech": [ "OK. Appreciate that color. Then, Marvin, I'm curious for your perspective on the potential duration of this weakness we're seeing in discretionary spending. You know, what's your take on how long this potentially could last? There's a lot of macro crosscurrents at play.", "So, just curious for your opinion." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. It's a really good question. And really, to be quite honest with you, as you can imagine, we spent a lot of time looking at it, but it's just hard to predict. What we can say is that the overall structural drivers for home improvement remain really strong.", "And so, we are bullish to the medium- and long-term health of this business. You know, things like the savings rate of consumers, and you're looking at pent-up demand in the housing, shortage, the age of homes. I mean, all of these things are still incredibly relevant. And when you think about the highest correlating factors to our sales, historically, they remain disposable personal income, home price appreciation, and the age of housing stock.", "So, although we can't predict the duration of what we think will be a more short-term turbulence, we think the medium- and long-term health of this segment is incredibly strong." ] }, { "name": "Steven Zaccone", "speech": [ "OK. Thanks for the detail. Best of luck for the remainder of spring." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Brian Nagel with Oppenheimer. Please proceed with your questions." ] }, { "name": "Brian Nagel", "speech": [ "Hi. Good morning. My first question, Marvin, you know, just maybe a bit of a follow-up on the prior question, but just with respect to the commentary around discretionary. Maybe would you give a little more color on what you're seeing and how do you think about this weakness in discretionary relative to some of the weather disruptions? And then if you look here at Q1, is there anything really noticeably different than what we saw maybe in Q4 on the discretionary side?" ] }, { "name": "Marvin Ellison", "speech": [ "So, while I'll give you some thoughts, I'll let Brandon jump in and provide any additional thoughts. But candidly, what we're seeing is pressure across the big ticket discretionary purchases, primarily. We're seeing some pressure in small ticket, but it's more pronounced in big ticket and it's almost exclusively discretionary at DIY. As you know, 75% of our business is penetrated in the DIY customer, and Q1 is our most discretionary quarter of the year because of all the seasonal purchases.", "So, when we run into, you know, timing of unseasonal weather, it has a disproportionate impact on our business. So, we've been trying to pull apart the difference between discretionary pullback and weather-related nonspending. And so, as we look at the month of May, as an example, we can start to see more clarity that when the sun comes out and the weather gets some more normalized, you know, kind of performance, as you would expect, the business in those discretionary categories have picked up. So, that's why Brandon noted that we have an expectation we're going to get roughly 250 million back from delayed spring.", "So, for us, we're seeing discretionary big ticket pullback primarily in DIY. The other good news for us is because our Pro consumer and our target consumer is that small- and medium-sized customer, that customers backlog remains healthy, and that customer spend has been relatively consistent. That's why we're able to positive comp in Pro for the quarter with over 800 basis points of lumber deflation specifically for that consumer. Brandon, I don't know if you'd add anything else." ] }, { "name": "Brandon Sink", "speech": [ "Brian, this is Brandon. I think just looking out a little bit beyond the weather that Marvin just spoke to and we look at this topic of normalization, home improvement share of wallet, definitely seeing normalization back to services in terms of where discretionary purchases are going from consumers, travel, restaurants and a shift back to some necessity-based spend, groceries, gas, taking up a larger share of wallet given the inflation that we're seeing. But just as we look at the business at a broad level, units, transactions, well documented back and below, in some cases, to 2019 levels. But as Marvin mentioned, really, nuances within that.", "We're seeing Pro categories, in particular, building materials, rough plumbing, lumber has been a great story with what we've been able to drive with units, and then categories like appliances where we've continued to grow units and share. So, all that combined, we are very optimistic in the medium to longer term that the categories where we've seen reversion or normalization, we've got a new baseline there to which to manage the business. And then in these other categories that are out running, we can continue confidence that we can continue to take share there." ] }, { "name": "Brian Nagel", "speech": [ "That's very helpful. I appreciate it. And maybe a follow-up separately. Interesting comments about your rural stores and your strategy there.", "Anything you could say to help us better size this opportunity? Where are those -- the volumes of those units now versus maybe the chain average or some of your larger volumes? And then as you think about this remerchandising effort, I mean, how much could that add and over what time frame to store volumes there?" ] }, { "name": "Marvin Ellison", "speech": [ "Brian, what I'll do is I'll let Bill give you just some specifics on some of the categories that we're adding. And again, we piloted this for over a year to get the mix right, to get the assortment right. And we came away extremely pleased with the pilot results. And thus, we identified roughly 300 stores that we're expanding this to.", "But I'll let Bill give you some specifics on those categories and what we believe that we can get from them." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. Brian, this is Bill. And so, in my opening remarks, I mentioned some of these key categories in areas like pet. And we think there's an opportunity in these rural markets to do more in that category.", "There's opportunities with apparel. And so, the launch of our Carhartt -- the Carhartt brand, Wrangler brands, you know, gives us an opportunity to do something there in those markets. And then you think around livestock. And really, livestock feed is the consumers looking for options from us to be able to serve that consumer.", "And then you can get into areas like fencing and some of these small pens that folks will use. And we're finding some interesting things with, you know, water troughs that are being used, you know, certainly to water livestock, but they're also being used as a decorative piece for consumer's home where they're planting flowers in it. So, just a lot of interesting stuff that we're starting to learn here that the customer has given us a lot of credit for and wants to see Lowe's carry in their community. And that was part of the early pilot in those few stores that has allowed us to accelerate to get it to 300." ] }, { "name": "Marvin Ellison", "speech": [ "And, Brian, this is Marvin again. Just the last point on that. You know, both Bill and I grew up in rural parts of the country. Bill in rural Montana.", "I grew up in rural Tennessee. And I think rural Tennessee is actually more rural than rural Montana, but that's for another discussion. We're seeing things like ATVs. We pilot it, having no idea if customers will respond.", "And it's been an incredible growth category for us. And in these rural markets, they're responding really well. So, a lot of learning. But what's also interesting is we're finding categories in these rural stores that we think will be relevant in nonrural locations, and that's been the beauty of this entire pilot and the strategy.", "And we'll continue to learn. But I'll just repeat what I said in my prepared comments. Many of us, including me and many in the marketplace, perceive these rural and remote stores as a true competitive disadvantage to Lowe's, but we've now determined that that is the opposite. We think that these stores give us incredible opportunities to not only grow top line with more improved sales per square foot but also just the operational profit opportunity with improved technology, improved omnichannel capabilities, improved efficiencies.", "I mean, this is something that we're very excited about over the next, call it, three to five years." ] }, { "name": "Brian Nagel", "speech": [ "Very helpful. I appreciate it. Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Brian." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question is from the line of Seth Sigman with Barclays. Please proceed with your questions." ] }, { "name": "Seth Sigman", "speech": [ "Hey, everybody. Good morning. I wanted to just follow up on the May comment. I think you said it was consistent with guidance.", "I just want to clarify, does that mean consistent with the comment that Q2 would be at the upper end of the range? And then I think if you step back for a second, your original guidance had assumed some sequential improvement in the second quarter. Can you just remind us what some of the drivers of that were going to be? Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "So, I'll take the first part on May. We tend not to give specific detail on current trends for all the obvious reasons, and so I'll leave my comments at May is performing at guidance and we feel good about what we've seen, areas of sustained weather and how our seasonal categories are responding in those geographic locations, and that's reflective of May's performance. And with that, I'll let Brandon answer the second part of your question." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Sure. Seth, just consistent with the upper end of guidance is what we referred to. And just the components, again, the $250 million delayed spring benefit, the lumber deflation is going to step up, so a 350-basis-point pressure in Q1.", "Now expecting that to be 150 basis points in Q2. And just a reminder of the week shift benefit from Q1 is now flipping into Q2, and we expect that to be a $400 million drag. So, those are just the components again as it relates to Q2." ] }, { "name": "Seth Sigman", "speech": [ "Gotcha. OK. And then just a follow-up question on average ticket and inflation. It sounds like you still have some of the wrapping of the price increases from last year.", "But I guess, in general, how are you thinking about pricing going forward? Is there an opportunity to maybe roll some prices back? And maybe if you could tie in commentary around the elasticity that you're seeing in lumber? And I realize that category is a little bit different, but your commentary around the unit volume increase that you saw seem to be quite strong. So, maybe we just tie those two together. Thank you." ] }, { "name": "Brandon Sink", "speech": [ "So, if I can take that as well. So, when we look at the makeup in terms of ticket and transaction, as you mentioned, you know, we're seeing the pace and cost increases. Those have slowed pretty dramatically here over the course of the last couple of quarters. We are still expecting a modest level of product inflation as we look out at '23.", "Most of that is wrapped from pricing actions that we've taken in the second half of last year. We are -- ex-lumber, average ticket is actually up in most categories when we look at Q1. The lumber deflationary pressure is expected to continue to impact average ticket in Q2, but not as significant as Q1. And then when we look outside of commodities, we're not anticipating any meaningful deflationary pressure as we move through the year.", "Mainly, the pressure is going to be coming from what Marvin mentioned, the pullback in DIY discretionary, which is going to put pressure on ticket, and that's especially true in the larger ticket buckets. So, all in, the makeup of the comp and the outlook assumes more pressure overall on transactions, and we expect the average ticket number to hold up." ] }, { "name": "Seth Sigman", "speech": [ "OK. Thank you for that. Appreciate it." ] }, { "name": "Brandon Sink", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Our next question is coming from the line of Kate McShane with Goldman Sachs. Please proceed with your questions." ] }, { "name": "Kate McShane", "speech": [ "Hi. Good morning. Thanks for taking our question. Is there a view, just given that you do cater to the smaller and midsized Pro, just that you can hold up maybe a little bit better given the industry backdrop? And with regards to market share, it sounds like there were some wins there during the first quarter.", "Have your share assumptions changed at all based on that for the year?" ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Kate. This is Marvin. I'll take the first part of Pro with Joe, and then we'll let Bill and Brandon provide some market share input. I would first say, we're really pleased with our Pro strategy.", "We spent a lot of time in the last four-plus years trying to refine this strategy but also being very disciplined on not trying to overreach beyond our capabilities. And that's why the small and the medium Pro has been our target Pro customer, and we feel like we're gaining traction. Any time you can face over 800 basis points of lumber deflation and comping up against a 22% growth last year and still deliver a positive comp, I think it sends a signal that we're making progress. I'll let Joe talk specifically about a couple of the key initiatives that we rolled out that's gaining the most traction and why we feel confident that we can continue to take market share in that segment." ] }, { "name": "Joe McFarland", "speech": [ "Yeah. Thanks, Kate, for the question. And as you look at the makeup of our Pro, it is on that smaller side. And as we've rolled out our MVP Pro Rewards Program, we're really seeing the pros engage with us in our loyalty, our credit programs.", "Of course, when they are engaged there, they spend three times more than those not engaged. We've rolled out new CRM insights so we can better anticipate the pros' needs. We can build those relationships. And with the loyalty program and the CRM system, they continue to improve as they mature.", "And so, really excited about the unlock that is still ahead. Very pleased with the Pro LTR that we're seeing as a result. So, we feel we're in a good place." ] }, { "name": "Marvin Ellison", "speech": [ "And, Kate, before I hand it to Bill, I'll just add one additional thing. We did a recent survey in April of our Pro customers, and then 75% of those customers came back saying their backlogs were still healthy compared to Q4. And that gave us confidence that we still believe that we can grow market share and grow two extra market with this specific customer segment. So, Bill, you can talk about market share." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. So, when you look at market share, obviously, it's hard to measure home improvement share specifically, but we try to triangulate using data from NAICS track line, you know, other data, relevant market, and broader market data. And then we look at our performance, obviously, in key categories like we've mentioned in our prepared remarks in areas like appliances where we've had unit growth, feel like we've picking up share there, in addition to the Pro growth that we've had and the continued acceleration with our online business, gaining traction with private brands, all of that -- and those elements kind of give us confidence that we're gaining some share here in these key categories. And when you see, you know, a positive growth in areas like paint, we also feel like we're gaining share in those areas as well." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Bill, the only thing I would add is just really pleased with the execution of Total Home strategy. We talked about Pro positive comp with an 800 basis point drag on top of 11 consecutive quarters double-digit growth. Really pleased with the online performance at plus six.", "So, clearly, as we look at share gains, both for relevant market and broader home improvement, confident in what we're seeing, and it gives us confidence when we look at the broader market and our ability to grow 100 basis points to 200 basis points above the market and grow and put Pro 2x when we look at 2023 and beyond." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Kate." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Jonathan Matuszewski with Jefferies. Please proceed with your questions." ] }, { "name": "Jonathan Matuszewski", "speech": [ "Great. Good morning and thanks for taking my questions. First one was on the rural pilot. Marvin, you've talked about localization for a couple of years now.", "A lot of the commentary in the past has been removing lawnmowers in Brooklyn, patio sets in West Philadelphia, decks stain in Scottsdale. When we think about this initiative here, it feels like it's a bit more strategic, more poised to benefit the top line versus limiting markdowns from the prior localization efforts. So, if we go a bit deeper, is the benefit going to manifest itself more in terms of new customer acquisition or greater wallet share from existing customers? Presumably both, but just trying to understand kind of maybe where it may be more weighted in those pilot stores. That's my first question.", "Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "Jonathan, it's a very good question. And I think it is a combination of both, you know, because in order to add these new categories, we're taking categories out. And the categories we're taking out are the ones that were most at risk of being marked down because of the lack of localization. We had a -- what I describe as a peanut butter spread on our assortment planning because our tools were so inferior, it is almost impossible for the merchants to do any really specific localization.", "So, now we've improved our assortment planning tools. We now have the ability to execute the localization strategy as part of our Total Home strategy. And because of that, we now know what categories to pull out of these rural stores that were not productive. And now, we're adding in new categories, which will give us the ability to take the customer who's shopping us and shopping other retailers because of the lack of fullness of our assortment.", "And we're getting a larger share of wallet of that customer, and we're also attracting a new customer that's now coming in because we're selling items, i.e., pet that we didn't sell before that they are now coming to us as a destination. And so, we think this is something that has lots of potential. Not to mention, as we also implement the technology with the retiring of this old legacy system, and we can then put in self-checkout and we can put in mobile devices and all the other technology advancements that Joe and Seemantini and team have developed is going to also drive increased productivity and profitability in these stores. So, we think it's a really clear example of our strategy working.", "And it all hinges on getting the localization right. And, Bill, I don't know if you have anything to add." ] }, { "name": "Bill Boltz", "speech": [ "No. I'm just going to add, Marvin, that the early read in the test stores would tell us that we're getting our new customer coming in categories like pet, like apparel. Those are two of the -- the two categories that we had early read on that said we were drawing a new customer to the door. And so, that's exciting to see." ] }, { "name": "Jonathan Matuszewski", "speech": [ "That's really helpful. And then just a quick follow-up on regional trends. Any trends you're seeing in markets where housing prices have cooled a little bit? I think they were down a bit in April. Any discernible trends in terms of where you're seeing pressure specifically in markets with cooling home prices? Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Jonathan, as you can imagine, we're paying close attention to that. And the short answer is no. I mean, we're not seeing any disproportionate sales impacts in some of these markets.", "And we are tracking these markets very aggressively and paying very close attention to them." ] }, { "name": "Jonathan Matuszewski", "speech": [ "Best of luck." ] }, { "name": "Marvin Ellison", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. And our final --" ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, all." ] }, { "name": "Operator", "speech": [ "Please, go ahead. Kate, I'm sorry." ] }, { "name": "Kate Pearlman", "speech": [ "Apologies. Go ahead, Rob." ] }, { "name": "Operator", "speech": [ "Oh, no. I was just going to announce our final question, Kate. That's coming from the line of Steven Forbes with Guggenheim Partners." ] }, { "name": "Steven Forbes", "speech": [ "Good morning and thanks for squeezing me in. I'll ask my two together just in the interest of time. The first one, guys, can you just expand on how the first quarter Pro comp compared to your internal expectations, ex-lumber deflation? It seems like a big highlight during the quarter and wanted to know if you sort of identified what drove the outperformance, whether it's simply wallet share or accelerated new Pro growth. And then a quick follow-up is just around the progress against the opex productivity initiatives.", "Any quantification of where you are versus those opex productivity goals as of the first quarter and/or what the guidance implies for a year-end goal?" ] }, { "name": "Marvin Ellison", "speech": [ "So, Steven, I'll take the Pro question. I'll give Brandon the productivity question. The short answer is Pro did outperform our expectations. We -- candidly, we didn't anticipate 800 basis points of impact to lumber deflation for that specific customer.", "So, the fact that we were able to deliver positive comp, it actually exceeded our expectations. And I think it comes down to what you heard Joe mentioned earlier, and that is the maturity of our MVP Pro Rewards Program and our CRM tool, the increased Pro-related national brands that Bill and his team have worked to get added to the assortment, and our improved fulfillment capabilities that Don Frieson, the supply chain team, in partnership with operations, have really worked to create a more seamless ability for pros to get product, and not to mention, the improved digital capabilities that helped deliver a 6% online comp during the quarter as well. We think all of those things combined, and we believe we will continue to lean into those initiatives to drive continued market share gain. Brandon." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Steven, I'll speak to PPI. So, very much in line with our expectations there. I mentioned earlier 40 basis points to 60 basis points of EBIT expansion plan this year.", "We have a really aggressive portfolio, a road map of initiatives across the business, across every function set to drive operational efficiencies. We've mentioned a few of those today, store tech modernization, front-end transformation, to name a few. So, really aggressive plans, and we're very much seeing those come to fruition in line with how we've guided." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you all for joining us today. We look forward to speaking with you at our annual shareholders meeting this Friday and on our second quarter earnings call in August." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2019-08-21	[ { "description": "President, Chief Executive Officer and Director", "name": "Marvin R. Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "William P. Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joseph Michael McFarland", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "David M. Denton", "position": "Executive" }, { "description": "Chief Financial Officer, Executive Vice President", "name": "David Denton", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin R. Ellison", "position": "Executive" }, { "description": "President, Chief Executive Officer and Director", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joseph Michael McFarland", "position": "Executive" }, { "description": "JPMorgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Wells Fargo -- Analsyt", "name": "Zach Fadem", "position": "Other" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Loop Capital -- Analyst", "name": "Laura Champine", "position": "Analyst" }, { "description": "Oppenheimer -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone. And welcome to Lowe's Companies' Second Quarter 2019 Earnings Conference Call. This call is being recorded. [Operator Instructions].", "Also, supplemental reference slides are available on Lowe's Investor Relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the Company's results and to be used as a reference document following the call.", "During the call, management will be using certain non-GAAP financial measures. The supplemental reference materials include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks, and the Company can give no assurance that they will prove to be correct. Those risks are described in the Company's earnings release and in its filings with the Securities and Exchange Commission.", "Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. David Denton, Chief Financial Officer.", "I'd now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you, Regina. Good morning. Our total company comp sales grew 2.3% in the second quarter. Our US home improvement comps were positive 3.2% exceeding expectations, despite lumber deflation and unfavorable weather. In fact, we saw broad-based growth across all 15 geographic regions generating positive comps. Three of our top four performing regions were in the Western Division. In addition to the Western regions, we also had great performance across the following regions that outperformed the total company comps, Atlanta, Boston, Charlotte and Tampa.", "Weather was particularly challenging early in the quarter, exerted approximately 195 basis points of top line pressure, in the month of May. And as weather improved, we saw broad-based sequential improvement in US console, a positive 0.7% in May, positive 4.2% in June, and positive 4.7% in July. Commodity deflation exerted approximately 110 basis points of pressure to comp sales in the quarter, however unit growth, and impacted departments such as lumber and building materials remained strong.", "For the quarter, comparable transactions grew at a positive 0.3% and average ticket grew at a positive 2%. We executed very well during key holiday events and converted strong foot traffic into sales. Once again, Pro comp significantly outpaced DIY during the quarter and our strong Pro performance was particularly driven by investments in job lot quantities coupled with our improved service model.", "As Joe will detail, we continue to make progress to better serve our Pro's and we received very favorable feedback on our improved in-store experience with our customer service scores increasing 900 basis points. Overall performance in the quarter demonstrated continued momentum executing our retail fundamentals framework. And with the initiatives we put in place we continue to make steady deliberate progress to better serve customers, position our business for long-term success and improve our results in categories that have historically underperformed.", "Bill will discuss some of those categories in a moment. On Lowes.com, we posted comp growth of approximately 4% in the second quarter. There are a couple of key items that contributed to this underperformance.", "First, we intentionally slowed the number of new SKUs that we added in the quarter, while we addressed systems and process issues that negatively impacted our stores productivity. These systems and process issues were resolved in early Q3. Second, we took steps to improve the quality of our online business by eliminating certain programs, which were unsustainable from a profit perspective. In taking these steps, we knew that we would stun our short-term growth. However, we took the necessary actions to position ourselves to grow our online business for long-term sustainable success.", "In addition to solving these process and systems issues, we're taking aggressive steps to improve the technology foundation of Lowes.com. We replatformed the entire site to Google Cloud. At the beginning of this year our dot-com site was only a decade old platform. So we expect to have the entire site on the cloud in the first quarter, which will improve our agility as we redesigned the customer experience from search and navigation to checkout.", "Omnichannel is a tremendous growth option for Lowe's, and we have a very detailed transformation plan to modernize our platform and dramatically grow Lowes.com sales in the future. Our goal is simple. We want to serve customers [indecipherable] shop and we look forward to updating you on our progress on future calls. In fact, our commitment to having a world-class technology team is reflected in our announcement to open a new global technology center to 2000 additional technology professionals in Charlotte. Construction of this new facility began this month, with plans to open the center in 2021.", "The global technology center underscores our commitment to recruiting world-class talent and becoming the best-in-class omnichannel retailer. But in the meantime, we are utilizing a temporary space in downtown Charlotte for the technology professionals that will ultimately be based in our new global technology center.", "In Canada, we posted negative comp sales for the quarter. Our negative comps was driven in large part by our ongoing RONA integration. After a strategic reassessment of the Canadian business, we decided to make adjustments to the original RONA integration strategy. Although, we remain confident in the long-term potential of this business, this shift in strategy has [indecipherable] slow growth. But once again, we're sacrificing short term growth to position ourselves for long-term success. And I look forward to providing you additional updates on future calls.", "Diluted earnings per share were $2.14 for the quarter and adjusted diluted earnings per share were $2.15, supported by solid top line growth and expense leverage. Now let's take a moment to provide an update on the progress to deliver gross margin improvement in 2019. The improvement since the first quarter reflects immediate benefits from the actions that we've taken. In fact, we realized compounding benefits as we moved through the second quarter with marked improvement in gross margin for the second half of the quarter as compared to the first half.", "Our second quarter performance coupled with actions still to come give me confidence that we're on the right path to sequential gross margin improvement in the third and fourth quarters. Although we're pleased with the progress we made in Q2 to recover gross margin dollars, we have additional work to do to modernize our systems and our pricing tools. Therefore over the next 12 months, we'll be focused on two major initiatives to deliver this monetization. Our first initiative is focused on the deployment of our new price management system, which will allow us to better systemically analyze, prioritize enough significant retail pricing actions. This new system will create a single repository of pricing to provide better visibility for the merchants to understand the impact of our pricing decisions.", "This new pricing management system will be in place by the end of the year and will get us to compare to currently with most retailers. Our second initiative is focused on fully integrating our acquisition of the Boomerang retail analytics platform. Integrating this platform will allow us to incorporate Boomerang's technology into our core retail business, both to a strategic data driven pricing and also allow us to make better merchandising decisions across the business from an assortment perspective.", "This Retail Analytics platform will be fully integrated with our price metrics during the first half of 2020 and will provide us with a best-in-class pricing analytics system. We're confident in our strategic initiatives as we enter the back half of the year and we expect to continue our strong top line performance while delivering margin improvement. And we'll also begin to manage down our inventory to more sustainable levels.", "So now, allow me to take a moment to discuss the inventory in more detail. This year, we invested in inventory to support offers such as earlier season to load-ins, CRAFSTMAN resets, increased presentation minimums and job lot pf Pro's. These strategic investments in inventory helped us to deliver improved sales performance in Q1 and in Q2. And although our inventory has increased year-over-year, we have a very minimal seasonal inventory, which limits our risk of unplanned markdowns.", "In the back half of the year, we will refine our in-stock expectations and began to reduce inventory in certain categories. One key initiative tied to our supply chain transformation strategy is rollout of predictable deliveries in our stores. This more predictable product enable us to lower safety stock across many SKUs. In addition, we will execute a list of strategic initiatives in the back half of the year that will allow us to strategically manage down inventory while protecting our in-stock position and our margins. Though we made great strides and we are pleased with our second quarter results, we're not taking victory laps. We have a lot of work to do and we're fully committed to driving top line growth, improve our gross margin, intensifying our commitment which fits the management. We're very excited about the upside potential of our company and we believe we are on the right path to generate long-term profitable growth.", "And lastly, I want to take a moment to thank our associates for their hard work, dedication and commitment to each other and commitment to serving customers. And with that, I'll turn the call over to Bill." ] }, { "name": "William P. Boltz", "speech": [ "Thanks, Marvin, and good morning everyone. We were pleased with our second quarter performance, as we capitalized on the continued spring demand and strong event execution. We posted a US comparable sales growth of 3.2%, exceeding our expectation. On a two-year stack, US comp sales accelerated from 4.7% in Q1 to 8.5% in Q2. During the quarter, we leveraged our successful Memorial Day, Father's Day and July 4th events, taking advantage of the seasonal project demand. And we also drove traffic with our compelling values, relevant assortments and our continued shift into digital marketing channels.", "We were well prepared for our holiday events with excellent coordination and alignment between store operations, supply chain and our marketing teams. Our success in driving spring sales was supported by the improved service model in our stores and better in-stock execution. Joe will share more of that in a moment on how well our associates delivered in the aisle. Our continued focus on retail fundamentals drove strong performance in areas of [technical issues] strength and more importantly, help deliver improved performance in categories which has historically underperformed.", "In fact, we had seven departments perform above the company average in the quarter. For example, we began the implementation of our retail fundamentals framework in the Paint department two quarters ago. Prior to that implementation, Paint had delivered comps below the company average for 10 consecutive quarters. This quarter, because of an improved service model and better in-stock position, along with compelling offers, paint led the merchandising department growth with the strength coming from both interior and exterior paint products. All of that being done despite some weather pressure early in the quarter.", "This marks the first time in 10 years that Paint has led the merchandising department comp growth. We will continue to invest in this important area given that paint is a traffic driving category and that painting is the number one DIY project. We are working closely with our suppliers to rollout an improved propane offering. And we see a significant opportunity to drive an increased Pro penetration in paint, all of this by better serving the repair, remodelers who need paint to complete a larger project such as a kitchen or bathroom remodel.", "Prior to our implementation of retail fundamentals, our core department had performed below the company average for 12 of the last 13 quarters. In Q2, we drove mid single-digit comps in the core with double-digit comps coming in blinds and shades. The improved performance was largely driven by job lot quantity investments and our improved product offerings in both our private and national brands.", "Millwork is another merchandising department that has historically underperformed. In 11 of the past 12 quarters, Millwork had posted comps below the company average. This quarter with a heightened focus on the Pro and improved in-stock position, a refresh department and investment in job lot quantities and some new product introductions, Millwork delivered comps above the company average.", "For the quarter, we also continue to achieve strong comps in areas of historical strength for Lowe's. In Tools, we delivered strong mid single-digit comps and continue to see market share gains as a result of our craftsman resets. The strength in craftsman came from categories such as power tools, tool storage and mechanics tools. We're excited to now have completed the CRAFTSMAN resets this quarter and we're proud to be the exclusive destination in the home center channel for this iconic brand.", "During the quarter, we also leveraged key programs such as the Dewalt, the number one power tool brand in the industry. Along with the introductions of other new and innovative products from Bosch, Spider and Metabo HPT, all to help drive strong comps in Tools. Within our Appliance department, we drove solid mid single-digit comps building on our leading market share position with our top brands and breadth of assortment. In Hardware, we posted solid mid single-digit comps with strength coming from our family hardware and our fastening categories. The investment we made in job lot quantities and new product introductions help deliver the results in these two categories to support the Pro demand in hardware.", "And lastly we again delivered above average comps and saw market share gains in seasonal and outdoor living, led by double-digit comps in pressure washers as well as riding lawn mowers where we continue to leverage the top three brands in riding equipment with John Deere, Husqvarna and CRAFTSMAN. We continue to be pleased with the results that we are seeing from our new merchandising service teams or MST. These teams are supported by our vendors and they're responsible for day-to-day bay maintenance, the resets in our stores, setting and maintaining our end caps and executing our off shelf displays. The MST teams are a critical component to improving our merchandising reset execution at the store level, as they continue to take tasking activities off the shoulders of our selling associates, so that they can be freed up to dedicate more time to serving our customers.", "The early results of our MST program are positive and these teams have shown a reduction in out-of-stocks and improved sales productivity and an increase in bay service per hour. Now as we look ahead to Q3, we remain focused on our retail fundamentals and driving profitable sales with our upcoming Labor Day and fall harvest events, leveraging additional target events throughout the quarter that will take advantage of the fall micro seasons, continuing to drive the strength of the traffic power of CRAFTSMAN. Building on the responsibilities are our field merchandising team who will be instrumental in driving the localization in our stores along with executing our seasonal transitions, continuing the focus on the Pro categories as we continue to capitalize on our investments and our focus on this important customer segment.", "And lastly, we look forward to leveraging our new NFL partnership including -- introducing new exclusive products and events that will help drive a strong connection with both the DIY and our Pro customer. As I've shared on previous calls, we are in the process of implementing our category management strategy. This cohesive strategy is going to be critical to driving merchandising productivity by ensuring that we are allocating our resources to the areas of greatest opportunity. The merchandising team is committed to aggressively driving top line sales while growing gross margin dollars.", "Thank you and I would like to turn the call over to Joe." ] }, { "name": "Joseph Michael McFarland", "speech": [ "Thanks, Bill. And good morning everyone. Our commitment to improving in-stocks and customer service along with intensifying our commitment to the Pro customer were integral to our stronger event execution and comp growth in the second quarter. I'm pleased to be accumulating benefits we've seen from actions we took in the first quarter to further improve assisted engagement and drive store simplification. We recently deployed the new mobile devices for our store sales, we call smartphones, the acronym smart represents our customer service philosophy.", "Our new smartphones are designed to reduce tasking hours by providing real-time data without ever stepping up the sales floor. In the second quarter, we added our standardized performance scorecards to the smartphones. We also deployed store walk application to allow for more efficient, strategic store review process. These applications allow our store managers to drill down and evaluate productivity by department and by associate to manage their store more strategically. These new mobile devices are an example of how we can leverage modern technology to make significant advancements in the capabilities we make available to our associates. Putting the new mobile devices in the hands of our managers and supervisors is a significant step toward revolutionizing how we deliver sales and operational productivity in our stores.", "Our investment in over 600 assistant store managers and 5500 department supervisors paid dividends in Q2. On average, we've added 120 customer facing hours per store per week while still leveraging store payroll. Because of this investment, we are to provide better departmental coverage and expertise as well as coaching for our associates in delivering excellent customer service.", "With the addition of department supervisors, we ensured that we have proper coverage for strategic areas of focus such as Pro and Paint, and it is no coincidence that both Pro and Paint were two top performing areas for the second quarter. All said, our commitment to improving both store efficiency and customer experience drove 600 basis point increase in overall Q2 customer service stores.", "As Marvin indicated, we're very pleased with our Pro business performance in Q2, with Pro comp significantly outpacing DIY. We're also pleased with the Pro customers willingness to grow their business with us. We continue to leverage our investments in job lot quantities and product presentation in key areas such as Pro Canopy and end caps, improved store level service including dedicated loaders and preferred parking under the Canopy. To ensure we can get our Pro customers in and out faster and staffing our Pro dedicated associates working a consistent schedule, dedicated department supervisors for Pro areas, a consistent volume pricing message and our redesign field structure with 15 new regional Pro directors and experienced leaders to focus our in-store and outside Pro sales.", "We're already seeing great results from this team with double-digit comps this quarter. We also continue to leverage key brands to grow our Pro business such as Little Giant Ladder Systems, Lithonia commercial lighting along with Bosch, Metabo HPT, and Dewalt. And our merchant teams continue to work at more key Pro items to our assortments, including the new exclusive Dewalt 12 volt cordless extreme brushless platform launching this quarter.", "We're proud to be the destination for this platform offering extreme power and a compact lightweight design that allows Pro's to work more efficiently in tight spaces. We are seeing positive results from our actions with increased Pro customer service scores. Once again this quarter we invited customers in to see our improved environment with another very successful Pro appreciation event, which allowed us to grow our Pro accounts.", "In fact, we opened over 35,000 new Pro accounts in the quarter. Although, we are pleased with Pro performance in Q2, we are in the early stages of our transformation. Therefore, we are pursuing additional opportunities to deepen our relationship with the Pro including our upcoming propane test in select markets focused on improving our staffing and training model to better serve the needs of this key customer. We have additional initiatives on our Pro roadmap and I look forward to keeping you updated on future calls.", "As we look to the back half of the year, we're working to improve staffing and better leverage our payroll spend with the national rollout of our new customer centric labor scheduling system. We have deployed the system in four geographic regions and will complete the rollout to our remaining 11 regions by the end of the fiscal year. This system will better predict customer demand by time of day, day of week and department, allowing us to align our labor hours with peak traffic to provide better department coverage and customer service, while ensuring that we're using our labor hours efficiently and reducing payroll expense.", "This new system will replace our current staffing system that doesn't effectively capture and predict sales and customer traffic patterns. We're also deploying a new one task team to ship task work from our selling associates to one centralized team that will be responsible for completing non-selling task during the evenings and overnight hours. The centralized team will drive more consistent execution of tasking, streamline non-customer facing payroll and allow for cross trading. Though we are pleased with the changes we've made and excited about the results we're seeing, we are very focused on the hard work ahead to drive further improvements and transform Lowe's into one of the most operationally efficient retailers in the world.", "Thank you, and I'll now turn the call over to Dave." ] }, { "name": "David M. Denton", "speech": [ "Thank you, Joe, and good morning everyone. I'll begin this morning as I often do with a brief review of our capital allocation program. In the first six months of 2019, we generated $3.1 billion in free cash flow and through a combination of both dividends and share repurchases, we've returned over $3.5 billion to our shareholders. In the second quarter alone, we paid $382 million in dividends and our dividend payout ratio currently stands at 37% over the trailing four quarters.", "Now given the dislocation of our stock price coming out of Q1, we ramped up our share repurchase activity and bought back nearly $2 billion of our stock at an average price of approximately $100. Early in Q2, we entered into a $990 million accelerated share repurchase agreement retiring 9.9 million shares. And additionally, we repurchased 9.7 million shares in the open market for $974 million. This brings our year-to-date share repurchases to $2.8 billion with a plan to repurchase $4 billion for the year. We also have approximately $11.2 billion remaining on our current share repurchase authorization. We continue to invest in our core business with a focus on high return programs designed to drive long-term shareholder value. In Q2 we had capital expenditures of $321 million.", "Now turning to the income statement, we generated GAAP diluted earnings per share of $2.14. On a comparable basis, we delivered adjusted diluted earnings per share of $2.15, an increase of 3.9% compared to adjusted diluted earnings per share of last year. Sales for the second quarter increased 0.5% to $21 billion, supported by total average ticket growth of 3.2% to $77.97. This was partially offset by a 2.7% decline in total transactions.", "On our comp sales basis, we were up 2.3% driven by a comp transaction increase of 0.3% and an average ticket increase of 2%. Our US comp was 3.2% for Q2. Looking at monthly trends, total comps were negative 0.3% in May, positive 3.4% in June and positive 4% in July. Additionally, monthly comps for our US business were positive 0.7% in May, positive 4.2% in June and positive 4.7% in July.", "Gross margin for the second quarter was 32.1% of sales, a decrease of 85 basis points from Q2 of ROI. But 65 basis points better than Q1. The improvement since the first quarter reflected immediate benefits from the actions we've taken including retail price adjustments that had minimal impact to units. It pivot to more strategic and targeted promotions and greater vendor support from key promotional activities. We are very pleased with the progress we made to improve our gross margin performance.", "The actions we implemented are gaining traction but there is additional work to be done on this important area for the balance of the year. This quarter we experienced approximately 50 basis points of rate pressure. As expected we experienced approximately 15 basis points of pressure from supply chain cost. We've added new facilities to the network that are still ramping to full capacity, coupled with ongoing increases in customer delivery costs. Product mix shifts and inventory shrink each ahead at approximately 10 basis points negative impact on gross margins during the quarter.", "SG&A for Q2 was 19.3% of sales, which levered a 170 basis points. It's worth noting that in last year's second quarter, we recorded a non-cash charge of $230 million related to the strategic reassessment of Orchard Supply Hardware. This resulted in approximately 110 basis points of leverage this year. We drove approximately 50 basis points of leverage and retail operating salaries in the quarter and approximately 15 basis points of leverage to improved advertising efficiencies.", "Operating income increased 98 basis points to 11.34% of sales. The effective tax rate was 24.2% compared to 24.4% to LY. At $13.7 billion inventories increased $1.8 billion or 15.5% versus the second quarter of last year. But it's down $1.3 billion versus Q1.", "As Marvin indicated, this increase was driven by strategic investments in the first half of the year to drive sales, such as an earlier seasonal load-in, CRAFTSMAN reset, increased presentation minimums and investments in job lot quantities for the Pros. In the back half of the year, we will refine our in-stock expectations and began to strategically reduce inventories in certain areas, while protecting our in-stock position as well as sales and margins.", "Before I close, let me address our 2019 business outlook. The underlying macroeconomic fundamentals in the US remains supportive as demonstrated by the solid pace of job growth. The home improvement sector should continue to benefit from several factors including strengthening wage growth, gain in household formation and rising home prices that encouraged homeowners to engage in discretionary projects.", "Additionally, the aging US housing base is driving ongoing maintenance and repair spending across the nation and despite a strong financial performance in Q2, which exceeded our own expectations, and a solid underlying economic outlook for the remainder of 2019, we've elected to maintain our current 2019 business outlook. We are still recovering from a disappointing first quarter margin performance, but we have assembled the very talented management team and we are aggressively implementing initiatives to improve our business. Therefore, we feel prudent to maintain this intense focus on retail fundamentals throughout the remainder of this year.", "And as we've said many times, we are in the early days of our transformation. We expect a total sales increase of approximately 2% for the year driven by comp sales increase of approximately 3%. We expect an adjusted operating margin increase of 20 basis points to 50 basis points. The effective tax rate is expected to be approximately 24%, and we now expect adjusted diluted earnings per share of $5.45 to $5.65.", "We shared previously that our business outlook includes the waive of trading tariffs. We have a value-weighted waive for A, and have concluded that we can manage through that limited impact in the second quarter of this year within our existing guidance range. We are forecasting operating cash flows of approximately $4.5 billion and capital expenditures of approximately $1.6 billion. This is expected to result in free cash flow of approximately $3 billion for 2019. Our target leverage ratio stands at 2.75 times and our guidance assumes that we complete approximately $4 billion in share repurchases for this year. So in closing, we remain extremely excited about the future of the company and its ability to deliver significant shareholder value over the long term.", "So with that, we're now ready for take questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator Instructions] Our first question comes from the line of Christopher Horvers with JPMorgan." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, good morning. First, a question on Dave, your comments on the guidance and your decision not to raise it. So I appreciate your comments on being prudent, because there is a lot of uncertainty in the turnaround and it's now early stages, but is there anything in any area or any initiative in particular that causes gives you that pause or any area that P&L, and your guidance where you see more risk versus other areas?" ] }, { "name": "David Denton", "speech": [ "No, listen. We're really extremely pleased with the progress coming out of Q2 . We are very confident in our outlook for the balance of the year. Keep in mind, as I said in my prepared remarks, we've worked, we've committed ourselves to retail fundamentals and improving our financial performance recycling of the back half of the year. But as you know, we've launched many broad cross-functional efforts touching almost all areas of our core business. Thus, creating a little bit of a fluid environment in our business model. Having said that, we feel very confident in where we stand today and our outlook for the balance of the year. So there is nothing on that horizon that we see that is a disappointing news coming forward from that perspective." ] }, { "name": "Marvin R. Ellison", "speech": [ "Hey, Chris, this is Marvin. The only additional comments that I'll make, Bill outlined in his prepared comments some of the key initiatives for the third quarter and the back half of the year. We have a lot of confidence in our strategy. Q1 was a disappointment, and we are still candidly digging out of that. But as we look forward, I mean we're very confident in our ability to drive the business. We just think it's prudent to just focus on retail fundamental execution to get this still relatively new team or time to continue to get our arms around every aspect of the business and then we'll evaluate guidance as we continue to progress through this quarter and beyond that." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. And then just a question on the margin front. So SG&A dollars are down in the first half of the year, and if you look at on a per foot basis, it's up about 0.5% year-to-date with 2Q better than 1Q. So how are you thinking about SG&A as we proceed through the year and lap the store closures? Should the SG&A dollars be down in 3Q and then, and then up modestly in the fourth quarter on a year-over-year basis as you get through the store closures in 4Q?" ] }, { "name": "David M. Denton", "speech": [ "Yeah, let me just take it first half, second half, I think we continue to make really nice progress from an SG&A perspective. I think the second half -- we won't leverage nearest March in the second half driven by the fact that many of our initiatives from a project perspective are continuing to ramp into the back half of the year. And so you will see those expenses show up back half of the year." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. Thanks so much. Best of luck." ] }, { "name": "David M. Denton", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Simeon Gutman with Morgan Stanley." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, good morning everyone. I wanted to ask about gross margin. If we look back, I think, the right base on a rebase basis is around 33% for this business before some of the one-time issues occurred. Is there any reason that you shouldn't recoup and get back to those levels and you mentioned this modernization. Do you need the modernization to recoup what you lost in Q1 or does this enable you to even get past that 33% level over time?" ] }, { "name": "David Denton", "speech": [ "Yeah, this is Dave. Maybe I'll start. Clearly, if you look at the long-term algorithm of our business model, as we said, to get to our 12% operating margin over time is that, we would think about gross margin, they are substantially flat if you will over time. I don't think there's anything on the horizon that we've seen our business model that would change that expectation. Clearly, as we go through the years to come, we need to do two things. We need to increase our performance from a sales perspective, thus leveraging SG&A flowing through a higher profit margin through that algorithm and through that approach. So I don't think there's anything from a margin perspective that gives us pause at this point." ] }, { "name": "Marvin Ellison", "speech": [ "Simeon, the only thing I'd add, this is Marvin is, from a technology dependencies we don't have high dependencies on technology specifically for the back half of this year, when I talk a little bit of detail about our price management system and leveraging the Retail Analytics platform that we acquired from Boomerang, we're going to have a new product management system in position in the fourth quarter. That will get us to a competitive parity and now candidly, we're quite a bit behind what a modern large retail would be from the ability to leverage a pricing and to have agility pricing in local markets in-store and online.", "We're going to get build a team just better visibility and just single repository which believe or not, this company has never had. Within the first half of next year, we're going to merge the price management tool with the Retail Analytics platform that we acquired and we think that's going to unlock the ability to meet the expectations that they've laid out and that is relatively flat gross margin. Our operating income store is going to really be about flat gross margin in driving continued SG&A leverage by implementing technology and taking task out and putting more labor on the floor to serve customers and so that's going to be more of an ongoing year-over-year process." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. And then for my follow-up, I'll stay on the same topic. I mean there is some big events, you're going to be lapping first and the third quarter with the write down and then next year's first quarter. Is there any reason today that you see that you couldn't recoup in what was lost in the write down, it should have been a one-time event. Is there any reason we don't get back that amount coming in the third quarter and then through the first quarter, a lot of the issues from this prior year's first quarter should be resolved?" ] }, { "name": "David M. Denton", "speech": [ "Well, clearly that's within our plans. Our guidance assumes that we're going to lap that in the back half of the year and as you look at the continued performance of our business, both from a sales perspective and a margin perspective, we're actively managing up against that fight, there is no -- there is no doubt that we would sequentially continue to make progress from a margin perspective for the balance of the year." ] }, { "name": "Simeon Gutman", "speech": [ "Okay, thanks. Good luck." ] }, { "name": "David M. Denton", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Zach Fadem with Wells Fargo." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. So, Marvin, you called out strong execution on holiday events. Curious, if you could talk a little more about what you're doing differently there both in terms of just the execution and merchandising assortment, but also the traffic driving initiatives like the paint promotions that you ran and how that's impacting your take rate?" ] }, { "name": "Marvin R. Ellison", "speech": [ "So Zach, I'll take the first part and then I'll let Bill add some additional color. When you look at the home improvement business the one thing that we brought from a strategic standpoint is the importance of the event execution because you have certain DIY customers that will traditionally to shop you about four times a year. So it's really important that you start the year off really effectively and in the past, Lowe's has kicked off their spring Black Friday types of events and they've been out of stock at some degree of services. So you disappoint customers and those customers just don't come back for that second, third and fourth shopping occasion later in the year.", "So we put in enormous emphasis on great execution, product load-in, in-stock great value for spring Black Friday, understanding that customers who may have been disenfranchised by shopping at Lowe's in the past, would come in to shop Lowe's because the values were compelling but the goal was to create such a great service experience that they would come back on that second, third and fourth occasion this year. And so what we, what we believe we're seeing in Q2, as we're seeing that second shopping occasion because of the great event execution and spring Black Friday that led to continual execution in Father's Day and 4th of July, etc, etc. And so it starts with great product and great value, it starts with compelling marketing message. Again the stores have to take it from there to turn that foot traffic in to sales. And so we've done a really nice job of that and it's been a collective team effort.", "So I'll let Bill talk about what some of the values that drove our success and kind of what we're going to be leaning into as we think about the rest of this quarter." ] }, { "name": "William P. Boltz", "speech": [ "Yeah, I think just to add to Marvin's comments, a couple other things. The investment that we made propping up our MST team as well as our field merchant team certainly started to take hold in Q2 and we're able to pull a lot of this event recovery, event execution off the shoulders of our selling associates and really recover faster inside the stores and that was a big -- that was a big difference this year versus last year.", "And then the marketing teams and the merchant teams did just, I thought a superb job of coming with just great values that we drive traffic into the store and drive the basket and your comment around paint was we know that that's a traffic driving category. We know it's the number one DIY project and by being able to strategically look at our overall promotional strategy inside the store we were able to do something disruptive in paint that drove some unprecedented traffic into that category for Q2.", "So we're excited about what's happened, we're excited about where the learning we've received, it will help aid certainly as we go into the back half of the year and more importantly, in to 2020." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And then on some of the merchandising efforts, you removed from the SKU rationalization, could you talk about the success of that initiative. Whether the replacement SKUs have have been more productive from a volume and margin perspective and then with your inventory up over 15% in Q2, how should we think about the timing potential for further inventory rationalization initiatives ahead?" ] }, { "name": "Marvin Ellison", "speech": [ "So Zach it was less inventory rationalization and more of the removal of non-productive inventory. So that sounds like a nuance but this is a different because the steps we took in the second half largely was that basically just identify all the age inventory that had been sitting and not turning and just take aggressive action to exit it from the business. We didn't in many cases go back in and replace it with more productive SKUs. We just tried to create better presentation of our most productive SKUs. So what we build is in the process of doing now is identifying what we described as slow turning SKUs and as we stabilize e-commerce, what really efficient retailers are doing, they're taking the slow moving SKUs off the shelf in their brick and mortar location and putting it online, and these will have it and the handful of powerful fulfillment centers didn't have it in 1700 stores. So that work is just beginning for us.", "But as we take a lot of inventory and as I said in my prepared comments we made a strategic decision to invest. If you take a look back at Lowe's historically, Lowe's had wanted to ever since our acquisitions of any major retailer and to be quite candid, it was actually worse than what we anticipated when we started to take actions to get in-stock. So as we think about kind of the timeframe around kind of getting our inventory to more what I'll describe as rebalanced, we're going to have some supply chain initiatives that are going to be happening right now. I've mentioned predictable delivery. That's really important for us because we're so out of stock and our delivery and supply chain process were so inefficient that we had excessive amounts of safety stock in stores just to compensate for late and slow deliveries. Now that our supply chain has become much more efficient, this more predictable delivery will allow us to reduce safety stocks. So we'll have more frequent flow of products. That doesn't sound like a big deal, but in our environment it's going to be a big deal and that's going to be one of the most significant initiatives that we're going to take to get our inventory rebalanced.", "We think this is going to be a multi-quarter initiative, we'll be updating externally more at the end of this quarter, but we're going to see how our process goes this quarter. Again, we'll have a better perspective on when we think we'll be in a position that will be most comfortable. And the only caveat to that would be we are committed to staying in stock, we're committed to driving sales and we're committed to protecting margin. So we're not going to swing this pendulum from one digit to the other, and so it's all about finding balance. But we feel comfortable that the quality of our inventory is really good, we have a small amount of seasonal inventory. So we don't have risk of taking excessive markdowns. So we feel like we have time on our side to get us in order." ] }, { "name": "William P. Boltz", "speech": [ "One other thing I would add that the merchant teams now getting their feet on the ground as they've all come together. Along with our planning replenishment teams on the supply chain side SKU rationalization, is an ongoing effort right, it goes on all the time. So that's part of the rhythm of what they do, always looking at making sure you've got the most productive stuff inside the store." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Appreciate the time." ] }, { "name": "Marvin R. Ellison", "speech": [ "Okay, thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Michael Lasser with UBS." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot from taking my question. It seems like you went to a deeper level of promotion on the Paint category than the industry has seen in the past. So how does that inform your view on what you might do in other categories? Would you try the same strategy in other products?" ] }, { "name": "Marvin R. Ellison", "speech": [ "No Micheal, it's a fair question. So let me, let me just kind of take a step back and just give you kind of a broad view of the strategic approach that we were taking. One of the first observations that Bill made to me upon arriving is that we have too many category wide promotional events, and so it is our intent and expectation that we will become less promotional not more promotional. What we're trying to do with our promotions is to be more strategic and make them more event base, [indecipherable] that's something we're going to slowly line ourselves out of and be more event based.", "Having said that, we're going to strategically choose categories that we believe our product starters, project starters and they drive traffic. But when we lean in to something like they we're going to be pulling back from other areas, so the net effect will be less promotions but more effective promotions and so new paint was the first attempt at that. We are very pleased with the results. Obviously for competitive purposes, we are not going to telegraph what our next strategic move will be, but philosophically I think the message is we're going to lean into certain categories that we think provides a broader strategic gain, will pull back the models and we're going to be more SKU focused on promotions than overall category.", "And that's going to allow us to drive price perception to drive value perception would do it while protecting margin more effectively and Bill I don't know if you have anything to add to that." ] }, { "name": "William P. Boltz", "speech": [ "No, I think just it was also an area where we looked at a lot of disruption a year ago when we came in and we have struggled really through the balance of the second half of last year to try to get paint stabilized. So really 2019 gave us an opportunity to try to do something different and that was an opportunity that we had to be able to mix it up a little bit." ] }, { "name": "Michael Lasser", "speech": [ "And I have one follow-up and two parts on that. So if you're going to pursue a similar strategy in other categories. Do you see the risk or is there a risk of potential ripple effects across the industry as others might be forced to follow suit. And then as part of that are you using some of the pricing actions that you're taking as you described in the first quarter to use that as a source of funding to go out and make some of these investments in promotional activities within certain categories. Thank you so much." ] }, { "name": "Marvin R. Ellison", "speech": [ "Yeah, Mike, we think, again, the net effect is going to be fewer promotions and more targeted promotions. So we don't see this as a risk. I mean, as a matter of fact, we see it as a benefit because it's going to create an even more rational promotional atmosphere than what we have right now. And we think we have a relatively rational sector from a promotion standpoint. We're in the process of redefining how we go to market. Anytime you have lost a market share and lost relevance over a 5 year to 7 year period like Lowe's had done prior to 2019, you can't just run the same play over and over again and expect that you're going to get a different result. And so, we believe, one of the reasons why in Q1 and Q2, we've grown sales and taken share is because we've taken a more strategic approach to how we go to market.", "Having said that, we have no intentions on being more promotional, we have no intentions on doing anything that's going to ratchet up the promotional environment. This is an environment that competitors do special buys, all the time and a special buy not really described as a promotion is described as taking advantage of a specific category during a specific event period. So you'll see us do a lot of those different things, but we have no intention of being more promotional. We will be less promotional, less or low with a lot more strategic." ] }, { "name": "Michael Lasser", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Scot Ciccarelli with RBC Capital Markets." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys, thanks for the time. Do you guys have any -- we talked about supply chain and inventory and some of the changes happening there, Marvin. Are there any examples of categories where you've been able to pull back on the amount of inventory in the category without it actually adversely impacting your comp growth?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Well Scot, I would say that we try to test and learn in everything that we do. And so I would say that from this whole predictable delivery process that we're rolling out, part of that has been in cooperations with the stores and with supply chain. So because of that we have taken a few items, we are not, for comparative purpose, we are not going to kind of lay everything out there, but short answer is yes, we have and as we roll predictable delivery out to the entire company, we are evaluating safety stock levels by SKU by store. So that we can understand what level of safety stock will be required for us to maintain the proper in-stock position, the proper presentation minimum, while driving sales and then that ties to the frequency required from the supply chain. So it was all predictable delivery model in large part driven by test with the operations team on how effective we can do this while still hitting our financial targets." ] }, { "name": "Scot Ciccarelli", "speech": [ "And just to clarify, I mean you've made some, let's call it adverse comments previously on some of the legacy systems that the current team kind of inherited. Do you have the analytics in-house to be able to make sure you're not adversely impacting your comp growth when you make some of those inventory changes on the delivery side?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Yeah, yeah, that's what -- testing and learning, Scot, is the way you do it. I mean, and that's just really the environment we put in place. We're not going to roll anything out chain wide, and we're not going to test that first. So the short answer is, we have the analytics, we have the process design and anytime when we roll something chain wide, you can be assured that we are pretty confident of what the outcome is going to be." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thanks a lot guys." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Laura Champine with Loop Capital." ] }, { "name": "Laura Champine", "speech": [ "Thanks for taking my question. I'm just wondering if you can help quantify all the comments that you've made on your inventory management and the changes you expect to make? So by the end of this year, would we still be likely to see inventories up, call it high single digits or because you need to reset levels to keep your in-stocks in good shape? Or should we start to see inventories growing in line with sales growth?" ] }, { "name": "David Denton", "speech": [ "This is Dave. I don't think you're going to see much movement in inventory levels this year. I do think we'll, as we indicated earlier, we're going to strategically rationalize inventory in certain areas, but this is probably a multi-year journey, as we make sure that we have the right analytics in place, we have the right supply chain in place, and we've really thought through by category, what's the right assortment. And that's a multiple quarter or multiple year journey to get us back to that. I'll say that's the optimal level of inventory." ] }, { "name": "Marvin R. Ellison", "speech": [ "The only thing I'll add to that is to reinforce the point that I've made a couple of times this morning. We have very minimal seasonal inventory, so we don't have markdown risk of excessive inventory that we just have to work out of the system in a certain timeframe. The good news about the home improvement sector is when you load in job lot quantities and in Pro-related categories, these are year-around SKUs, and when you look at presentation minimums, if you're doing it on core SKUs, you have a limited markdown risk.", "Having said that, we're still going to be working quarter-over-quarter to make sure that we are getting our inventory more in line with our rate of sales. We will learn a lot in the next two quarters and we'll have a much more efficient and clear point of view as we head into 2020." ] }, { "name": "David M. Denton", "speech": [ "And I think also as Marvin and I said, listen, it's really important, we're going to be focused on our in-stock levels, we're going to make sure that we're supporting our sales plan and we're going to be supporting our margin plan. So we have all three of those kind of working in tandem and we don't want to harm our business, we got to make it more efficient over time. But right now those things are -- those three elements are pretty important to us." ] }, { "name": "Laura Champine", "speech": [ "Understood. Thank you." ] }, { "name": "David M. Denton", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Brian Nagel with Oppenheimer." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning. Thank you for taking my questions. Nice quarter." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thanks, Brian." ] }, { "name": "Brian Nagel", "speech": [ "So the first question, I just want to, I guess, bigger picture on the Pro, you've guess, you've discussed success you're having lately with the Pro. We talked a lot here about better in-stocks which is obviously an effort that would help both Pro as well as DIY. Marvin as you look out, you may be further and to continue to really better serve this professional customer what are some of the next initiatives we should be thinking about that that Lowe's undertake." ] }, { "name": "Marvin R. Ellison", "speech": [ "Hey, Brian. It's a good question. I'll take the first part and I'll hand it off to Joe who spent quite a bit of time on this. So let me first take a step back and give a more strategic overview of why Pro is important. I think one of the strategic missteps over the last seven years here is not really understanding what the Pro customer does to the overall productivity of the business. I mean our stores operate with a -- in some cases, fixed expenses and variable expenses and so, as you drive more productivity through those boxes, it just creates and unlocks a lot of value. And so as we lean in the Pro, our strategic rationale for this was how you take a box that has a certain amount of expenses allocated to it and exponentially increased volume, which makes it more productive and so we're pretty confident that our sales momentum over the last two quarters, our improvement in transactions in our Pro improvement in sales per square foot in large part is driven by Pro. So the strategic rationale for Pro is traffic, transaction, sales per square foot productivity and just unlikely more value in every location. And so based on that, I mean, we're committed to it, I'll let Joe kind of provide kind of some what's on the horizon that we think will allow us to continue to build on this very important customer." ] }, { "name": "Joseph Michael McFarland", "speech": [ "I would, Brian. Thanks for the question. So the first phase of our journey to win the Pro business, we're setting up the proper retail fundamentals which we've been discussing and we largely feel we're completed with that in the first half of the year. As we look out in our Pro roadmap, we have a lot of initiatives coming, when we think about having that foundation in place, we can now lean into better Pro marketing, focus on things like customer acquisition, driving awareness and it was different at Lowe's, the future focus, key segments, national accounts, our outside sales team, integration of MSH, a better job site delivery. We have a laundry list of improvements that will continue to make for the Pro customer. And we're very, very encouraged by what we're seeing across the total store from a Pro standpoint." ] }, { "name": "Brian Nagel", "speech": [ "That's helpful. Thank you. Then my follow-up question, shifting gears a bit. I just wanted to discuss again gross margin and maybe more for -- I guess for Dave. But Q1, you have the inventory, the systems type issue. You articulated clearly that you isolated that impact on your gross margin. So what I'm wondering is what was that in Q2? And how should we think about that specific impact as it mitigates through the back half of '19? And the second of that, it seems just looking at your results today. It seems though you're correcting those problems that have emerged in Q1 quicker than you initially expected. So, A, is that fair and then B, why is that happening?" ] }, { "name": "David M. Denton", "speech": [ "Yeah. So listen, I think we have a fairly comprehensive plan to improve our margin performance in, I would say that if I just kind of tick down some of the things that we've done, you can get a sense for the progress we're making. But first and foremost, we kind of really did an evaluation our price complement across the categories, we've adjusted price. At the same time we've gone through and enhanced our point-of-sale system such that we're eliminating unnecessarily -- unnecessary discounting that is kind of, I'll say meeking at point of sale. As the team spoke many times throughout this morning, we really leaned in to kind of more targeted, efficient promotions and as you can imagine even coming out of Q1, we couldn't touch all the promotions earlier in the quarter, they were kind of already locked and loaded. So the changes that we made to adjust the promotional calendar largely happened in the back half of the quarter given the lean time.", "And then finally, we're working with our vendors and making sure that we're managing cost and making sure that we're getting the right support for all the efforts that we're doing within our stores. That's probably the long pole in the tent to get done for the balance of the year. All of those factors are things that we're managing through the balance of the year, clearly when you change price is the quickest to respond from a P&L perspective.", "So I think what you've seen is that the effect of that happen more rapidly in Q2, we're going to probably lean more aggressively on some of the other actions to improve our performance in the back half of this year. So that's what you're going to see that progression in both in Q3 and Q4 as we cycle into back half." ] }, { "name": "Marvin R. Ellison", "speech": [ "And Brian, this is Marvin, the only additional comments. I mean we, there was a lot of work and I just have a ton of admiration for the merchant team financing, store operations team that really worked very hard to accelerate the recovery, but as I outlined in my prepared comments, I mean we have two initiatives coming for over the next 12 months that are going to be critically important. The rollout of our price management system in Q4, it's going to be just critically important for us to just get to competitive parity and then as we integrate this Retail Analytics platform from Boomerang it's going to really take us from trailing almost every major retailer to be at a best in class level on pricing analytics and I think you are aware that one of the most significant levers that any retail our size has is disposal around margin improvement is strategic pricing actions.", "And we learn a lot of our strategic pricing in Q2 and we did it kind of the hard way and as our systems continue to get better, it's going to make this a lot more agile and so we have a lot of confidence in the future that we can continue to drive more sequential margin improvement from Q1. And you just continue to get this whole platform stabilize." ] }, { "name": "Brian Nagel", "speech": [ "Great. Well congrats on that." ] }, { "name": "David M. Denton", "speech": [ "Thank you. We're going to take one more question, please." ] }, { "name": "Operator", "speech": [ "Our final question will come from the line of Eric Bosshard with Cleveland Research." ] }, { "name": "Eric Bosshard", "speech": [ "Thank you. Two things, first of all, the follow-on within gross margin. Dave, I'm curious what we should be expecting in the back half for gross margin, obviously 2Q was notably better than you had thought. Is that progress sustainable? Excluding the impact of the markdowns in 3Q, can we get all the way back to flat gross margin on a comparable basis in 3Q? How should we be thinking about that?" ] }, { "name": "David M. Denton", "speech": [ "Yeah, I think you should expect a sequential improvement in the second half, jumping off of where we are in Q2. I don't think you're going to have a full recovery by the balance -- by the end of the year. Just I think mathematically that's tough to deliver at this point." ] }, { "name": "Eric Bosshard", "speech": [ "Okay. And then secondly, the step down in online. I assume it's more precipitous than you had expected, but if you could characterize that and then also characterize the pace and timing of the road back in growing the online piece of the business?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Yeah, Eric. So I think when we look at online, it was definitely a below our plan, but as I mentioned, we made a strategic decision that we were going to slow it down primarily by not adding additional SKUs, but there is a broader pointed out, I'd like for everyone to consider. So, we delivered a 3.2% comparative sales in the US with 4% online growth. And so, to me that just screams upside opportunity because we know how to fix an online business. We've hired a outstanding President of Online, Mike Amend and Seemantini, our CIO has a depth of online experience from her time at Target.", "So we have the right people in position to get this fixed and we have a very detailed transformation plan. So although we are disappointed with the results. It was part of a strategic decision to slow down short-term to make sure that we could get some issues corrected. We had just some fundamental process issue, if you added a new SKU online every store has to go through a manual process as though that SKU is being added to the shelf. And that was a priority project for every store, because of, they didn't flag it in the store, print a label and go through the same manual processes, though they were little added into the shelf you couldn't add it online.", "As rudimentary as that sounds that was the process and we were able to get that fixed in the early part of Q3. And there were other just really prehistoric processes like that that really hindered our ability to add additional SKUs, and so the way we look at online is that we think for the balance of this year, we're going to have modest growth, but we're going to be working very aggressively on replatforming to Google Cloud and a lot of other foundational functionality to -- search checkout navigation, etc. And then we believe as we get into 2020 you're going to start to see this business began to grow at the rate that we expected to and we see nothing, but upside potential. Just as a reminder, online is, give or take 5% of our total sales and it grew at 4% and we still delivered 3.2% comp. So what we know that we have upside potential for the business by getting our arms around this business and we have the people that can do it." ] }, { "name": "William P. Boltz", "speech": [ "And Eric the only thing, this is Bill, the only thing I would add to Marvin's comments is that we're just in the early stages of getting the online merchants integrated with the core merchants. And so as that starts to gain traction and we get some of these legacy systems issues fixed, then the acceleration in the SKU, in the SKU expansion certainly starts to happen and we start to be able to really gain some traction on the online space. So there's a lot of good things in front of us for dot-com." ] }, { "name": "Eric Bosshard", "speech": [ "Okay, thank you." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "I will now turn the conference back over for any closing remarks." ] }, { "name": "Marvin R. Ellison", "speech": [ "No. Well, thank you for your interest in Lowe's. We look forward to updating you on our next quarterly earnings call." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
LOW	2023-11-21	[ { "description": "Vice President, Investor Relations and Treasurer", "name": "Kate Pearlman", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Brandon Sink", "position": "Executive" }, { "description": "Guggenheim Securities -- Analyst", "name": "Steve Forbes", "position": "Analyst" }, { "description": "Robert W. Baird and Company -- Analyst", "name": "Peter Benedict", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies third quarter 2023 earnings conference call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, vice president of investor relations and treasurer." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you and good morning. Here with me today are Marvin Ellison, chairman and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president, stores; and Brandon Sink, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2023.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties, and important factors, including those discussed in the risk factors, MD&A, and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found on the quarterly earnings section of our investor relations website.", "Now, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate, and good morning, everyone. For the third quarter, comparable sales declined 7.4%. Our results were driven by a greater-than-expected pullback in DIY discretionary spending, especially in bigger ticket categories. While we've seen a more cautious consumer for some time now, this quarter, we saw some of these consumers increasingly prioritizing experiences over goods, spending on travel and entertainment.", "As a reminder, at Lowe's, 75% of our revenue is driven by DIY customers and 25% by Pros, while the broader market mix is roughly 50% DIY and 50% Pro. As a result, whenever the DIY customer becomes cautious, it disproportionately affects us. And while we face a softer DIY demand in the third quarter, I'm pleased that, at the same time, we once again delivered positive sales comp in Pro. Now, I'd like to take a moment to dig a bit deeper into our DIY performance for the third quarter.", "In categories like appliances, decor, flooring, and kitchen and bath, where we have strong DIY penetration, we saw increased pressure on sales of bigger ticket purchases like appliances where consumers are postponing purchases if they can. For example, customers who may have previously bought an entire kitchen suite may now just buy a refrigerator. Keep in mind that the industrywide pullback in appliance sales has a large impact on Lowe's since we are the market leader in appliances in the U.S. with 14% of our sales coming from this category.", "Later in the call, Bill will discuss some of the initiatives we're implementing in Q4 to improve DIY performance with a more targeted effort to reach value-conscious customers, including our most competitive offers on single-unit appliance purchases ahead of the holiday season, and the launch of our Lowe's lowest price guarantee, so our customers can shop with confidence knowing that they'll always find the best price at Lowe's. Despite the pullback in DIY, Pros are still working, and many of their projects are a result of increased wear and tear on aging homes, which lead to unavoidable repairs. This continues to create project backlogs for small- and medium-sized Pro who is our core customer. In our most recent survey, nearly 70% of Pros reported healthy project backlogs, but given the uncertain macro environment, they're feeling a little less confident.", "Although Pros may be a bit cautious in this environment, our ability to deliver a positive Pro sales comp in the third quarter is a reflection that our strategy is working. We're making progress with the investments we've made over the last several years to improve our service offering, including increasing loyalty through our MVP Pro Rewards, developing a world-class CRM platform, improving job site delivery, enhancing service levels in our stores, creating a more seamless online experience, and a number of merchandising initiatives that Bill will discuss later in the call. Overall, we built a competitive Pro sales and service model, which is creating a flywheel effect that will enable us to grow Pro sales at two times the pace of the market. Let's now turn to online sales, which declined 4% in the quarter as the same pressures in DIY bigger ticket categories impacted digital sales.", "Now, let's talk about what we're doing to manage this unique environment. In store operations, we've made foundational improvements to associate productivity that enable us to effectively align labor to demand while continuing to serve our customers. During the quarter, we leveraged these new capabilities to reduce operating expenses while enhancing the customer experience for both Pro and DIY customers at the same time. Joe will provide more detail on these initiatives and our improved customer service scores later in the call.", "I'm pleased that our disciplined focus on expense management across the organization contributed to a 46-basis-point increase in operating margin rate compared to adjusted operating margin in the prior year despite the sales decline, which led to diluted earnings per share of $3.06. As we explore ways to drive improved sales with our DIY customers, I'd like to provide you with an update on two initiatives: our new Lowe's outlet stores and our rural strategy. Let me start with our Lowe's outlet stores. We opened our 15th Lowe's outlet location in Q3.", "With these smaller format stores, we can leverage lower cost real estate and trade areas closest to our core customer without cannibalizing a nearby Lowe's store. In an environment where our DIY consumers are seeking value, we're pleased with the customer response and the overall performance of our outlet locations. These stores complement our market delivery network, allowing us to offer savings between 25% to 70% off on big and bulky scratch-and-dent items like appliances, patio furniture, and grills, all while maximizing profitability and offering our customers enhanced value. We look forward to discussing the potential growth opportunities of this strategy on an upcoming call.", "Turning to our rural strategy. This one-stop-shop concept is designed to give customers located in rural areas across the country everything they need for their home and farm, including a wide offering of farm, ranch, and outdoor products. During the summer, we launched this rural assortment to over 300 stores where we're selling products like livestock feed, pet food, utility vehicles, and apparel from brands like Carhartt and Wrangler. These programs include a Petco store within a store, which enhances the total home solution we offer by bringing together home improvement and pet care services, products, and expertise under one roof.", "We're pleased to see this new initiative already gaining traction with strong performance in pet, apparel, and automotive. In fact, these rural customers are our best-performing DIY segment, and these stores are performing significantly above the company average. Given this initial success, we're now exploring expanding this rural assortment beyond the original 300 designated rural stores. In addition, we're planning to add incremental merchandising initiatives within these original 300 stores because the customer is responding favorably to these new assortments and product lines.", "Looking ahead, we remain focused on our merchandising and marketing efforts that highlight the everyday value at Lowe's for our price-sensitive customers. And we'll continue to invest in our strategic growth initiatives within our total home strategy as we strive to become a world-class omnichannel retailer. And as I wrap up, let me say that we remain bullish on the medium- to long-term outlook for the home improvement industry, supported by favorable housing and demographic trends. We expect home prices to be supported by a persistent supply demand imbalance of housing, while at the same time, 250,000 millennial household formations are expected per year through 2025, and their parents and grandparents, the baby boomers, increasingly prefer to age in place in their own homes.", "And we cannot overlook the fact that we now have the oldest housing stock in U.S. history with the median age of homes now 41 years old, which will need ongoing investments in repair and remodel projects. These factors continue to reinforce our optimism about the mid to long-term outlook for our industry. In closing, I'd like to thank our front-line associates for their continued hard work and dedication to serving customers and our communities.", "And with that, I'll turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. Despite a pullback in DIY discretionary demand, we are pleased that we delivered positive Pro comps this quarter as our enhanced product and brand offerings continue to resonate with the Pro. Over the past several years, we've added the brands that Pros want, and we have invested in the inventory quantities Pros need, and we continue to tailor our product assortments to local building codes and preferences. These investments continue to pay off even in a more challenging macro environment where we remain laser-focused on highlighting everyday value and convenience, both in our stores and online, to a price-conscious consumer.", "Turning to our results in building products. We continue to serve our resilient Pro customer who remains active, especially on repair and maintenance projects. We delivered positive comps in building materials, partly driven by strong performance in Pro-heavy categories like roofing and drywall. We also delivered comps above the company average in rough plumbing, largely driven by positive comps in water heaters, demonstrating that Lowe's is the go-to solution for critical repair needs.", "This quarter, Klein Tools returned home to Lowe's. This trusted brand is the No. 1 tool brand for electrical and HVAC professionals, and we are thrilled to now offer the largest assortment of Klein Tools in the home improvement retail channel. Our Pro customers' response to our relaunch of Klein Tools has exceeded our expectations, and we're excited about our plans to expand this iconic brand to support the unique needs of these trade professionals.", "Now, let's shift gears to home decor, which was most heavily impacted by lower DIY project-related demand. And as you heard from Marvin, this had a greater impact in categories like appliances, flooring, and kitchens and baths. Within appliances, we are seeing lower industry unit volumes, as well as the reintroduction of pre-pandemic levels of vendor-funded promotion, which puts pressure on average selling price. And while our results in kitchens and baths were also impacted by softer DIY demand, we are seeing our private brand products gaining traction as the consumer continues to look for value like with our new Allen + Roth butcher block countertops.", "These are made of solid FSC-certified wood, and this stylish product is a cost-effective way to refresh your kitchen, bar, or studio. This item has been so popular that we are now doubling our sales expectations. Turning to paint. We delivered comps above company average in the quarter, largely driven by the Pro who paints who relies on Lowe's as a one-stop shop for their project needs.", "We continue to look for opportunities to expand our product offering, including a recent launch of an exclusive line of Sherwin-Williams primers from HGTV Home. These new primers designed for the Pro who paints gives them a versatile multisurface application that makes it easier to work on both interior and exterior projects. Shifting gears to hardlines. In addition to a broad-based DIY pullback, we also saw pressure in categories impacted by storm-related activity such as generators, gas cans, fuel, and chainsaws as we cycled Hurricane Ian from last year.", "We delivered comps above company average in lawn and garden as our customers engaged in smaller fall cleanup projects, and we also drove comps above company average in hardware, led by key Pro categories like fasteners, safety equipment, and cleaning products. Lastly, we continue to build out our brand portfolio like with our new strategic partnership with The Toro Company. Their exciting product lineup further complements what is now the strongest brand offering in outdoor power equipment, one that resonates with both the Pro and DIY customer who relies on Lowe's to offer the best selection. We're looking forward to launching Toro ahead of our upcoming spring season and building on our momentum as the leading retailer of outdoor power equipment.", "In response to the customers' increased focus on value, I'd like to talk about how we are highlighting some of the ways that customers can save time and money during this holiday season. For starters, we recently kicked off our holiday campaign with a commitment to supporting shoppers in new ways, all season long, which includes a wave of exciting offers and new deals every week on great gift ideas, including power tools from some of the best brands like DEWALT, CRAFTSMAN, and Kobalt, and pre-lit Christmas trees trimmed with the innovative energy-saving LED lighting. Our customers can also look forward to same-day delivery on key holiday and home improvement items, as well as services like holiday light hanging for the home through Angi. And as Marvin mentioned, we recently launched our new Lowe's lowest price guarantee to remind customers that not only can they expect a great shopping experience, but they'll also receive the lowest price on items for their home.", "In fact, customers can now find our lowest prices of the year on select major appliances. And in an effort to simplify the offer and make it easier to understand, we're offering $100 off for every $800 a customer spends. For our Pros, we have tailored exclusive bulk-saving offers on appliances as well. And to drive even greater excitement in traffic on Black Friday, we will feature more than 10 major appliance Storm-Busters.", "We are excited to deliver what we think will be the most compelling offers in the market. In addition to these great deals, Lowe's is now offering Carhartt apparel online and in select stores. This iconic workwear brand makes a perfect gift for the Pro this holiday. Before I close, I'd like to highlight just a few of the perpetual productivity improvements, or PPI, work streams that are underway in merchandising.", "Our teams continue to make progress in our three main focus areas: product cost management, inventory productivity, and pricing and promotional strategies. We continue to partner with our suppliers to take costs out, especially now that transportation and commodity costs have come down. And we're expanding our private brand portfolio, which delivers great quality and value at a lower price to our customers while also driving better margin rate productivity. Our teams are working hard to ensure that customers have the best value every day at Lowe's while also delivering productivity for the organization.", "And as I close, I'd like to extend my appreciation once again to our vendors and our merchants for their hard work, dedication, and ongoing partnership. Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thank you, Bill, and good morning, everyone. I'd like to begin by thanking our front-line associates for their ongoing efforts to deliver excellent customer service. As Marvin mentioned, we were able to reduce operating expenses this quarter while, at the same time, delivering a 200-basis-point improvement in DIY customer satisfaction scores and a 300-basis-point improvement for the Pro. This represents the ongoing benefit of our foundational technology investments designed to modernize our stores' operational process and simplify our associates' jobs while also creating a great shopping environment for our customers.", "Let me highlight just a few of these changes. For starters, we created an industry-leading customer-centric scheduling system, which allows us to predict customer demand and align staffing around peak customer traffic for each store and each department. This system creates enhanced operational agility so we can rapidly adjust as demand patterns shift. Second, we've enabled greater productivity by putting mobile smart devices in all of our associates' hands to make them more efficient, reducing manual tasking and enabling faster customer service.", "For example, by integrating smart devices with our new store inventory management system, or SIMS, our associates can find products 40% faster. And through Project Simple, we've eliminated duplicative tasks and reduced nonproductive hours so we could repurpose associate time from tasking to selling and service. A third foundational improvement is the expansion of our merchandising services team or MST. This team keeps our shelves stocked, and they recently assumed responsibilities for price changes across the store and watering in the garden center.", "MST is now leveraging a new app that directs them to serve a specific base based on the rate of sales, making their hard work even more productive and freeing up more time for our Red Vest associates to spend with customers. Another important aspect of delivering excellent customer experience is convenience. That's why we're making a number of enhancements to create a more convenient shopping experience ahead of the holiday season. For example, we're extending our same-day delivery to in-store purchases through our gig network to both Pro and DIY customers.", "And in certain locations, we'll even be delivering live Christmas trees to our customers' doors, saving them the hassle of getting it home themselves. This new gig delivery capability, which we first rolled out on lowes.com, enables us to tap into the OneRail network of 12 million drivers to deliver directly to Pro job sites and customer homes in just a matter of hours. Our store operations team is also focused on unlocking even more productivity through our perpetual productivity improvement initiatives or PPI. This past quarter, we fully retired the old self-checkout systems and have shifted to the proprietary self-checkout systems that we built for the home improvement shopper.", "We've seen greater customer adoption of these new systems since they're so much easier to use. In fact, our front-end transformation is well underway, with approximately 450 stores planned by the end of this year. Over a three-year timeline, we're revamping the checkout experience across all of our stores and increasing the selling space at the front, where we're adding more merchandise right at checkout, with a new design that makes it easy to showcase grab-and-go items. And with this front-end transformation, we're shifting to an easy-to-use assisted self-checkout, with cashiers who will be right there to answer questions and help customers when they need it.", "Finally, we're tripling the staging area for buy online pick up in store orders to support increased online sales and create a much faster, easier customer experience, building on our momentum when it comes to driving improved customer service scores for these orders. At the same time, we're excited to launch omni-selling in our stores, a critical milestone in our journey to become a world-class omnichannel retailer. Enabled by our new store operating system, we can now easily sell our endless aisle on lowes.com within the aisles of our stores. For example, let's say a customer is shopping for new faucets and browsing our selection of the most popular finishes in the store.", "While talking with an associate, they decide to go with the unique finish from lowes.com that the associate highlights on their mobile device. The associate then saves the faucet in the customer's digital cart with their phone number, and the customer can continue shopping in the store. When the customer is ready to check out, all the cashier needs to do to combine the digital and physical purchases is pull up the digital cart using the customer's phone number. We're still in the early innings here, but we know this is a great opportunity to drive our omni sales and make sure our customers get everything they need to complete their project in one shopping trip.", "As I close, I would like to thank all of our store leaders and associates once again for their hard work, serving customers and delivering results each and every day. Thank you. And now, I'll turn it over to Brandon." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Joe, and good morning, everyone. Starting with our Q3 results. We generated diluted earnings per share of $3.06. Please note, in the prior year, we recorded an asset impairment charge of 2.1 billion associated with our Canadian retail business.", "Now, my comments from this point will reference comparisons to certain non-GAAP measures from last year, where applicable. Q3 sales were 20.5 billion. For reference, prior-year sales included $1.2 billion generated in our Canadian retail business. Additionally, Q3 results include a $115 million sales headwind due to the shift in our fiscal calendar as we cycle over a 53-week year.", "Comp sales were down 7.4% as a slowdown in DIY bigger ticket spending offset growth in Pro. Q3 comps were negatively impacted by approximately 50 basis points due to lumber deflation. As a reminder, the calendar shift impacted total sales growth but had no impact on comparable sales as comps are calculated based on Weeks 28 through 40 in fiscal 2022. Comparable average ticket was down 0.5%, driven by lumber deflation, more normalized appliance promotions, and a decline in big-ticket DIY transactions.", "However, average ticket still increased in the majority of our merchandise categories. Comp transactions declined 6.9%, driven by softer demand in DIY discretionary projects, partly offset by positive comp transactions in Pro. Our monthly comps were down 6.3% in August, 8.3% in September, and 7.3% in October as DIY traffic slowed as we exited our peak seasonal weeks. Gross margin was 33.7% of sales in the third quarter, up 36 basis points from last year.", "Gross margin benefited from our ongoing merchandising PPI initiatives, as well as favorable product mix and lower transportation costs. This was partially offset by costs associated with the expansion of our supply chain network. And consistent with our year-to-date performance, shrink was in line with prior year. SG&A of 18.4% levered 30 basis points versus prior-year adjusted SG&A, demonstrating our enterprisewide agility to manage expenses and drive productivity in a lower sales environment.", "These results would not have been possible without the exceptional efforts of our store leadership teams to rapidly respond to the sales pressure, as well as the ongoing benefits that we are harvesting from our technology-led PPI initiatives. Operating margin rate of 13.2% improved by 46 basis points versus prior-year adjusted operating margin. The effective tax rate was 24.6%, in line with prior-year adjusted effective tax rate. Inventory ended the quarter at 17.5 billion, down 2.3 billion compared to Q3 of last year.", "U.S. inventory dollars and units were both down compared to last year as we align inventory purchases with sales. Turning now to our capital allocation. During the quarter, we generated 485 million in free cash flow.", "We repurchased 7.3 million shares for $1.6 billion and paid $642 million in dividends at $1.10 per share, returning $2.2 billion to our shareholders. Capital expenditures totaled 579 million as we continue to invest in our strategic priorities within our total home strategy. Adjusted debt to EBITDAR finished the quarter at 2.72 times, in line with our stated 2.75 times leverage target. Finally, we delivered return on invested capital of 35%, inclusive of an unfavorable 125-basis-point impact related to transaction costs associated with the sale of our Canadian retail business and the gain we reported in Q1.", "Now, turning to our 2023 financial outlook. Given the recent pullback in DIY bigger ticket discretionary spending and the uncertainty surrounding the macro factors that impact our business, we are updating our full year 2023 financial outlook. With this in mind, we are now forecasting Q4 comp sales to be fairly consistent with Q3 results. Also, the fourth quarter of 2022 included approximately 1.4 billion in sales from the additional 53rd week.", "We are now expecting 2023 sales of approximately 86 billion, with a comparable sales decline of approximately 5%. We also now expect adjusted operating margin of approximately 13.3% as our ongoing PPI initiatives and disciplined expense management help to offset volume deleverage pressure from lower sales. Additionally, we expect full year interest expense of approximately 1.4 billion, capital expenditures of up to 2 billion, and an adjusted effective income tax rate of approximately 25%. This results in an updated outlook for adjusted diluted earnings per share of approximately $13.", "Please note that our outlook for operating margin and diluted earnings per share are adjusted to exclude the gain associated with the sale of our Canadian business that we recorded in Q1. Finally, we are reconfirming our capital allocation priorities. We will continue to invest in the business to take market share, target a 35% dividend payout ratio, and then return excess cash to shareholders through share repurchases, which will be funded in the near term through free cash flow. And in closing, I'm confident that our continued investments in our total home strategy, our strong balance sheet, and our ability to effectively manage our business in any environment will allow us to navigate the near-term challenges while continuing to deliver sustainable shareholder value.", "And with that, we will open it up for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We are now ready for questions. [Operator instructions] Our first question comes from the line of Steven Forbes with Guggenheim Securities. Please proceed with your questions." ] }, { "name": "Steve Forbes", "speech": [ "Good morning. Marvin, you mentioned in your prepared remarks the 300 rural stores comping above average and some of those categories being the best-performing ones. So, curious if you can maybe help reframe how you guys are thinking through the more medium-term and longer-term opportunity there. How many stores do you think can accommodate such an assortment? And any contextualization of the spread in the DIY comp in the 300 stores versus the company average?" ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Steve. Thanks for the question. We're not going to get into that level of specificity for competitive reasons, but what I will tell you is that the rural stores have exceeded expectations. And as we noted, we started out with roughly 300.", "But candidly, the performance and the customer response has been such that we're now looking at a couple of different options. One option is we're going into those original 300, and we're adding incremental investments, initiatives, categories based on feedback from customers. We're also looking at categories that are working really well in those rural stores and asking the question, can we now take some of these categories and put them in nonrural format locations because we believe we could get the same response from customers in nonrural environments. And then thirdly, we're just looking at expanding our profile and definition of rural because some of these characteristics, we think, can fit other locations.", "And because of the response and because of the DIY customer being such a critical component of our company strategy, we think this makes a really good strategic rationale, and it's something that we're pursuing. But again, we'll speak more about this on future calls, but I don't want to get into more specifics for obvious competitive reasons." ] }, { "name": "Steve Forbes", "speech": [ "And then maybe sticking with some initiatives here, maybe a follow-up for Bill, the front-end transformation, we're probably far enough, right, into it where it'd be helpful if you can maybe frame the ROI of such transformations. I don't know if you can sort of maybe go through what you're seeing in terms of comp lift and/or just the -- you know, what is the outlook, right, for next year as we think through, you know, the maturation benefit of such an agenda?" ] }, { "name": "Bill Boltz", "speech": [ "Yeah. So, you know, as Joe said, we've got roughly 450 stores that we'll complete by the end of the year. We continue to test and learn in these stores. As you can imagine, there's opportunities for us to try some additional merchandising opportunities upfront at the store.", "It's all about getting another item in the basket. And, you know, there's opportunities, you know, in the obvious areas like snacks and drinks, but we're also looking at other categories as well that, you know, can complement what we're doing and also that, you know, shopper, both the Pro and the do-it-yourself, that's making that transaction in our store that could pick that kind of stuff up, and you think about like aspirin, Band-Aids, stuff like that that could complement what they're doing and could be used on a job site or in a glove box of a car or at your home." ] }, { "name": "Marvin Ellison", "speech": [ "And, Steve, the other thing that I'll add is this also complements the ongoing omni expansion that Joe talked about. You know, as we extend these capabilities of connecting digital and physical stores, we need more productive space and we need to just optimize all the things that the associates are doing to accommodate and fulfill those orders. And as Joe mentioned, you know, part of this is to create more designated space in a more productive fashion, you know, for that process. But also, it's creating a much better customer experience, and it's also driving a lot of productivity, you know, for Joe's team in the store." ] }, { "name": "Steve Forbes", "speech": [ "Thank you. Happy Thanksgiving, everyone." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Peter Benedict with Baird. Please proceed with your questions." ] }, { "name": "Peter Benedict", "speech": [ "Hi. Good morning, guys. Thanks for your question. Just kind of curious, as you talk a lot about the PPI initiatives and your ability to kind of be agile with expenses, if we think kind of longer term, think maybe out to next year, if there's another environment where comps for sales are maybe down in the mid-single digit range, how do we think about your ability to manage margins in that environment? I know some of the benefit this year is cycling Canada, but just maybe some benchmarks to think about as we move to next year on how the P&L could act in different top-line environments? Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Hey, Peter. This is Brandon. Just in terms of as we're looking at 2024, we're in the later stages of our planning process at the moment across the organization.", "So, we're going to hold off on providing any in-depth guidance until our Q4 call. But what I will tell you just in terms of top line, macro, home improvement, you know, there's continued uncertainty on interest rates, you know, when we're going to see relief, when existing home sales are going to turn the corner and begin to improve, and obviously the ongoing impact of inflation, higher rates on consumer wallets. So, we're watching all that. I think to your specific question on margins, you know, we're managing several puts and takes as we look at next year.", "We're cycling one-time legal settlements, normalization of incentive comp, wage growth, the pacing of our PPI initiatives. So, we're looking at all that. We're going to take all those factors under consideration as we develop our guide and hold off on providing that until we get to February." ] }, { "name": "Marvin Ellison", "speech": [ "Peter, this is Marvin. And the only thing I'll add is, you know, you heard in some of the prepared comments, I was talking about an old operating system. And we've talked a lot about this 30-year-old operating system that's really been a significant impediment to some of the technology advancements. And we're going to be sunsetting that system at the end of this year.", "And it's going to just unlock a little bit of acceleration in some of the technology advancements that we have on the project list and we just -- candidly, we couldn't get to because of this system. And so, the good news is we're going to continue to work, to Brandon's point, on all the elements of running an improved business, from a merchandising, store operation, supply chain. But also, the technology project list over the next three to five years is robust, and it's going to allow us to continue to find ways to drive profitability, irrespective of the macro environment that we're in. We're hoping the macro environment gets better.", "But to Brandon's point, we're going to wait until our Q4 call to talk about '24 and give a much more educated perspective at that time." ] }, { "name": "Peter Benedict", "speech": [ "Right. Fair enough. Appreciate that perspective. I guess my follow-up would be just around maybe the cost environment that you're seeing out there.", "A lot of talk of, obviously, disinflation and some outright deflation in certain areas. What are you seeing right now in terms of the cost you're receiving from your suppliers, and how do you kind of view that as we look out over the next few quarters? Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Peter, this is Brandon. I would say, just in terms of costs coming into the organization at this point, just from an inflation, price action response to that, it's, you know, leveled off pretty dramatically here as we've moved through the year. We've had targets in terms of clawback for this year.", "We laid those expectations out back in December. I would say very much pacing in line with those targets. We laid out about $500 million over the course of three years. We're leveraging cost management teams, working closely with the merchants, the tech-enabled tools that we've invested in.", "We have very detailed product cost breakdowns that are informing those negotiations with our suppliers. So, we're continuing to be balanced. We're taking a portfolio approach. We're investing in price strategically, where needed, but also looking through the lens of protecting our margins." ] }, { "name": "Peter Benedict", "speech": [ "Understood. Thanks so much, guys. Happy Thanksgiving." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Peter." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Thanks, Peter." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Simeon Gutman with Morgan Stanley. Please proceed with your questions." ] }, { "name": "Simeon Gutman", "speech": [ "Hey. Good morning, everyone. I want to try to take another stab at this margin question for next year. I know there's not a whole lot you can provide.", "If you think about the levers that you have, do you lose any for next year, realize that you're going to lap the legal settlement in the first part of the year? And then connected to it, as you manage your selling expenses, do you think that's having an impact on sales at all? Meaning, is that not something you press on as hard for next year?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Simeon, this is Brandon. I wouldn't say when we look at next year, we're losing the benefit of any of those levers. In fact, I think we're looking at where we have opportunities to accelerate.", "We've talked about PPI, talked about, you know, where we were in that journey in terms of middle innings. You know, Marvin mentioned the conversion of the store technology to a modern omnichannel platform. We got a lot of initiatives stacked up where we expect to see those benefits as that gets delivered next year. Earlier question on transforming the front end, really expanding assisted checkout, expanding the BOPIS experience.", "And then Bill talked in his prepared comments about multiple other kind of merchandising PPI initiatives, whether it's cost clawback, inventory productivity, pricing, promotional strategies, expansion of private brands. So, we're really confident in that portfolio of initiatives. We feel like it's in our control. We're managing the road map and the pacing of that and have a lot of confidence as we look at the longer term margins that we can deliver against our stated targets there." ] }, { "name": "Marvin Ellison", "speech": [ "So, Simeon, this is Marvin. I'll add this perspective. The reason why we call this a perpetual productivity improvement initiatives is because we're trying to stay away from one-time events. We think that good companies create an ongoing sustained process of improvement and productivity gains.", "And so, we have a road map of initiatives. And it's important that it's not just about store operations. You heard Bill talk about the PPI initiatives specifically for merchandising. If Don Frieson was here, he could speak specifically to supply chain, and Seemantini could speak specifically for IT.", "And so, this is a culture that we've created here that candidly did not exist. But the key word is perpetual, and that means that it's ongoing, it's consistent, and it's sustainable. And so, as we look at '24, even though we're not going to get into the details, what Brandon is reinforcing is that we have a list of things that we're going to do. We're well aware of what we're overlapping.", "We understand some of the one-time factors we're going to face. And we built processes, initiatives in place to address that. And we'll be more transparent and more detailed in our Q4 call because we think it's really important to lay out to you all exactly how we see it and the steps we're going to take." ] }, { "name": "Simeon Gutman", "speech": [ "So, my gentle follow-up to that, Marvin, is you have opex productivity and PPI. Those are the two biggest unlocks. I just -- to clarify or an assumption, it doesn't sound like what the business comps has anything to do on what those two buckets produce. And then is there a situation in which those two buckets actually produce more in terms of sequencing in '24 than what it was yielding in '23?" ] }, { "name": "Marvin Ellison", "speech": [ "So, I'll give you the perspective of a long-term operator. If we get to top line, PPI works a whole lot better. So, irrespective, we're going to intensify the focus. Obviously, if we have a softer top-line perspective, we're going to be a lot more aggressive in the PPI side.", "But irrespective of our comp outlook, PPI is going to be in existence, and we're going to work really hard to make sure that we hit some of the key targets that we lay out. And again, you have our commitment that as we lay out 2024, as best we can, we'll be as transparent as possible about all of these things in our February call." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Happy Thanksgiving." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Thank you, Simeon." ] }, { "name": "Brandon Sink", "speech": [ "Thanks, Simeon." ] }, { "name": "Operator", "speech": [ "Our next questions are from the line of Chris Horvers with J.P. Morgan. Please proceed with your questions." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, guys. I want to focus a bit on the top line. You've seen increased big-ticket sensitivity.", "You know, others are talking about -- you mentioned flooring. People are doing smaller projects. They're not buying the suite of appliances. You're doing the bathroom, not the entire first floor and flooring.", "I guess, you know -- so my question is why isn't the Pro and the remodel business -- or maybe the remodel business is -- and the answer is different from you on the Pro because it's shared. But why isn't the remodel business and the Pro business the next shoe to drop? And given the changes that you've seen over the past three or four months, how are you thinking about the bottom of the comp cycle and, you know, sort of when does it start to revert back to positive?" ] }, { "name": "Marvin Ellison", "speech": [ "So, Chris, I'll take the first part of that, and I'll just let Bill Boltz talk about some of the initiatives relative to addressing some of the top-line concerns. So, specific on sales for us, and when we look at the quarter, we look at it from penetration from a DIY perspective and a product mix. So, as a reminder, 14% of our revenue comes from appliances. So, when you have pullback on some of these big-ticket categories like appliances, it's going to be disproportionately impactful for us.", "You know, having said that, we look at the Pro, and to your point, we had a positive comp, and we're really pleased with that. And I went through some of the investments we've made over the course of the last four years that we believe are paying dividends relative to that specific small and medium Pro. And the reason we think that that specific segment of Pro will remain healthy, although cautious, as we noted from our survey, is because of the age of homes. I mean, it is a foregone conclusion that if you have a house over 40 years old, things are going to break.", "And when those things break and those repairs are required, that small to medium contractor is typically the one that's going to get that call. And these Pros are incredibly transparent with us, and 70% say they feel really good about their backlog. But they also said that when they watch the news and they read the headlines, they're a little cautious because they just don't know what's lurking around the corner. But they're busy because these homes are old, these homes are not turning, so people are living in these homes.", "And so, that's really the driver of that customer segment remaining healthy and busy. And look, we can't predict the bottom. But what we can say is that we're incredibly disciplined. Anytime you can deliver a 46-basis-point improvement operating margin on a negative 7 to negative 4 comp, it tells you that there are a lot of, really, things working from a productivity standpoint that drives margin rate improvement and basis for improvement in customer service that we're really proud of.", "So, we feel good about the execution of the team. And we can't predict kind of what's going to happen when, but we can say whenever it happens, we're well positioned to take advantage of it. And I'll pivot to Bill just to talk about kind of what we're trying to do to remain agile and to try to make sure that we are driving a business environment that's attracting DIY customers and keeping these Pros coming back also." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. Thanks, Marvin. And, Chris, you know, just some of the things that we've talked about really over the last few quarters that I'm pleased with, the work that the team has done is, you know, the continued, you know, acquiring of brands and making sure that we've got, you know, relevant assortments inside of our stores and online. And so, you know, we announced today, you know, Toro as part of our outdoor power equipment.", "We talked about Klein last quarter, and we're just starting to get that, you know, brand now into the electrical and the tool category. So, that's excitement for us. We've talked about, you know, localized assortments. And Marvin touched briefly on the rural strategy, that's just one element of a localized opportunity.", "And then we continue to try to pivot to where the customer is. So, as -- you know, we've seen some of this softening in appliances from an industrywide standpoint. You know, because, you know, we're the industry leader here, we want to make sure that we can meet the customer where they want us to meet them, and that's, you know, adjusting. And so, we feel like, you know, the adjustments the teams have made to, you know, make sure that we can go after the 100,000-plus appliances that break in the United States every single week, that we're there when the consumer needs us, both online and in store.", "We continue to enhance our fundamentals and our foundation online. And so, you know, offering Apple Pay as a way to make it easier for the customer to transact online is just one element. Same-day delivery. And then obviously, being seasonally relevant.", "As we go into this Friday with Black Friday, it's about making sure that we've got strong offers out there that gets the customer to the door and to the website. And that's the stuff that we'll continue to do. And at the same time, we have to be competitively priced. We've got to be relevant every single day.", "And so, that's the kind of work that the team continues to stay focused on. And it takes time, obviously, to get that customer to know that these changes have happened inside of our store and online. And, you know, we're just going to stay -- we just stay focused on what we can control." ] }, { "name": "Chris Horvers", "speech": [ "And then my follow-up is, again, on the Pro side. As you think about the momentum in that business over the -- over this year or what you're seeing in the basket in terms of the projects that they're doing, whether it's size or price point, you know, price spectrum, is there any change in momentum on the Pro side of the business?" ] }, { "name": "Marvin Ellison", "speech": [ "Chris, thanks for the question. And listen, we can tell you that, you know, with the Pro loyalty and CRM that we launched, you know, we continue to view the basket, we continue to view the mix. We are very encouraged and continue to exceed expectation in the core metrics, and we continue to launch new capabilities, things like online quotes for the bulk pricing that Bill talked about. In my prepared remarks, I mentioned the integrated same-day gig delivery, streamlined order tracking.", "And so, you know, there's a lot going into that Pro from an effort standpoint, and so we continue to be pleased at the progress." ] }, { "name": "Chris Horvers", "speech": [ "Got it. Have a great Thanksgiving. Thanks very much." ] }, { "name": "Marvin Ellison", "speech": [ "Thanks, Chris." ] }, { "name": "Operator", "speech": [ "Our next questions are from the line of Seth Sigman with Barclays. Please proceed with your questions." ] }, { "name": "Seth Sigman", "speech": [ "Hey. Good morning, everybody. Thanks for taking the question. So, I wanted to follow up on pricing and promotional activity.", "Obviously, you talked about elevated promotions in appliances and how that's being funded by vendors. I realize that category is a little bit unique, but how would you categorize discounting activity across other categories? And maybe you could also just elaborate on what you have seen and what you've been doing with that low price guarantee? Thank you." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. So, it's Bill. And so, you know, just a couple of things here. You know, as I said, you know, we are seeing, you know, probably more of a move on pre-pandemic levels of promotions, specifically in the appliance area.", "These are largely vendor-supported, but, you know, we want to make sure that we're there, you know, obviously, and we're part of all that. As it relates to the overall, you know, the industry remains, you know, pretty rational and pretty stable. You want to make sure that, you know, at certain times of the year, you're out there with the relevant offers and that you're, you know, doing the things that you need to do. So, whether that's in the spring or this Black Friday, you know, we're excited about, you know, having some of those offers out there and working within the guardrails and the profitability targets that we've established.", "But, you know, all in all, it remains, you know, I think relatively rational. I think the consumer's looking for value, and so we've got to find different ways to highlight value, and those are the things that this team is doing. And value can come in a lot of ways outside of just a reduction in price. You can highlight it through new and innovative products.", "You can highlight it through, you know, a special offer, if that's what comes out, or you can do it through a vendor-funded promotion. So, those are the things that we're trying to take advantage of." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. And, Seth, this is Brandon. I would just add, you know, the adjustments that Bill was talking about that we're making as the consumers change, and as we're moving through the year, our go-to-market strategy, all of that's fully embedded and reflected in our updated outlook and confidence that we're able to achieve our flat gross margins for the year." ] }, { "name": "Marvin Ellison", "speech": [ "And, Seth, on a low price guarantee, you know, our research just indicated that we needed a more simplistic straightforward message to the customers about our value. We had something that was a little too cute called a price promise that I think was way too ambiguous. And we just decided just to keep it simple and stand by the fact that we will support the lowest price in the industry on the products that we sell. We just launched it.", "We think the timing is perfect going into holiday season, where you have a slightly cautious consumer looking for a value. And so, you take everything that Bill said about the definition of value and the fact that that we're going to put media behind this lowest price guarantee, we hope that sends a message to the consumer that they could always expect the lowest price at Lowe's." ] }, { "name": "Seth Sigman", "speech": [ "OK. Thank you for that. That's very helpful. I did have one follow-up on capital allocation, specifically share repurchases.", "Just based on what you've done year to date, where leverage sits today, how do you think about the pace of buybacks from here? Should we be thinking about that starting to slow into the fourth quarter and even over the next couple of quarters based on the demand backdrop? How do we think about that?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Seth, this is Brandon. So, our capital allocation priority is unchanged. We're going to continue to invest in the business in high-return projects, targeting a 35% dividend payout ratio, and funneling the remainder to share repurchases.", "As I mentioned in my prepared remarks, we do expect funding a share repurchases through operating cash flow here in the near term and expect modest, if any, share repo in Q4. Also, expect to be in line with our stated leverage target at the end of the year. So, we're also looking at our debt towers, paying those off as they mature. We had 500 million this past Q3.", "We have 450 million coming due in 2024, and we remain committed to our BBB+ credit rating and expect to manage our leverage accordingly." ] }, { "name": "Seth Sigman", "speech": [ "OK. Great. Thanks and have a nice holiday." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Seth." ] }, { "name": "Operator", "speech": [ "The next questions are from the line of Michael Lasser with UBS. Please proceed with your questions." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thank you so much for taking my question. Given the importance of sales to the PPI initiative, if you're looking at, call it, another down five comp next year, do you start to become more aggressive with promotions or other actions in order to start to drive sales because you'll get a return on it in other ways?" ] }, { "name": "Marvin Ellison", "speech": [ "Michael, we're not going to get into 2024 at this time. We'll speak more specifically about that on the Q4 call. What I'll just repeat is, you know, PPI is perpetual for a reason. We're going to keep doing it.", "It is sustainable, it's ongoing, and we're going to be agile. We'll take the necessary steps to make sure we're running a really sound business, thinking first about driving service for the customers and giving our associates a great place to work. But other than that, you know, PPI will be in place irrespective of top line, and we'll adjust it accordingly." ] }, { "name": "Michael Lasser", "speech": [ "OK. My follow-up question is, Marvin, as you look at your sales by market, by region and tie that to the underlying housing characteristics and dynamics in those markets, where are you seeing better trends and where are you seeing worse trends such that informs how you think about how the rest of this cycle is going to unfold from here? It's likely at some point, hopefully, housing turnover is going to pick up. That could bode well for home improvement demand. But if it comes with a corresponding tick down in home prices, that could be not so good for home improvement demand." ] }, { "name": "Marvin Ellison", "speech": [ "No, Michael, it's a fair question. If you strip out storm overlaps, geographically, our performance is relatively balanced. So, there are really no outliers. When you look at markets that had a dramatic run-up in housing costs and some level of moderation, there's really no material impact to our business based on that.", "Obviously, it's something that we stay really close to. We're paying attention to it. But as of right now, it's not material, and we don't see it as something that's going to affect our business in the near term." ] }, { "name": "Michael Lasser", "speech": [ "Thank you and have a great holiday." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, sir." ] }, { "name": "Operator", "speech": [ "The next question comes from the line of Brian Nagel with Oppenheimer and Company. Please proceed with your questions." ] }, { "name": "Brian Nagel", "speech": [ "Hi. Good morning. Thanks for taking my questions. So, a couple questions on top line.", "I'm just going to merge them together. But first off and a bit of a follow-up, just on appliances. So, Marvin, you just talked about maybe some normalization in overall promotions vendor-led. I guess the question I have on appliances, are you seeing anything shift in the market? I mean, obviously, we're against very fluid demand backdrop.", "Are you seeing anything shift from a competitive standpoint? And then my second question, just with respect to the underlying cadence of the business, we saw what appears to be a weakening trend through the fiscal third quarter and then presumably here into the fourth quarter. Anything that you can -- clearly, there are some seasonal factors there. But is there anything else you can really call out that may have -- as you can identify as kind of a driver of that weakening trend in the overall business? Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "Michael, I will -- I'll take both and just allow Brandon to be able to jump in if they have any additional comments. On the appliance shift, I mean, we're not seeing anything other than what Bill talked about where you have vendor-funded promotions kind of driving average ticket down. And also, as we mentioned in the prepared comments, we're seeing customers being just a little more specific on their purchases, going from an entire suite to just a refrigerator, as an example. And I think that's just the cautious nature of the DIY discretionary spending on some of these bigger ticket categories we talked about.", "You know, we are the market leader in the U.S. in appliances. And as I mentioned earlier, 14% of our annual revenue is, you know, predicated to appliances. And so, when the market is soft, we have a disproportionate impact.", "Having said that, we feel great about our market-leading position. And as Bill outlined, we have some competitive offers on single-unit purchases for the holiday season that's the best in the industry. And so, we feel like we're in a good place relative to the marketplace. On weakening trends, you know, there's not anything we can put our finger on.", "I mean, you know all the macro indicators with the resumption of student loan debt and sustained inflation interest rates. And I just think that those things, you know, combined with the fact that people are just choosing to take discretionary dollars and have more experiences with those dollars, is really leading into some of the things that we're seeing. And when those discretionary categories are impacted, those are typically DIY-related purchases. And again, at 75% penetration in DIY, we just have a disproportionate impact to that.", "So, I'll let Brandon or Bill add anything else, if they have it, you know, in addition to what I just said." ] }, { "name": "Bill Boltz", "speech": [ "The only thing that I would add, Brian, is that just -- you know, as I said earlier, just a reminder that, you know, over 100,000 units of appliances break in the marketplace every week. And, you know, we've got to be there, you know, for that consumer as the market leader. And that's what we're trying to do, and do that in a responsible manner to make sure that we can hit all the financial targets that we need to hit but also make sure that we can meet the customer where they want to be met, both online and in store." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. And, Brian, this is Brandon. Just to wrap it out in terms of how we are looking at Q4, I think our outlook is largely a continuation of the macro and the traffic trends that we've experienced in Q3. We do expect a light or a slight impact from lumber deflation as we transition into Q4.", "All of the offers that Bill has talked about with appliance holiday offers are reflected in there. We do expect some light pressure from cycling Hurricane Ian. So, we've triangulated all that. We've looked at one, two, four-year trends.", "All of that is sort of baked into the expectations that we set, and we believe it's very achievable for us here for Q4." ] }, { "name": "Brian Nagel", "speech": [ "All right, guys. Appreciate all the color. Happy Thanksgiving. Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Brian." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Brian." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you all for joining us today. We'd like to wish everyone a Happy Thanksgiving and a wonderful holiday season, and we look forward to speaking with you on our fourth quarter earnings call in February." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2022-02-23	[ { "description": "Vice President, Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Dave Denton", "position": "Executive" }, { "description": "Goldman Sachs -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Mike Baker", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" }, { "description": "Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies fourth quarter 2021 earnings conference call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I'll now turn the call over to Kate Pearlman, vice president of investor relations." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning. Here with me today are Marvin Ellison, chairman and chief executive officer; Bill Boltz, our executive vice president merchandising; Joe McFarland, our executive vice president stores; and Dave Denton, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2022.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our investor relations website.", "With that, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate, and good morning, everyone. Our results once again beat expectations this quarter, with comparable sales up 5% for the total company and 5.1% for the U.S. on top of over 28% growth last year. This resulted in comp sales of 34.5% for the total company and up 35.2% for the U.S.", "on a two-year basis. These results capped of outstanding financial results for fiscal 2021 with sales of $96.3 billion, up 6.9% on a comparable basis and earnings per share of $12.04, up 36% on an adjusted basis. With these outstanding results, 100% of our stores earned a quarterly Winning Together profit-sharing bonus. This $94 million payout is $24 million above the target payment level.", "And in recognition for their hard work throughout the pandemic in 2021, we are awarding an incremental discretionary bonus of $265 million to our frontline associates. Altogether, we rewarded our frontline associates with bonuses of over $350 million in the fourth quarter. As Joe will discuss later in the call, financial support of our frontline associates is consistent with our commitment to being an employer of choice in the retail industry. Our Total Home strategy continues to gain momentum, as we grow our share of wallet with both Pro and DIY as they increasingly rely on Lowe's as a one-stop solution for all their project needs.", "In looking at our results this quarter, I'm particularly encouraged that our growth was broad based and balanced across product categories, across both DIY and Pro, both online and in-store. In Pro, we delivered growth of 23% and 54% on a two-year basis. And we are building on our momentum with the Pro with the launch of our new Pro loyalty program, MVPs Pro Rewards and Partnership Program. We redesigned our loyalty program based on feedback from our Pro customers who expressed a desire for a business partnership rather than a series of stand-alone transactions.", "Our data shows that Pros who leverage our loyalty and credit offering spend 300% more than Pros not engaged in these programs. Our Pro business is off to a strong start this year, and we're excited about the national launch of our MVPs Pro loyalty program. I look forward to providing updates on this critical initiative throughout the year. Now turning to our DIY customer, where we delivered growth on top of exceptionally strong demand last year.", "Later in the call, Bill will discuss how we continue to grow our DIY market share by elevating our private brands product assortments in our home decor category. On Lowes.com, sales grew 11.5% on top of 121% growth in the fourth quarter of 2020, which represents a two-year comp of 147% and nearly 11% sales penetration. Our intuitive online shopping experience and expanded on-trend assortments are resonating with our customers. And while we're pleased that our online sales have more than doubled over the past two years, we still have tremendous growth opportunity in front of us.", "And as part of our efforts to enhance our omnichannel experience, we are expanding our same-day and next-day fulfillment capabilities. With that in mind, we're actively piloting several gig network solutions, including partnering with Instacart in several markets with same-day DIY home delivery. And building on the success we gained in the Florida and Ohio Valley regions with our market delivery strategy, we completed the conversion of our third geographic area, the Carolina region, during the fourth quarter. By way of reminder, in the market-based delivery model, big and bulky products flow from our supply chain directly to customers' homes.", "This replaces the highly inefficient store delivery model where each store acts as its own distribution and transportation center for these products. As we continue to expand our market-based delivery model, we're freeing up space in our 10,000 square foot store back rooms, which on average are considerably larger than our competition. And we are testing out different options to drive both greater in-store fulfillment and expanded delivery alternatives for both Pro and DIY customers. In a few minutes, Bill will discuss our continued investments in online as we create a best-in-class integrated omnichannel shopping experience.", "During the quarter, operating margin expanded approximately 115 basis points, leading to diluted earnings per share of $1.78, which is a 34% increase as compared to adjusted diluted earnings per share in the prior year. These results reflect our disciplined focus on driving operating leverage through our perpetual productivity improvement initiatives or PPI, as well as the ongoing benefits of our new pricing strategies. Joe and Dave will discuss these initiatives in further detail later in the call. Turning to our results in Canada where performance lagged the U.S.", "The Canadian leadership team continues to drive productivity through proven technology and processes that have delivered great results in the U.S. Before I close, I'd like to share my perspective on the home improvement market, as well as our opportunity to continue to win share. Our outlook for the home improvement industry remains strong, supported by a very healthy consumer balance sheet, especially for homeowners and continuing home price appreciation. Persistent solid demand for homes despite an uptick in interest rates is also expected to support residential investment.", "In fact, we're encouraged by the strengthening millennial household formation trends that will support home buying in the coming years. Other trends remain favorable, including baby boomers' increasing preference to-age-in-place. And with the extension of remote work for some employees, we're expecting a permanent step-up in repair and maintenance cycle. And as a reminder, 50% of the homes in the U.S.", "are over 40 years old and will continue to require investments for upkeep and approximately two-thirds of Lowe's annual sales are generated from repair and maintenance activity. Therefore, we're encouraged that the macro environment for home improvement remains very supportive. As we close the year, we continue to give back to the communities where we operate, with total donations of $100 million in 2021 well over our pre-pandemic levels. And we're pleased that our efforts to enhance our brand reputation while supporting our associates and driving long-term value for our shareholders and was recently recognized by Fortune Magazine as they named Lowe's the No.", "1 most admired specialty retailer for the second year in a row. This is the first time in our history that we received this recognition in back-to-back years. In closing, I'd like to extend my heartfelt appreciation to our frontline associates. As I travel the country every week visiting stores, I continue to be struck by their commitment to supporting our communities while providing excellent customer service.", "And with that, I'll turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. In the fourth quarter, U.S. comparable sales increased 5.1% and 35.2% on a two-year basis. We delivered positive comps in all three merchandising divisions in the quarter with growth across Pro and DIY customers.", "Growth was well balanced with 12 of 15 merchandising departments comping positive and was broad-based on a two-year basis with all 15 departments up more than 18% in that time frame. Beginning with our Home Decor merchandising division, flooring and appliances delivered the strongest comps in the quarter. In flooring, vinyl flooring once again led the way as we continue to see consumer preference shifting toward this affordable and stylish solution. Lowe's already offers a wide selection of vinyl flooring products, including several Pergo WetProtect options.", "And this year, we look forward to extending our own trusted STAINMASTER brand with its high performance characteristics and lifetime stain-resistant warranty across a full range of flooring products, including laminate, tile and vinyl. Within appliances, sales of ranges, cooktops, along with dishwashers were the strongest in the quarter. As we continue to extend our private brand offering, we recently launched Origin 21 across several product categories in home decor. This is our new modern brand designed for the trend-setting millennial consumer, while our ever popular Allen + Roth brand is tailored to the more traditional style.", "Now, turning to our performance in hardlines. The team delivered an exceptional holiday season. Customers were active early and shopped often in our trim and tree category, which drove excellent sell-through in this holiday category. Seasonal, outdoor living and lawn and garden delivered standout performances, as customers continue to enhance their outdoor living spaces with new grills, patio heaters, fire pits, as well as live goods for the yards and garden.", "With the home serving as a center for entertainment, our customers are making the most of their homes, inside and out. We continue to build on our No. 1 position in outdoor power equipment with further share gains in battery outdoor power equipment, as we drove over 37% growth in this area for the quarter and over 118% on a two-year basis. Both DIY and Pro customers enjoy the convenience, reliability and the power of our innovative battery-powered products available in the EGO, Kobalt, CRAFTSMAN and Skill brands.", "In this spring, we are thrilled to expand our exclusive lineup of EGO battery products with their new 52-inch zero-turn riding mower with features that include a fabricated deck and power to mow up to four acres on a single charge. Also new for EGO is the industry's most powerful handheld battery-powered blower with power that will outperform the leading gas blower with 765 cubic feet per minute of blowing capacity. These new products will complement our existing lineup and assortments from powerful brands, such as John Deere, Honda, Husqvarna, Aaron's and CRAFTSMAN. This spring, we will launch our new Origin 21 patio collections, as well as our new style selection replacement cushions.", "These cushions are made with 100% recycled plastic bottles and they are fade-resistant, UV-protected as well as easy to clean. Now turning to the building products division. Our comps were very strong driven by broad-based balanced growth across lumber, electrical, rough plumbing, millwork and building materials. We are pleased with the continued momentum we are building with the Pro as we work to expand our brand and product offerings to meet their project needs.", "New this year will be a full range of CertainTeed roofing, insulation and gypsum products. As a leading manufacturer of building products for both residential and commercial construction, CertainTeed is an important strategic partner that we are proud to add to Lowe's as we continue to enhance our Pro offering in the building materials category. We also continue to build out our Pro power tool program with the introduction of the new DEWALT power stack battery technology, which is the smallest and most energy-densed battery pack on the market. These new products and new brands are strong additions to our Pro brand arsenal, which already includes other great brands like Bosch, Eaton, Estwing, FastenMaster, FLEX, GRK, ITW, LESCO, Little Giant, Lufkin, Mansfield, Marshalltown, Metabo, SharkBite, Simpson Strong-Tie, SPAX, Spyder and Werner.", "Moving to Lowes.com. As Marvin mentioned, we delivered sales growth of 11.5% in the quarter and 147% on a two-year basis in the fourth quarter. We are focused on further enhancing our omnichannel capabilities in 2022 across three key areas: expanding our online assortment, enhancing the user experience and improving fulfillment. First, we are expanding our Lowes.com assortment to meet our customers' design and lifestyle needs.", "For example, within Lowe's Livable Home products, we will offer a range of products to help our customers adapt to their changing mobility needs. At the same time, we will continue to enhance the user experience with continued upgrades to the visualization and configuration tools, like kitchen visualizer and measure your space. Finally, as we continue to improve our fulfillment capabilities, our customers can now track their appliance delivery in real time, and we will soon be leveraging enhanced technology to further streamline the buy online, pick-up in store experience for our customers through an improved store execution process. As we look ahead to spring, we are well positioned to capitalize on what we expect to be another strong spring season.", "Consistent with our approach over the past year, we have worked hard to land our spring product early. Through an expansion of our network of coastal holding facilities, we are better able to manage the flow of imported product enabling us to quickly flow product where needed as spring arrives across the country. As one of the largest importers in the U.S., we continue to leverage our scale and carrier relationships to secure capacity and work to mitigate and manage the impact of cost increases across our supply chain. Before I close, I'd like to extend my appreciation to our merchants and inventory and supply chain teams, along with our vendors for their hard work and continued support.", "Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Bill, and good morning, everyone. I would like to begin by thanking our frontline associates for delivering tremendous results in 2021. In recognition of their outstanding efforts, we awarded the discretionary year-end bonus of $6,000 for assistant store managers, $1,000 for department supervisors, $800 for full-time hourly associates and $400 for part-time hourly associates. As Marvin mentioned, the combination of Winning Together and this discretionary year-end bonus will result in a payout of over $350 million for our frontline associates this quarter.", "As someone who started his career in home improvement as an hourly associate, I understand how meaningful this type of financial recognition is for our hourly associates. At Lowe's, our people are truly our most valuable asset. When it comes to recruiting and retaining top talent, we strive to be an employer of choice. From the moment that a candidate applies for a position at Lowe's, we are committed to creating a positive impression.", "We have invested in leading technology that accelerates the hiring process, so that we are processing applications in a matter of minutes rather than the weeks that the manual process required as recently as last year. We also continue to improve our onboarding process so that our new hires can quickly come up to speed, leveraging the technology and product knowledge that is readily available to them on their handheld mobile devices via the Lowe's University application. As I mentioned on our last call, we are also leveraging our new Lowe's University in-store training labs to provide the ongoing training that our associates need to build their skills and confidence so they can continue to progress in their career. Over the last three years, we have created valuable career opportunities for our associates with the incremental 10,000 department supervisor roles and 1,600 ASM positions that we have added.", "Since 2018, we have also invested well over $2 billion in incremental wage and equity programs for our frontline associates to ensure that we continue to offer a strong competitive wage and benefit package to our associates. I'm really pleased to report that our investments to position Lowe's as an employer of choice are paying off. Heading into spring, we anticipate being even better positioned than last year from a hiring perspective. And we are also confident that we will continue to drive productivity in our operations through our perpetual productivity improvement or PPI initiatives.", "As a reminder, this is not a single win. It is a series of improvements that are scaling across our stores over time. In fact, we are working on over 20 different PPI initiatives in our store operations this year. To highlight just a few key PPI initiatives, we have just launched a new store inventory management system, or SIMs across all of our stores.", "This platform gives store associates real-time visibility to inventory in their store. This includes inventory in the home bay location as well as product in the top stock and cap, off-shelf and back stock room. This new system will eliminate the countless nonproductive hours associates have been spending looking for product. I'm also excited about our continuing efforts to eliminate the ancient green screen technology with the launch of our simplified user interface to other selling stations throughout the store.", "First introduced at our front-end registers, we are beginning to implement this new technology across the sales floor. With this new platform, we are accelerating the associate training process and facilitating cross-training in other departments. This new technology will free up our associates to focus on providing excellent customer service while reducing customer wait time. While these two initiatives are just a few of the PPI deliverables planned for this year, we expect that these two initiatives alone will drive $100 million in productivity this year.", "Looking forward, we will continue to leverage technology to reduce manual tasking for our associates while also enabling them to deliver better service to our Pro and DIY customers. I would like to close once again by thanking our store associates for their continued hard work and dedication and the great results we achieved together this year. With that, I will turn it over to Dave." ] }, { "name": "Dave Denton", "speech": [ "Thank you, Joe. I'll begin this morning with a few comments on the U.S. economy as it relates to the home improvement sector. As Marvin indicated, the consumer backdrop remains favorable, as we are confident that home improvement demand will remain strong despite an uptick in interest rates.", "Historically, when interest rates have risen against a strong economic backdrop, the home improvement sector has delivered solid growth. During these periods, housing affordability was supported by growth in jobs and personal income, which offset the impact of higher borrowing costs. Today, housing affordability remains above the pre-pandemic average. The market is expecting moderately higher interest rates in the coming quarters.", "But keep in mind, rates are increasing off historic lows. Home equity has increased due to rising home prices and consumer savings are about $2.5 trillion higher than pre-pandemic levels, positioning consumers for continued residential investments. Given all these factors, we are expecting another strong year of demand in the home improvement market. Now, let me turn to capital allocation.", "We remain committed to be best-in-class when it comes to our ability to create value for our shareholders through our strong capital allocation program. In 2021, we generated $8 billion in free cash flow driven by outstanding operating results, and we returned $15.1 billion to our shareholders through both share repurchases and dividends. During the fourth quarter, we paid $551 million in dividends and repurchased approximately 16 million shares for $4 billion. This brought the total to $13.1 billion in share repurchases for the year, ahead of our expectations of $12 billion.", "This reflected better-than-expected financial performance and our commitment to return excess cash to shareholders. Capital expenditures were $597 million in the quarter and nearly $1.9 billion for the full year as we continue to invest in strategic initiatives to both drive growth and enhance returns across the business. Our balance sheet remains very healthy. Adjusted debt-to-EBITDAR stands at 1.98 times, well below our long-term leverage target of 2.75 times.", "As I mentioned at our December 15 investor update, we are planning to return to our leverage target over the next two years, driven by our shareholder-focused capital allocation strategy. With that, I'd like to turn to the income statement. In the fourth quarter, we reported diluted earnings per share of $1.78, an increase of 34% compared to adjusted diluted earnings per share last year. This increase reflected better-than-expected sales growth, improved gross margin rate and favorable SG&A leverage, driven by our productivity initiatives.", "In the quarter, sales were $21.3 billion, reflecting a comparable sales increase of 5%. Comparable average ticket increased 9.4% and with higher ticket sales in appliances, flooring and seasonal and outdoor living and 90 basis points of commodity inflation in both lumber and copper. In the quarter, comp transaction count decreased 4.4%, but on a two-year basis, comp transactions increased 8.9%. We continue to gain traction with our Total Home strategy as reflected in Pro growth of 23% and positive DIY comps on top of extremely strong DIY growth last year.", "On Lowes.com, sales increased 11.5% in the quarter. U.S. comp sales increased 5.1% in the fourth quarter and 35.2% on a two-year basis. We saw acceleration in both our Pro and our DIY comp sales trends from our third quarter performance.", "By month, our U.S. comparable sales were up 8.1% in November, up 7.4% in December and down 1.3% in January. Recall that we cycled over government stimulus in late December and early January of last year. But looking at U.S.", "comp growth on a two-year basis from 2019 to 2021, November sales increased 33.8%, December increased 37.4% and January increased 33.9%. Gross margin was 32.9% of sales in the fourth quarter, up 115 basis points from last year. Product margin rate increased 65 basis points, driven by our disciplined pricing and cost management strategies. Improvements in both shrink and credit revenue benefited gross margin by 50 basis points and 25 basis points, respectively.", "These benefits were partially offset by roughly 30 basis points of pressure related to higher transportation and importation costs, as well as the expansion of our supply chain network. I'd like to spend just a moment addressing the recent increase in lumber prices. We are confident that we have an effective strategy to carefully manage our inventory and rapidly adjust pricing. Although we are planning for our lumber margins to be compressed when prices decline, we are confident in our outlook for gross margin rate to be up slightly in 2022.", "Turning to SG&A. We levered 15 basis points versus LY, driven by higher sales and our relentless focus on productivity. This quarter, we incurred $50 million of COVID-related expenses as compared to $165 million of COVID-related expenses last year. This reduction in these expenses generated 60 basis points of SG&A leverage.", "Additionally, we incurred $150 million of expenses related to the U.S. stores reset in the fourth quarter of last year. As we did not incur any material expenses related to this project in '21, this generated approximately 75 basis points of SG&A leverage versus LY. These benefits were pressured by 100 basis points related to the discretionary year-end bonus of $215 million for our store-based frontline associates.", "Operating profit was over $1.8 billion in the quarter, an increase of 21% versus LY. Operating margin of 8.7% for the quarter increased 115 basis points over last year, largely driven by higher gross margin rate, as well as favorable SG&A leverage. The effective tax rate was 25.3% in the quarter, which is in line with prior year. At year-end, inventory was $17.6 billion, up $920 million from Q3 and in line with seasonal trends and consistent with our effort to land spring products earlier.", "Driven by both improved operating performance and a disciplined capital allocation strategy, we delivered return on invested capital of 35% for the year, up 760 basis points from 2020. Now, turning to our 2022 financial outlook. We closed out 2021 ahead of the expectations that we presented at our December 15 investor update. Month-to-date, February, U.S.", "comparable sales trends are in line with our fourth quarter performance on a two-year basis. And based on the continued momentum that we are seeing in Pro sales, as well as higher expectations for commodity inflation, we are raising our sales outlook for 2022 to a range of between $97 billion to $99 billion for the year, representing comparable sales of down 1% to up 1%. Now, please keep in mind that our outlook assumes that lumber pricing will return to a more normalized level in the second half of the year. We continue to expect Pro to outpace DIY in 2022.", "Keep in mind that we are cycling over an estimated 300 basis points of stimulus in the first quarter. Also, as a reminder, our 2022 sales outlook includes a 53rd week, which equates to approximately $1 billion to $1.5 billion in sales. We now expect gross margin rate in 2022 to be up slightly as compared to the prior year. With higher projected sales, improving gross margin outlook and continued execution of our PPI initiatives, we are raising our outlook for operating margin to a range of 12.8% to 13% from a prior range of 12.5% to 12.8% for the full year.", "We are also raising our outlook for diluted earnings per share to a range of $13.10 to $13.60 from a prior range of $12.25 to $13. In 2022, we continue to expect capital expenditures of approximately $2 billion and share repurchases of approximately $12 billion. Finally, we are raising our outlook for return on invested capital to above 36% from our original outlook of approximately 35%. In closing, we are off to a great start in 2022.", "We have significant runway ahead of us to both grow our market share, expand operating margins and deliver meaningful long-term shareholder value. And with that, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our first question comes from the line of Kate McShane with Goldman Sachs." ] }, { "name": "Kate McShane", "speech": [ "Hi. Good morning. Thanks for taking our question. I wondered if you could maybe talk a little bit more about inflation, how you're viewing inflation as part of the comp sales guide for 2022." ] }, { "name": "Dave Denton", "speech": [ "Yeah. Kate, good morning. Thank you for the question. As we think about next year, if you look at our guide of down one to up one, we would expect units to be modestly down and our average ticket offsetting that almost dollar for dollar." ] }, { "name": "Kate McShane", "speech": [ "OK, thank you. And based on what you said about February, it does seem like there may have been an acceleration from what you saw in January into February on a one year. Is it right that you're seeing better trends in February than January? Should we really just be thinking about things on a two-year stack?" ] }, { "name": "Dave Denton", "speech": [ "Kate, it is true. We are seeing better trends in February than January. But on a two-year basis, you need to think about it, our trends in February, consistent with the two-year trends for the fourth quarter, which is really solid." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Mike Baker with D.A. Davidson. Mr. Baker, your line is live for question." ] }, { "name": "Mike Baker", "speech": [ "Hi. Thanks. Sorry. On the Pro side, in the past, you've talked about it as being anywhere between 22% and 25%.", "Your orange competitor yesterday bumped there, talk of what the Pro is to 50%. They used to say somewhere in the low to mid-40s. I understand that it's hard to get the exact number, but any update on what you think on an annual basis the Pro penetration is? And then more importantly, what do you think it can get to?" ] }, { "name": "Marvin Ellison", "speech": [ "Yes. Look, I think your first statement is directionally correct on what and where the penetration is. We just know the business continues to be very strong. If you think about 23% comps in the quarter and 54% on a two-year basis, I mean, we feel great about that business.", "And I think you noted, we spent quite a bit of time over the last three-plus years making not only investments in adding products to our assortment, but also our service levels fulfillment. And we're very pleased, as I mentioned in my prepared comments with the launch of our new Pro loyalty program. And as I mentioned as well, we're seeing a 300% increase in Pro sales for Pros engaged in our loyalty and credit program. And so Pro is going to be a significant part of our growth this year, and we still feel very encouraged by the progress." ] }, { "name": "Mike Baker", "speech": [ "OK. And as a follow-up, DIY, you said up on strong gains last year, fair to say up in the low single digits, slightly up something in that range, just what the math suggests." ] }, { "name": "Dave Denton", "speech": [ "That's correct. We saw expansion in growth in both, obviously, the Pro, but importantly, the DIY as well." ] }, { "name": "Mike Baker", "speech": [ "Thank you." ] }, { "name": "Dave Denton", "speech": [ "Welcome." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Good morning, everyone. My first question is on EBIT margin. Now that it looks like you could get to 13% in '22. If you look at the model in the out years, and I know you haven't really given anything past this, is the correct way to think about moving past 13%, it's productivity-driven, meaning it's all throughput as sales per foot keeps rising?" ] }, { "name": "Dave Denton", "speech": [ "Yeah. I think that is correct. Simeon, we're excited about in December to come back as a complete management team and really outline the building blocks for our progression above and beyond our 13% level as we think about our EBIT margins. But yes, I think about productivity as the main driver of that, as we continue to lean into both the Pro business, as well as healthy growth in our DIY business." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. And my follow-up is on inventory. There's been -- there's this big divergence in Q4 now between you and Home Depot. And if we try adjusting to see if there's a catch-up, it doesn't look like it's the case.", "And so I guess, Marvin, when you got to Lowe's, I think it was the first and maybe even the second spring where you put Lowe's on the offensive in terms of inventory. So the question for you is, are you pleased with what you've bought so far? And are you pleased with the visibility of what's coming in for this spring and even for the year?" ] }, { "name": "Marvin Ellison", "speech": [ "Short answer is absolutely. I give a lot of credit to Bill and the merchant team, Don Frieson and the supply chain team for working in a very collaborative fashion to make sure that not only are we fully good about what we have from a product category, but also the quality of the inventory. And as Dave mentioned in his prepared comments, the coastal holding facilities that we established on both the East and Western Coast have given us the ability to land import product early, take possession of it, which on a temporary basis, will elevate inventory levels, but we feel that's a prudent thing to do to make sure that we have that product available out of that global supply chain, so we can get it to our RDCs and our stores. But we do feel good about where we are.", "We feel good about the investments we've made in job like qualities with Pros. And we think headed in the spring, which, as you know, is a significant sales period for us, we're in really good shape." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist Securities. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. Obviously, business is still exceptional but what kind of impact are you projecting from higher interest rates on the housing market? And what is your framework for those projections?" ] }, { "name": "Dave Denton", "speech": [ "Yeah. Scot, kind of in my prepared remarks, we talked about that interest rates do have an impact to some degree. But if you go back and historically look at periods of time when interest rates have risen, at the same time, we had really good economic backdrop. Actually, the home improvement sector has benefited from that.", "And I think if you cycle into '22, you see that same kind of economic climate now. So we feel like the demand profile of the sector is really healthy, number one. And number two, many of the efforts that we're embarking upon and actually beginning to gain some traction, we're going to actually disproportionately take share in the marketplace. So we feel like we're really nicely positioned to deliver a really solid '22 and think about the future growth of this business in a really healthy manner." ] }, { "name": "Marvin Ellison", "speech": [ "Hey. Scot, this is Marvin. Just one point to add. I do think that home improvement oftentimes gets combined with home building relative to interest rates.", "And obviously, the sectors are entirely different. And I think that we look at historically, that's why I think Dave's comments are so important that historical trends will show convincingly that high interest rates, combined with other positive macro indicators, do not have a negative impact on home improvement. Now home buying, I'm sure it's a totally different equation, but we want to make sure that there's a line of delineation between the two sectors." ] }, { "name": "Scot Ciccarelli", "speech": [ "So just to be clear, guys. So there -- at this point, there's no assumed degradation in sales trends because of higher interest rates?" ] }, { "name": "Dave Denton", "speech": [ "That's correct." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thank you." ] }, { "name": "Dave Denton", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chris Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, everybody. Can I just -- can you just delve into the factors a bit more about what's driving the increase in the comp outlook in 2022? So to what extent are you expecting a higher level of market growth versus what you laid out in December? To what extent are you assuming more share gains? And then how does that compare to your expectations on price inflation and how lumber will play out?" ] }, { "name": "Dave Denton", "speech": [ "Yeah. I think there's really three things that are driving our increase in our guide from a top-line perspective. One is we do think the market is going to perform a bit better. And by the way, we still think we're going to -- and believe and plan for us outpacing the market from a growth perspective.", "Secondly, we are seeing higher levels of commodity inflation than what we planned back in December, largely in lumber. So that is ticking our sales progression up slightly in the first half of the year. And then third, we're seeing really strong sustainable performance in our Pro business. And that demand has been really consistent through Q4 and we're leaning into Q1 in a very consistent manner, in healthy manner from a Pro business perspective." ] }, { "name": "Marvin Ellison", "speech": [ "Chris, I'm going to just add a little commentary on the Pro business, this is Marvin. We did a cost survey stated Pro that we issued out publicly. And just a couple of interesting data points. When we talk to Pros and DIY customers, both said that they see continued investment in the home.", "The DIY, I said at a pace of 50% today, we're going to do DIY projects and a roughly 50% say they would hire Pro. And then when you talk to our Pro customers, we have in detail, they continue to let us know that their book of business is more robust than they've ever seen it. They have projects lined out for balance of this year. Some projects may carry over into '23.", "And health of that business is very strong. And I think all the investments that we made in our merchandise assortments, in our service levels, in our stores, in our supply chain is driving that business. Again, two-year comp in Pro is 54%, that's pretty good." ] }, { "name": "Chris Horvers", "speech": [ "Understood. And then can you also talk about the gross margin a little bit, the shrink and the credit performance were quite strong and gross margin came in better than expected. How do these sort of proceed into 2022? And what's elevating your gross margin outlook relative to what you talked about in December? Thank you." ] }, { "name": "Dave Denton", "speech": [ "Yeah. Listen, I think first and foremost, we're just extremely pleased with the performance from a shrink perspective. I think the store teams and the loss prevention teams have just done an excellent job of managing that. And now it's becoming a bit of a tailwind for us as opposed to a headwind, which was historic.", "I think as we lean into '22, think about a few things happening. In general, for the full year, we expect the gross margin to be up slightly, product margin to really lead the charge there as we really manage pricing costs very effectively. Our shrink and credit programs, think about that was largely neutral to our performance versus '22 versus '21. And then we'll have a little bit of headwind as we think about both rates and supply chain and our continued build out in the supply chain ecosystem." ] }, { "name": "Chris Horvers", "speech": [ "Thanks very much. Best of luck." ] }, { "name": "Dave Denton", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks, all for taking my question. Marvin, I think you mentioned earlier today that about half of Lowe's sales growth in the second half of last year was due to product inflation. Home Depot mentioned yesterday they got around 800 basis points of comp benefit from product inflation.", "At what point does the consumer start to push back or the industry experience an elastic response from all the inflation that's being passed through, especially as there's a return to normalcy, mobility increases and the interest in other categories shift on a return to normalcy? Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "Well, Michael, look, I'll give you just a more of a philosophical perspective based on the trends that we see. So we are very confident that there are certain trends that will sustain. You have millennial household formation trends that are much more robust than any of us had anticipated pre pandemic. You're also seeing the investments in the home that will maintain simply because there are so many millions of people working from home permanently that even as we hope and pray the pandemic will dissipate, you still will have millions of people who permanently work from home that's going to drive certain investments in repair and maintenance that we think will sustain going past 2022.", "And the work that the merchants and the finance team has done to drive cost out and to make sure that whatever price increase is driven by inflation we are pushing toward our customers, we're still doing that at a very competitive price because we're taking a multitude of actions to ensure that we're trying to drive other factors of cost out. Look, you know this, I think we're one of the only large retailers that reported, that's reporting an increase in gross margin for the quarter and for the year from a basis points standpoint. And also we're guiding that for the balance of '22, we're going to see gross margin rate continue to improve. That gives you an indication that we have some degree of confidence we can manage this.", "I'll let Dave provide more of the financial specifics on kind of what we've seen and what we see going forward." ] }, { "name": "Dave Denton", "speech": [ "Yeah, Michael, I would just add that to Marvin's comments here, we really put in a very robust process and analytical tools around this, such that we're measuring and monitoring as we take increases from a cost perspective. First, we push back on that when appropriate. We take a portfolio approach to adjusting our pricing and then we measure and monitor the performance from a unit velocity perspective. And we adjust as needed, when we need to do that such that we get the best price point from a consumable perspective, but importantly, what also drives the economic value here at Lowe's." ] }, { "name": "Michael Lasser", "speech": [ "Thank you. My follow-up question is Lowe's has some very interesting initiatives that are either in the early stages or just about to launch, most notably the supply chain transformation and the launch of the Pro loyalty program. So could you give a breakdown of the financial impact that you've seen from both of those programs as you've tested them and then what you factored in as far as the contribution from each of those in the year ahead?" ] }, { "name": "Dave Denton", "speech": [ "Well, maybe I'll take the contribution. Just from a planning perspective, these programs are well planned and well thought out. We have a substantial financial model associated with that. We test and learn as we go.", "And so we have a -- we feel like our plan for 2022, we have a very good line of sight to performance being driven out of those two programs. So first and foremost, we kind of checked that box. And then I'll let Marvin chat about the programs you like." ] }, { "name": "Marvin Ellison", "speech": [ "No, look, I'll just repeat what I said on the Pro. We tested a loyalty program. All of 2021, we've made different tweaks to it based on feedback and surveys from our Pro customers. We feel like we have a program that's going to drive differentiation and adoption.", "And as I mentioned, when customers engage in the Pro loyalty and our credit program, we're seeing a 300% increase in sales. And then we think that we're going to see some level of retention and engagement with our Pro customers based on the loss that will be happening within the next couple of weeks. So again, excited about the test and learn environment we've created. And to Dave's point, I mean we put a lot of robust processing in place to ensure that we have good visibility to what we think each of these programs will deliver." ] }, { "name": "Michael Lasser", "speech": [ "Thanks. Best of luck." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "The next question is from the line of Steven Zaccone with Citi. Please proceed with your question." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Good morning. Thanks for takin my question. I had a question on the DIY side of the business.", "So it sounds like most of the guidance raise is contemplated on the Pro and then commodity inflation. But can you comment if your DIY outlook has changed in 2022? And then larger picture on DIY, there's a thesis we'll eventually see a give back of spending in the category, but it seems to still be accelerating as of late and is still strong. What are you seeing in terms of purchase activity or project sizes from your customers that gives you confidence in the sustained strength in DIY?" ] }, { "name": "Marvin Ellison", "speech": [ "Steve, thanks for the question. Our DIY sales were very, very strong in 2020. So year over year, we had tough comparison, we were able to grow that business even on top of some really aggressive sales last year. One of the things that we're leaning into as part of our Total Home strategy is private brands.", "And private brands specifically in the core-related categories. I'm going to let Bill Boltz talk a little bit about what we're leaning in there and how we believe that, that's going to give us some level of continued growth and differentiation." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. Thanks, Marvin. And just a little more color around the DIY business. I think as we head into spring, as we mentioned in our prepared remarks, we talked about a couple of key private brands that will play a big role in the spring with the Origin 21, which we're excited about that.", "That's a new modern brand. So you'll see it introduced in patio. You'll see it in some of decor categories in our stores. And then Allen + Roth, we've worked really hard over the last 18 months to enhance that brand.", "And so that's more of a traditional style. And so that will play a big role as well. And then we're really excited about the expansion of STAINMASTER. STAINMASTER, as you know, we acquired a year ago.", "It was largely a carpet brand, but we have opportunities to use that in other categories in flooring, really building off of its characteristics. And then along the same lines, as we look into the spring season, our live goods and nursery business very strong, has been on a really nice run over the last couple of years, and that plays a large role in our DIY business as we go into spring as well. So we're really -- we're optimistic around the DIY business as we had in the first half of the year." ] }, { "name": "Marvin Ellison", "speech": [ "And Steve, we're students of history, and we know that one of the strategic mistakes historically at Lowe's was to overcompensate and over-penetrate in private brands in Pro-related categories. And so Bill and his team have been very, very specific to continue to lean in to national brands on the Pro side. But on the DIY side, specifically home decor, the customers are telling us overwhelmingly that they love our design capabilities of private brand. And so we're going to lean into that for differentiation and also for a margin rate benefit.", "And again, we think we're off to a great start." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Very helpful. Thanks, guys." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah, thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Liz Suzuki with Bank of America. Please proceed with your question." ] }, { "name": "Liz Suzuki", "speech": [ "Right. Thank you. How much market share do you think you've taken in the last three years? And if the supply chain disruptions normalize and some of your smaller competitors are able to get product again, do you see some of those share gains moderating?" ] }, { "name": "Marvin Ellison", "speech": [ "Liz, it's a fair question. But I will repeat what I've said a couple of different times. Home improvement does not have great market share data that we can glean very specific answers to. What I can tell you based on just our on-the-ground analysis is that we are, in fact, taking market share.", "It's hard to grow a business this size by over 35% on a two-year basis and it's not coming from somebody. We also are aware that there are winners and losers in retail based on the efficiency of your supply chain. We are fortunate that we are one of the largest importers of containers. And we have great supplier relationships that the merchants continue to foster.", "So do we believe that we're winning? We do. Do we think we'll continue to take market share in 2022? As Dave said earlier, we absolutely believe we will. And we think we'll take it across Pro and on -- and DIY, both in-store and online. But again, it's hard to give you a lot of specificity because the data set is not great." ] }, { "name": "Dave Denton", "speech": [ "And Liz, but from our internal data, we continue to -- our data suggests that we're performing 200 to 300 basis points ahead of the market pretty consistently. And that will be our expectations going forward as well to outperform the market." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you. And just, I mean, how much do you think that the expansion into home decor and new product categories increases your total addressable market?" ] }, { "name": "Marvin Ellison", "speech": [ "It's a great question. We can only go by the feedback that we receive from our customers when we do surveys and we do different types of focus groups and what they are telling us is that they are more brand-agnostic when it comes to home decor-related categories and they are more concerned with quality and good style and price. And what Bill and his team has done with the launch of Origin 21 and with the continued improvement in Allen + Roth as an example, gives us a lot of confidence and we're really excited about STAINMASTER. As Bill mentioned, you're going to see it going into more hard-surface flooring, but we have some other really exciting ideas that we'll be sharing over the next couple of quarters, but we're going to extend this very, very recognizable and high-quality brand in the other home improvement categories that customers, I think, will be very excited about." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you so much." ] }, { "name": "Dave Denton", "speech": [ "Rob, we're going to take one more question, please." ] }, { "name": "Operator", "speech": [ "The final question will be coming from Eric Bosshard with Cleveland Research. Please proceed with your question." ] }, { "name": "Eric Bosshard", "speech": [ "Good morning. Two things, if I could. First of all, the last two years have been relatively unique in terms of pricing and promotion and mix with a pretty aggressive consumer and Pro customer. As you think about '22, and it sounds like you think '22 kind of largely feels like the last couple of years, is your strategy the same with pricing, promotion and mix? Or do those efforts normalize a bit toward what we had seen historically?" ] }, { "name": "Dave Denton", "speech": [ "Eric, I think they're going to be fairly consistent. Our plan is fairly consistent in '22 versus '21. And -- but I'll let Bill comment on that, too." ] }, { "name": "Bill Boltz", "speech": [ "Yes, Eric, it's Bill. And so as you know, over the last couple of years, we've been on this journey of getting to more of an everyday competitive price and trying to wind down what has historically been here a very high low approach to marketing and promotion. And we've very successfully been able to do that. And that's now given us the runway to continue to provide value in a number of different ways to our consumers, both through special buys, special values, unique offerings.", "And so that's the journey we're on and that's what we're excited about. But being able to get off of that, what historically high-low approach allows us to be in this everyday competitive price in the home improvement business and that's what we wanted to be on." ] }, { "name": "Eric Bosshard", "speech": [ "OK. And then secondly, within the guide for '22, which I think you spoke to negative units and price offsetting that to get to comp dollar growth, haven't had a negative unit plan or outlook in quite some time for your business. I'm curious how you'd marry that up then with your inventory strategy and also with how you manage labor specifically in terms of the investment or the growth in both of those areas in a year where the outlook is reasonably for negative units?" ] }, { "name": "Marvin Ellison", "speech": [ "So Eric, I'll take the first part of it, and I'm going to let Joe just talk a little bit about how our new labor system allows us to make real-time adjustments by store, by department based on ticket and transaction. You have to understand that one of the reasons why you're going to see negative units is because the DIY customer in the heart of the pandemic made types of purchases that they're not going to make in an era where there is less concern around the virus and less nesting at home. We had cleaning purchases that drove a lot of transactions, not a lot of ticket. We had a lot of garden purchases and drove a lot of transactions, not a lot of tickets because people were at home and they were staying busy.", "Categories like paint, a lot of activity, not a lot of ticket. And so as we normalize year over year, we've got to see those activities are not sustainable. So when we say that the ticket is not as though we believe that we're seeing less customer traffic, we're just seeing DIY customers have different projects than they had when they were confined to their homes and staying busy with just random different projects around the house. And that's the difference.", "So when we look at that, we just made it really transparent around how we view the inputs to what's driving sales. And we have no concerns that we're having a traffic issue or we have a customer demand issue. This is just more normalizing over unique activity in the middle of the pandemic. So I'll let Joe talk about our labor system and how we can manage it based on all those inputs." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Marvin. And Eric, you remember just a few years ago, we put together just a topnotch workforce management team, and we developed a labor model that is activity based. So this labor model has served us well as sales have taken off and exceeded expectations from an appropriate leverage standpoint and does the same in balancing out the ticket and transaction. We're very pleased with our staffing and our outlook for '22." ] }, { "name": "Eric Bosshard", "speech": [ "Thank you." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you all for joining us today. We look forward to speaking with you on our first quarter earnings call in May." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2020-08-19	[ { "description": "Vice President, Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "", "name": "Dave Denton", "position": "Other" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Gordon Haskett -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Guggenheim Securities -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Mike Baker", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies second-quarter 2020 earnings conference call. My name is Michelle, and I will be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, vice president of investor relations.", "Thank you. You may begin." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning, everyone. Here with me today are Marvin Ellison, our president and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president, stores; and Dave Denton, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2020.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the Risk Factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release and on our Investor Relations website.", "With that, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Good morning, everyone. I'd like to start out by thanking our associates for their tremendous actions to support our customers and communities across both the U.S. and Canada. We are grateful for their hard work and ongoing commitment to safety.", "Without question, this has been the most challenging personal and business environment that any of us have operated in. Throughout all the uncertainty that we faced in the second quarter, we never lost focus that our No. 1 priority as a company is protecting the health and well-being of our associates and customers through a safe store environment and shopping experience. In the second quarter, we continued to prioritize the financial support of our associates and community while providing the customers with the products and services they need to manage and care for their homes.", "We were pleased and humbled that we were the first choice for many customers who needed home improvement items for their businesses and homes during this unprecedented time. And I would like to thank those customers who trusted us and for rediscovering Lowe's. More specifically, during the second quarter, we invested an incremental $460 million in support for our frontline associates, communities, and store safety. Through the first half of 2020, the company has invested $560 million in incremental financial support for our associates.", "In recognizing that helping people make their homes better extends into our neighborhoods, communities, and country, we've committed $55 million in grants to support minority-owned and rural small businesses. In total, during the COVID-19 pandemic, we've committed $100 million of assistance to those in our community who need it most. Our financial results this quarter demonstrate that we've experienced unprecedented demand in many of our business categories due to customers spending more time at home during the COVID-19 pandemic. However, these results could not have been realized without our efforts over the past 18 months to implement our retail fundamental strategy, which dramatically improved and modernized our business infrastructure.", "These modernization efforts have created technology and operational platforms to meet customer demand and grow our business during these challenging times. And some of these initiatives include hiring home improvement and retail subject matter experts in key leadership roles, which has allowed us to quickly make informed decisions and implement necessary changes during the COVID-19 crisis; replatforming Lowes.com from a decade-old infrastructure to the cloud and developing a top-rated mobile app that's allowed us to grow online sales triple digits; a customer-centric labor scheduling system that gave stores the flexibility to align payroll with the unique needs of the customer and the associate; deploying a new price management system to provide our merchants with better data to maintain cost discipline and take more strategic approach to pricing and promotions; enhanced Pro product and service offerings, combined with the new Pro loyalty platform, that helps us keep pros working and offers them meaningful rewards while providing us with better customer insights; and our field merchants and merchandise service teams who play an essential role in helping our stores quickly reconfigure to support social distancing and also respond to the significant increase in demand. While we still have work to do, we're pleased with the progress we've made thus far to modernize our company. And we're looking forward to building on this momentum in the back half of 2020 and for years to come.", "Now let me turn to our second-quarter results. We delivered strong sales growth beyond our expectations with total company comp sales growing 34.2% over the prior year. Diluted earnings per share grew 75% to $3.74. Our U.S.", "home improvement comps were 35.1% due to robust project demand from DIY and Pro customers that was broad-based across channels, product categories, and geographies. Overall, we saw a sharp acceleration from Q1 demand trends, including significant increases in the number of new Pro and DIY and millennial customers. DIY comps outpaced Pro comps in the quarter, driven by a consumer mindset that was heavily focused on the home and wallet share shifts away from other activities, like dining out, vacations, and purchasing apparel. Pro sales were also strong with comps in the mid-20s with demand accelerating in May and remaining strong throughout the quarter.", "Our Pro performance was supported by the progress we've made with retail fundamentals, like job lot quantities and improved service levels. From a geographic perspective, growth was balanced across the U.S. store footprint with positive comps of 30% or more in all 15 geographic regions in all three U.S. divisions.", "Importantly, we saw strong sales trends in urban areas. In fact, comp sales in our urban markets outperformed remote or rural markets by over 500 basis points. This is an important data point because it reflects the success of our business model in all geographic settings, as well as the importance of having a strong Pro business, as well as an effective omni-channel strategy to compete in urban settings. Our Lowes.com comp sales grew 135% as Pro and DIY customers increasingly shopped online, driving online penetration to 8% of sales.", "And as I mentioned earlier, we completed the replatform of Lowes.com to the cloud during the quarter. This enabled us to improve site functionality and sustain triple-digit growth without any systems interruptions. I'm very pleased with the work of our CIO, Seemantini Godbole, and her team to complete this replatforming effort in record time. And in Canada, we posted positive comps that exceeded 20%, driven by similar consumer focus on the home, as well as strong execution by our new leadership team.", "While we're pleased with their efforts to serve the incremental demand this quarter, our Canadian team remains focused on the work ahead to improve operating efficiency while driving sales. Looking ahead, we are confident that we'll continue to build on the momentum that we delivered in the first half. And in the second half of this year, we are reinvesting in the business to elevate our product, simplify our store environment, and improve our service offering. These investments will include store resets to improve product adjacencies, bay productivity, and sales per square feet.", "We're also advancing our supply chain infrastructure with our recent announcement that we'll open 50 cross-dock delivery terminals, seven bulk distribution centers, and four e-commerce fulfillment centers over the next 18 months. Our investments in our stores and investments in our supply chain evolution reinforces our commitment to becoming a world-class omni-channel retailer. We're making the right investments to drive long-term sales growth, operating profitability, and sustainable shareholder returns. In closing, I'd like to reiterate how incredibly proud I am of our associates and their dedication to supporting customers in our communities during this time when they need us most.", "And with that, I'll turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Marvin, and good morning, everyone. Over the past 18 months, we've been steadily improving our store operating efficiency and customer service. And we remained laser-focused on supporting a safe store environment through a data-driven approach based on an analysis of store traffic trends across our portfolio. As I previously indicated, we implemented numerous safety standards in the first quarter in support of social distancing and enhanced sanitizing and cleaning.", "We executed these standards in a consistent, uniform manner across our stores in the U.S. and Canada to protect the health and safety of our team members and the communities we serve. These standards included removing product to free up space for our customer, adding signage and floor markings and adding social distancing ambassadors and leveraging technology to monitor store traffic, which helps store managers limit customers based on the footprint, in line with the regulatory requirements. In the second quarter, we added further safety measures by requiring all frontline associates to wear masks beginning in early May and by adopting a nationwide standard for all customers to wear masks in mid-July.", "In support of this standard, we are providing free masks for customers who need them. And our customers' appreciation for these efforts was evident in a significant increase in our brand reputation and engagement scores as we shifted our marketing away from promotional messaging and instead focused on our commitment to our communities. I'm also pleased that we delivered strong customer service for both Pro and DIY customers in the second quarter while maintaining rigorous safety requirements and driving 35% U.S. sales comps.", "This is a testament to the outstanding work of our frontline associates and our commitment to our customers and communities. The health and safety of our associates and customers have always been and will remain our highest priority. Our strong results this quarter would not have been possible without the extraordinary efforts of our frontline associates, and we continue to recognize these efforts with incremental financial assistance. We announced two bonuses for July and August, which totaled $230 million.", "Full-time associates are receiving $300 and part-time and seasonal associates are receiving $150 in each payout. In fact, each payout was grossed up for taxes, so the company covered the incremental taxes as well. Combined with the support provided earlier in the year, we have now invested $560 million in COVID-related financial support for our frontline associates. And in addition, I'm really pleased to announce that 100% of our stores earned a record \"Winning Together\" profit-sharing bonus this quarter totaling $107 million.", "Based on better-than-expected store performance, this represents an incremental $35 million payout to our frontline associates, above the target payment level. And we supported our communities by hiring over 100,000 associates for the spring. We are converting these seasonal associates to permanent positions at a much higher rate than in past years, which will help us meet the strong demand that we're continuing to see across our stores. In addition, each of these associates received telemedicine benefits for themselves and their families, even if they were not enrolled in Lowe's benefits program.", "I'd like to now spend a few moments discussing our initiatives in support of our Pro customer. When the pandemic hit, we recognized that we needed to step up our efforts to keep pros working. On June 1st, we launched JobSIGHT for Pros in partnership with Streem. This is a free augmented video chat service that allows pros to conduct virtual home visits with their clients without entering their homes, which opens up their job opportunities.", "This is just another example of how we're innovating to leapfrog our competition. And to further support their job pipeline, we recently announced a partnership with HomeAdvisor for our Pro loyalty customers. These customers will receive a free one-year subscription to HomeAdvisor and a credit for an average of 10 free job leads, as well as access to webinars hosted by industry experts on how to grow their business. Our Pro customers know that we've got their back and are committed to help keep them working, particularly in these uncertain times.", "And today, we are thrilled to announce a significant step in the expansion of our product and service offering for the pro. We are beginning a multiyear national rollout of Lowe's tool rental program with the grand opening of our first location at our Central Charlotte store next week. As over 70% of pros are currently utilizing tool rental programs, this will provide a meaningful opportunity for Lowe's to deepen our relationship with this customer segment. After a successful pilot, we are launching this program nationwide with a broad product assortment, a fully equipped mechanic shop, a large store footprint, and importantly, intuitive customer-facing technology that creates a fast, frictionless process for this time-pressed customer.", "I look forward to updating you on our progress against this important initiative on future calls. Turning to our services business, installed sales delivered positive comps in Q2 with the results improving as we moved through the quarter as customers began to feel more comfortable allowing contractors back in their homes. And from a store technology perspective, we've also completed the rollout of our intuitive touchscreen point-of-sale system and checkout across all stores. This new interface dramatically reduces associate training time as compared to the cumbersome green screens and multiple interfaces that they were previously using and also improves the customer experience through a shorter checkout process.", "We also completed the launch of mobile printing across our store portfolio and installed digital signs in our appliance department. These initiatives reflect our ongoing efforts to modernize our store environment while giving our store associates more time in the aisles to serve our customers and move us further toward our goal of allocating 60% of their time to customer service and 40% to completing tasks. In closing, I'd like to reiterate my appreciation for our frontline associates and their continued hard work and commitment to safety in serving customers. Thank you, and I will now turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Joe, and good morning, everyone. As Marvin mentioned, we posted U.S. home improvement comparable sales growth of 35.1% in the second quarter, driven by broad-based outperformance across DIY and Pro customers, as well as indoor and outdoor product categories. We delivered indoor comps of 30%, driven by strength in indoor categories, such as decor and lighting.", "We delivered strong growth across all merchandising departments. In fact, all 15 merchandising departments generated positive comps exceeding 20%. As customers continue to spend more time at home this quarter, we saw an acceleration in both indoor and outdoor project activity, including core repair and maintenance, along with projects to repurpose home space for work and study, as well as discretionary indoor and outdoor projects to increase customers' enjoyment of their homes. We also continued to see robust COVID-related demand for essential cleaning products along with other home necessities such as appliances.", "During the quarter, we posted comps over 30% in core project categories, such as lumber, tools, and paint, driven largely by extensive indoor and outdoor project activity from both the DIY and Pro customer. Importantly, we saw significant improvement in installation-heavy categories, such as flooring, millwork, and kitchen and back. In paint, we continued to drive strong sales of both interior and exterior paint and stains, as well as applicators as our brand offering and service model positioned us to serve increased project demand with our paint products being key components of many home improvement projects. Lumber benefited from strong unit demand from both Pro and DIY customers, as well as our investments in job lot quantities.", "And in tools, we saw strength across all segments of power tools, along with growth in tool storage and mechanics tools, driven by the CRAFTSMAN brand as customers took to doing projects at home. Our lawn and garden and seasonal and outdoor living teams also delivered comps above company average this quarter, driven by seasonal demand and customers focused on enjoying their outdoor space. Our strong execution and powerful brand assortment allowed us to meet the elevated demand with brands, such as Weber and Char-Broil, the top two brands in outdoor grilling, and an outstanding outdoor power equipment lineup featuring John Deere, CRAFTSMAN, Husqvarna, Honda, and the Ariens brands. And today, I'm particularly excited that we are building on our industry-leading portfolio of outdoor power brands with EGO, which is the No.", "1 brand in battery-powered outdoor power equipment. Lowe's is already the No. 1 destination in outdoor power equipment. And the addition of the EGO brand to our arsenal now only reinforces that leading position.", "Beginning in December of 2020, Lowe's will be the exclusive nationwide home center to offer EGO's innovative battery-powered mowers, trimmers, chainsaws, and blowers. In addition, Lowe's will begin offering select skilled battery-powered outdoor power equipment in late 2020, which includes mowers, leaf blowers, and trimmers. The addition of the EGO brand furthers our commitment to expanding our assortment of sustainable products. EGO's battery-powered equipment is capable of matching or exceeding the performance of conventional gas items, which supports our corporate sustainability efforts.", "In hardware, we continue to expand our Pro brand offering with the national launch of Simpson Strong-Tie framing hardware and fasteners this quarter in conjunction with the Just For Pros customer acquisition event. This product offering meets a critical need for the pro in building out their projects, so we're now able to further extend our relationship with the Pro customer by helping them fulfill all their hardware needs in one place. And as Marvin mentioned, we are pleased to see higher-than-expected online sales this quarter, along with a significant increase in downloads of our mobile app, as well as improved customer ratings. We have also continued to enhance our omni-channel capabilities in the store with the launch of mobile check-in for curbside pickup that occurred in early July.", "This is also that customers can now let us know when they're on their way and when they've arrived at the store to pick up their order. And we added an internal order picking app to improve our associates' speed and accuracy in fulfilling these orders. We are also focused on other extensions of our omni-channel capabilities. With our transition of Lowes.com to the cloud now fully complete, the teams are working quickly to accelerate the front-end work and deliver improved customer-facing capabilities in the second half of this year, such as online delivery scheduling, online order tracking, a dynamic customized homepage, simplified search and navigation and an expanded online product offering to further enhance the customer experience and to continue to grow sales.", "As we look ahead to the second half of the year, we're excited to build on our retail fundamentals foundation. Consistent with our long-term plans, we are continuing with our merchandising investment in our stores with resets to address our product adjacencies that make it easier for the customer to shop, all with a focus on the pro. This work will be done throughout the back half of the year. And we expect to touch the majority of our stores by the end of the fiscal year.", "And as we plan for the holiday season, when customers are expected to stay closer to home this year with a keen focus on home improvement projects, we are prepared and committed to serve their needs for fall preparation projects, remodel activity, space conversion projects, holiday decorating and gifting, along with core repair and maintenance activity. In closing, I'd be remiss if I didn't again express our appreciation for our vendor partners, who again went above and beyond to help keep our shelves stocked despite facing unprecedented demand and their own operational challenges related to COVID-19. Across building products, home decor, and our hard lines businesses, there were a number of standout performances again this quarter. Thank you, and I'll now turn the call over to Dave." ] }, { "name": "Dave Denton", "speech": [ "Thank you, Bill, and good morning, everyone. I'll begin this morning with a few comments on the company's liquidity position and our capital allocation priorities. Last quarter, we decided to raise some incremental capital in light of the disruption in the global credit markets. After issuing $4 billion in senior notes and increasing the capacity of our revolving credit facilities by nearly $800 million, we now have $11.6 billion of cash and cash equivalents on the balance sheet.", "Additionally, we have $3 billion in undrawn capacity on our revolving credit facilities. So in total, we have an immediate access to $14.6 billion in funds, and we remain confident that we have ample liquidity to navigate any unforeseen circumstances. At the end of our Q2, our adjusted debt-to-EBITDA ratio stands at 2.4 times. During the quarter, the company generated $11 billion in free cash flow, driven by exceptionally strong operating performance.", "In the long term, we remain committed to delivering robust shareholder returns through our disciplined capital allocation program, consisting of three main pillars: first is strategically investing in our business to drive outsized returns; second is supporting our 35% dividend payout target; and finally, returning capital to our shareholders through value-enhancing share repurchases. However, as you know, we have currently suspended share repurchases in light of the unprecedented environment created by the pandemic. We continue to support our dividend program, and we returned $416 million to our shareholders by paying a dividend of $0.55 per share in the quarter. And importantly, we are investing in growth initiatives to build on the momentum that we are seeing across our business.", "In Q2, capital expenditures totaled $382 million. We continue to prioritize investments in our omni-channel capabilities as our customers are shopping more online. Now turning to the income statement. In Q2, we generated GAAP diluted earnings per share of $3.74, compared to $2.14 last year, an increase of 75%.", "In the quarter, there was a very modest impact on operating income related to the previously announced Canadian restructuring. Now my comments from this point forward will include certain non-GAAP comparisons, where applicable. In Q2, we delivered adjusted diluted earnings per share of $3.75, an increase of 74% compared to the prior year. These results surpassed our expectations due to higher-than-expected sales, gross margin rate, and SG&A leverage, as well as our strong execution to meet robust customer demand.", "Q2 sales were $27.3 billion, an increase of 34.2% on a comparable basis versus the prior year. This was driven by transaction growth of 22.6% and total average ticket growth of 11.6% as we saw strong repeat rates from new and existing customers. U.S. comp sales were up 35.1% in the quarter with truly broad-based strength across all geographies and across both DIY and Pro customers.", "Lowes.com sales growth remained robust, increasing 135% in the quarter. Given all of our previously announced investments in the product and service offerings for the Pro, we were particularly pleased to see mid-20% growth for the Pro customer in Q2. Our U.S. monthly comps were strong throughout the quarter with 41.5% in May, 34.4% in June, and 28.2% in July.", "It's important to note that we delivered these strong comps despite significantly reducing promotions during the quarter. Throughout the quarter, we saw strong COVID-related demand, driven by customers working on incremental projects to make their homes as safe and as functional as possible. It's clear that homes have become multifunctional spaces for many families, a place for work, for school, and for residence. We've also seen wallet share shift away from other forms of discretionary spending, shifting into home repair and maintenance work.", "Our sales also benefited from excellent execution and strong service levels across our stores in response to this unprecedented demand. Of note, sales trends remained strong in areas of the country where COVID-19 had been resurging. In August, we've continued to see the strong broad-based sales trend that we experienced in July with strength across both DIY and Pro customers. Month to date, August U.S.", "comp sales trends are materially consistent with July's performance levels. Gross margin was 34.1% of sales in the second quarter, an increase of 197 basis points compared to the second quarter of '19. Gross margin rate improved 137 basis points, driven by benefits from our improved pricing and promotional strategies. Favorable product mix also drove approximately 60 basis points of benefit.", "SG&A was 18.4% of sales in Q2, a 90 basis point improvement over LY. The company delivered a substantial improvement in operating leverage despite $430 million of COVID-related expenses. These investments included $260 million in financial assistance for our frontline associates, approximately $75 million related to cleaning and other safety-related programs, and approximately $95 million in charitable contributions. While $430 million of COVID-related expenses negatively impacted SG&A leverage by 157 basis points, this was more than offset by payroll leverage of 110 basis points related to higher sales volume and improved store operating efficiencies; advertising leverage of 35 basis points; employee insurance leverage of 40 basis points; and occupancy leverage of 40 basis points.", "Adjusted operating income margin increased 311 basis points to 14.5% of sales, driven both by robust sales and improved operating efficiencies. The effective tax rate of 24.4% was in line with our expectations and consistent with the prior year. At $13.8 billion, inventory was essentially flat compared to the prior-year levels as the supply chain worked to meet elevated customer demand throughout the quarter. Now before I close, let me address our 2020 business outlook.", "As I indicated last quarter, we have suspended our guidance. In this unprecedented operating environment, we, like many other companies, have limited visibility into future business trends, which results in an unusually wide range of potential outcomes for our financial performance. Having said that, I'd like to provide some perspective on the second half of the year. First, we expect that our top-line growth will moderate somewhat from Q2 levels, although demand is still expected to remain strong as consumers continue to invest in their homes.", "Further, we expect that our improved product offerings and customer service will allow us to retain new Pro and DIY customers. Now keep in mind that both the third and fourth quarters are typically smaller revenue quarters, given the natural demand patterns of the home improvement sector. For the remainder of the year, we expect that promotional activity will increase modestly but will not return to the prior-year levels. We will also be lapping harder prior-year comparisons as our sequential gross margin performance improved as we moved through 2019.", "As such, we expect lower levels of gross margin expansion in the second half of 2020 relative to the second quarter. Turning to expenses, we anticipate that we will incur COVID-related operating expenses of approximately $70 million to $80 million per quarter to support safety and cleanliness in our stores. And importantly, we are making significant investments in our business to support long-term growth and enhanced returns. Some of these investments include merchandising resets and the expansion of our supply chain infrastructure.", "In the back half of this year, many of these projects are weighted more heavily toward expense rather than capital. Based on all of these factors, we anticipate that operating income margin flow-through will moderate in the second half versus the first half. We're still planning for approximately $1.6 billion in CAPEX for the year with a continued focus on omni-channel investments. In closing, we are operating in a robust sector with strong underlying demand trends.", "We are investing in our business to further our capabilities, so we can continue to disproportionately capitalize on these trends. We have a strong balance sheet, and we remain committed to a disciplined capital allocation program, which should lead to long-term shareholder value creation. So with that, I thank you. We're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question comes from the line of Chris Horvers with J.P. Morgan. Please proceed with your question. Mr.", "Horvers, is your line on mute? Thank you. Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning, everyone, and nice quarter. I'm going to apologize, this will sound like the broken record question. I wanted to ask about the 12% EBIT margin target, realize an actual goal in terms of timing was never given, but that this environment probably speeds it up.", "Can you talk about 12%? I think some of the math to get there in the near term or medium term would imply that sales continued to grow at a nice rate but expenses actually get deleted or your productivity gets a lot better. So can you talk about the reality or the realistic nature of doing that in the next, call it, 12 to 18 months? Thanks." ] }, { "name": "Dave Denton", "speech": [ "Chris, this is Dave. I think you're right. Obviously, we are very focused on delivering upon that 12% operating margin target. And keep in mind, that's just a step function.", "That's not the end. We think we can do better than that over time. It's clear at this point in time, we're trending a bit ahead of that, given just how our business is performing. But having said that, we still have a lot of investments that we're making to be sure that we can consistently deliver that 12% day in and day out.", "I think you heard us talk about this morning that we're investing in assortment and merchandise in the store environment. We're making really important strategic investments in our online capabilities and technology platform, as well as in our supply chain. And we continue to focus in those areas to make sure that we can consistently deliver both really strong top-line performance, manage gross margin at a reasonable rate, leverage SG&A in a meaningful way, so we can deliver that off-base target over time." ] }, { "name": "Simeon Gutman", "speech": [ "And, Dave, is there any different thought with regard to gross margin? I know that, right, it's benefiting in the near term from lack of promotions. And you're expecting that level of promotion to continue or to rise to be a little bit less of a benefit going forward. But is there some level -- or is the calculus of getting to the 12% any different, where gross margin ends up being a little bit better than you thought initially?" ] }, { "name": "Dave Denton", "speech": [ "I don't know that there's anything materially that's changed there. Clearly, 2019, we had a bit of a step down in gross margin. Our objective in 2020 and beyond was to get our margin rate back. Keep in mind that we are making investments in supply chain that will disproportionately dampen gross margin rate but will allow us to lever SG&A more productively over time.", "So you have some natural kind of geography shift within the P&L, Simeon." ] }, { "name": "Simeon Gutman", "speech": [ "OK. Thanks. Take care." ] }, { "name": "Dave Denton", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thank you for taking my question. Marvin, do you think there's been any structural shift, meaning that this growth you're experiencing now won't just be a one-shot deal that will be given back next year when people go back to traveling and eating out? Said another way, under what conditions do you think you can comp positive next year when you lap all of this?" ] }, { "name": "Marvin Ellison", "speech": [ "Mike, I think it's a fair question. Next year is difficult for all the obvious macro reasons. But we feel good about our business trends. And look, I don't want to minimize the impact of what we describe as retail fundamentals.", "We talked about getting foundational things in place here at Lowe's for the last 18 months. And they're paying dividends. Getting dot-com on the cloud, hiring an experienced team of home improvement and retail experts in key functional areas, new price management system, field merchants, focus on Pro, I mean, all of these things matter. And when we think about market share and we think about the sustainability of it, our data is pretty consistent that when customers shop us in-store or online, they have a good experience.", "They come back. When customers shop us in our stores, especially in this environment and they feel safe, they come back. We've done an analysis that suggests that our COVID-19 safety protocols in our stores are among the strongest in the industry. And Forbes ranked Lowe's No.", "6 on their list relative to that. And our research tells us that when customers show up in our environment, specifically during this COVID-19 crisis and they feel safe and they feel well taken care of, they come back. And when you look at our first-half results, it demonstrates that customers are coming back over and over again. And so we believe that of all the things within our control, if we can execute these at a continual high level, then the rest will take care of itself." ] }, { "name": "Michael Lasser", "speech": [ "OK. Then my follow-up question is of the mid-20s percent Pro comp that you experienced, what portion of that came from new pros that Lowe's hasn't been regularly interacting with and where did you grab these from? And maybe somewhat unrelated, Dave, you mentioned that promotions are going to pick up in the back half of the year. Why would that be the case if this environment stays the same?" ] }, { "name": "Marvin Ellison", "speech": [ "Yes. So, Michael, let me take the first part of the Pro question, then I'll hand it to Joe and he can give you a little bit more context. We feel really good about our Pro business. And we stated in the prepared comments that DIY outperformed Pro from a comp perspective.", "But we expected that in this environment. But we also know that we had increased performance in our urban areas. And we think that that was driven by our improved performance in Pro, as well as our omni-channel and online performance, which you have to have in those urban markets. So I'll let Joe just briefly cover a little bit about the Pro segmentation that we have." ] }, { "name": "Joe McFarland", "speech": [ "Yes. Thanks, Marvin. Thanks for the question, Mike. Our strong Pro demand with comps in the mid-20s continues.", "And it's really around the investments that we've been making in both the product and the service offerings. So it's things like our job lot quantities, our dedicated supervisors, our Pro parking, our loaders, etc., etc. And as we now move to the more strategic phase of our Pro growth initiatives, what we're really excited about the progress we're making, things like our Pro loyalty platform that's integrated with CRM, keeping Pros working through the partnerships that I've announced at HomeAdvisor and JobSIGHT, really excited about our announcement of the tool rental. And so as these Pro customers continue coming back, seeing new product additions like Simpson Strong-Tie, and so we feel very good about the future of our Pro business." ] }, { "name": "Dave Denton", "speech": [ "And, Michael, as it relates to pros, I'll ask Bill to comment here a bit as well. But clearly, as we cycle in the back half of the year, we do think promotions will tick up just a little bit. I don't think it will be a material change. But I think it is important that we communicate really the value that we're offering to both consumers and the pros, the breadth of offering that we have at Lowe's.", "And I think because of that, you'll see just a slight tick-up, but I don't think a material change from a commercial cadence perspective. I'll ask Bill --" ] }, { "name": "Bill Boltz", "speech": [ "Yes, Michael. Just to add on what Dave was saying, I think we've clearly got to realize that gift centers and the holiday trim and tree programs were all committed for and bought prior to COVID happening. And so those were well in motion and on the way. And those are things that we have to work our way through based on how the consumer responds to those programs.", "But I think it's also important to clarify that during the quarter and during the first half of this year, we were dramatically less promotional all around building around our pricing and promo strategy that we've been working to put in place over the last 20 months, which has been a focus on everyday values and being priced right every day for our customer. And so really pleased with the traction that we're making with the teams. And I think as we look at the back half, it's not like we're going to go from one side of the road to the other and just get back into the promotional game." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much, and good luck." ] }, { "name": "Bill Boltz", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Good morning. Great results. Marvin, I just wanted you guys could just speak to the opportunity on the digital front now that you've completed the migration to the cloud, I guess, just to size up the opportunity for you guys in the back half and even into next year." ] }, { "name": "Marvin Ellison", "speech": [ "Well, we think it's significant. I mean we've talked from the very beginning about the importance of modernizing our online business. And I just can't help but reiterate that just a year ago, we were on a decade-old platform. And we were slowing our growth because we were disappointing customers.", "So the ability for Seemantini and her team to get this replatforming effort done in the second quarter is monumental for us because it gives us so much agility and flexibility to build on that platform. We're not going to put any numbers to that, Chuck, because I think in this environment, it's really difficult. But what we do know is that it will be impossible for us to deliver 135% comp as we did in the second quarter without that replatforming effort. Because our instability was such that back in Black Friday of 2018, the volume we had crashed the whole system.", "And we've had volume that exceeded that for probably 90 straight days. So that tells you where we were and where we are. I'll let Bill talk a little bit about some of the specific things coming online that we think will continue to build that business and open up to a whole new set of customers that will continue to rediscover Lowe's." ] }, { "name": "Bill Boltz", "speech": [ "Yes. I think it's important to note that during the quarter, all 15 departments grew at or above double-digit rates for dot-com. And the migration to the cloud, obviously, allowed for speed, allowed for us to be nimble. But we've got improved checkout and navigation continuing to happen as we go through the back half.", "We've continued to work on separating freight from costs. And if you remember our comments on this before, this will help make sure that competitive pricing shows up online the way it needs to show up online, continue to enhance our curbside pickup, working with Joe's team in store, continuing to improve our buy online, pick up in store process to make that store picking faster. And in my prepared remarks, I talked about the store picking app, that's all around designing for the associate to be able to handle the customer with speed. So we've got a lot of effort going in addition to adding SKUs and improving the content that we put out there on dot-com on a daily and weekly basis." ] }, { "name": "Marvin Ellison", "speech": [ "So, Chuck, we're not trying to avoid answering the specifics of the question. It's just really tough to forecast. We just know that we have a much better platform that we can take that demand and manage it as it comes our way." ] }, { "name": "Chuck Grom", "speech": [ "That's helpful. And then just taking a step back, the long-term sales per square foot target, I believe, is around $370. You're going to hit that number pretty easily this year. So I just to kind of build off of Simeon's question about margins but thinking about it from a sales productivity perspective, you're still about roughly $100 below your biggest peer.", "I'm just wondering if you guys just size up the opportunity of how much more productive your stores can be, that would kind of lend support that you guys actually should be able to comp to strong results in the next couple of years." ] }, { "name": "Dave Denton", "speech": [ "Yes, Chuck. Dave here. Obviously, we have a tremendous amount of opportunity here. Part of what we're doing is investing in our infrastructure such that our base can become a lot more productive day in and day out.", "And you heard Joe speak about all the investments we're making from a technology perspective within the store environment such that we can really leverage the hours that we have in our stores to put more of those hours to work facing customers and actually driving increased sales and productivity as we move volume through the box. So I think there's a big opportunity. You'll see us continue to talk about it and push on it. And actually, even leveraging the omni-channel environment will also help that.", "Because if we engage consumers both in the store and online, it really helps us leverage those fixed costs across our platform." ] }, { "name": "Marvin Ellison", "speech": [ "So, Chuck, this is Marvin. And I'll just add this last point. So if you think about where the opportunity exists for us to increase sales per square foot, first, it starts with what Dave talked about and Bill discussed in his prepared comments regarding the work we're going to do in the second half to get our adjacencies corrected and to go in and drive more bay productivity based on how we are merchandising the floor and also creating a more intuitive shopping experience. This sounds very basic.", "But we all were surprised with the poor adjacency structure in our stores and how most stores don't even have planograms in the system. And so it's almost impossible to merchandise and to have a good replenishment strategy. So that's number one. Number two, you have three things that are going to drive productivity in existing stores: an increased penetration in Pro, an improved e-commerce and omni-channel infrastructure, and a better install business.", "And we have negative comp in installed business last year. We've discussed dot-com to a high degree of detail and we've also talked a lot about Pro. And so all of these investments are part of our strategy to hit those targets that you talked about, and we think we're well on our way to making some progress." ] }, { "name": "Chuck Grom", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Scot Ciccarelli with RBC Capital Markets. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. Scot Ciccarelli. I think one of your bigger productivity unlocks was shifting some of the big -- large inventory categories, like appliances, out of the stores and back into the fulfillment network. Can you update us on where you are on that front? And related to that, are there any large productivity initiatives that you've maybe had to delay because of the unexpected sales surge?" ] }, { "name": "Marvin Ellison", "speech": [ "Scot, I'll take it. This is Marvin. So I'll take the second part first. No.", "I mean, we hadn't really delayed any large project. Dave mentioned, to the contrary, we've decided to push projects up that drive productivity and also that impact the improvement of our omni-channel strategy because we believe that we're behind. And candidly, we want to come out of this COVID-19 crisis a better company than we were going into it. And we think we're making progress in that area.", "Relative to supply chain and our transition of products like appliances out, we're in the early stages of that. I reiterated in my prepared comments that we are going to have an aggressive 18-month strategy to roll out, deliver cross-dock and bulk distribution centers, and also online fulfillment centers. Our pilots have proven successful in getting appliances and bulk products out of our backrooms into more centralized, local distribution or delivery and you're going to see us accelerate that in the back half of the year going into next year." ] }, { "name": "Scot Ciccarelli", "speech": [ "That's really helpful. And can you just give us a quick update on where you are in terms of the customer-facing hours versus tasking? Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "Yes. Let me hand that to Joe and he can give you some specifics." ] }, { "name": "Joe McFarland", "speech": [ "Yes. Thanks, Scot. So we've made significant progress. We're ahead of our 60-40 goal.", "We continue to engineer out-tasking in the stores to improve customer service. We are well on our way and ahead of our 60-40 goal." ] }, { "name": "Marvin Ellison", "speech": [ "Yes. And, Scot, the last point I'll make, just giving credit to Joe's team and the IT team. Without some of the advancements in technology, like the new labor scheduling system, I mean, we would be in a much different position as a company, trying to serve the needs of the customer and the needs of the associates in this unique environment. But having a system that gives us the ability to manage to the unique needs of both customers and associates, that system was put in place last year, it's created just an enormous benefit to our ability to not only serve customers but to drive productivity.", "So proud of the progress of Joe and the operations team. And we think we'll hit that target before what we committed to because it's just the right thing to do for our associates but also for our shareholders." ] }, { "name": "Scot Ciccarelli", "speech": [ "Very helpful. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Steven Forbes with Guggenheim Securities. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. And, Dave, maybe the first one for you, just given the number of facilities being stood up over the next 18 months. And you sort of mentioned the geography shifts in the prepared remarks. But can you help us better understand the P&L implications? I mean, should we expect a net margin headwind, I guess, an incremental one, given the pull-forward here or are there enough offsetting factors to neutralize the initiative as you roll it out?" ] }, { "name": "Dave Denton", "speech": [ "Steven, just keep in mind that what we have done here is consistent with our long-term plan because we were always in the mode of investing in the supply chain that we knew would drive incremental costs and dampen gross margin rate but would alleviate some SG&A pressure in the stores and across our platform. So I think the plan over the long term is consistent with that. Clearly, when you make investments in the short term, you have to stand up the facilities in advance for them being at full productivity level, so there will be some near-term headwinds. And that's somewhat of the commentary you heard me speak about as you thought about the back half of 2020 is really due to that fact." ] }, { "name": "Marvin Ellison", "speech": [ "Yes. I think -- and Steve, this is Marvin. The only point I'll add is, obviously, this is part of our plan. But we also have things we're implementing that will be offset.", "And I talked about the price management system. And the continued maturation of that system gives Bill and his team a lot more understanding to drive benefits relative to pricing and also having a more balanced promotional strategy. Some of the things that Joe is putting in the stores from a productivity perspective that's helping us to get that balanced payroll, which also drives operating income improvement. So there will be offsets to go along with the investments we're making.", "This is not really a pull-forward. This is really a reminder of where we are in the process, so it keeps us on track. We're not getting off track, and we're not going to create any downside scenarios that we didn't anticipate." ] }, { "name": "Steven Forbes", "speech": [ "And then just a quick follow-up. I guess, Dave, again starting with you. As you noted, right, the expectation for, I guess, a moderation, right, in top-line growth as we head into the back half of the year. But any context on how that pertains to both the DIY and Pro customers? Is there any sort of, I guess, dichotomy between the two channels or two customer segments?" ] }, { "name": "Dave Denton", "speech": [ "Listen, I don't think so. Listen, I think we've seen really strong growth and retention of both new and repeat customers in our channel, both from a Pro perspective and DIY. I think just practically speaking, we're going into kind of the season which demand begins to moderate just from a natural progression perspective. And I think that's just what we're trying to call out as you think about the back half of the year.", "I think we're really nicely positioned from a merchandising perspective and from a labor perspective that we're going to really do well from a service perspective and have the right product in stores and online to meet the demand for these customers." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "Operator, we're ready for the next question." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from Seth Sigman with Credit Suisse. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Thanks a lot. Good morning, everybody. Given the strength over the last few months, we get a lot of questions about pull-forward. I guess as you look at the composition of sales through the second quarter and then obviously early here in the third quarter, are you seeing any change in the types of projects that consumers are working on? Anything that maybe helps give you confidence that demand through this period has been incremental versus pull-forward? How are you guys thinking about that?" ] }, { "name": "Marvin Ellison", "speech": [ "We do not see it as pull-forward. I think what we've tried to articulate is that this is a really unique environment, where most of us are forced to spend more time at home than we ever have in our lifetimes. And so those customers are finding projects around the house that have been on the list, they just hadn't got a chance to get to them or candidly they just didn't notice them. So we don't see this as a pull-forward.", "This is more of an incremental add. In addition to that, as I mentioned, we've been running a negative install business for the past couple of years. And Bill Boltz and his merchandising teams made big investments last year in updating our flooring showrooms in our stores and updating our kitchen showrooms. We believe that those investments in the store has led to us improving our install business this year, along with the restructuring of the field team that Joe took on.", "So the short answer is we don't see this as pull-forward. We see it as incremental just based on the unique environment that we're in. And we also see it as market share gain. I mean, it's difficult for a company our size to grow sales by 35% comp without having some significant market share gain that's happening as well." ] }, { "name": "Seth Sigman", "speech": [ "Right. Right. OK. That's helpful.", "And then just a question on the regional consistency. It's helpful to get that color and it's obviously a very good trend that it's been so consistent throughout this period. I'm just curious, have you seen any change in comps or the composition of categories in markets where COVID cases have started to pick up?" ] }, { "name": "Dave Denton", "speech": [ "No. We have not. I think actually where COVID has picked up, we've seen very strong demand in those markets. And it's been pretty consistent, so we really have not seen a material change in that." ] }, { "name": "Seth Sigman", "speech": [ "OK. Great. All right. Thanks a lot, guys." ] }, { "name": "Dave Denton", "speech": [ "Thank you. Michelle, we'll take one last question, please." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Mike Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Mike Baker", "speech": [ "Thanks. So I wanted to follow up on DIY versus Pro. And I think some of your comments suggest that DIY was maybe up closer to 40% in the quarter versus Pro up 25%. But has that gap narrowed this quarter? I think at one point, it was said that Pro is up mid-20s and you sort of implied that the whole company is up mid-20s in August.", "So that would imply that that gap has narrowed. Is that a correct assumption?" ] }, { "name": "Marvin Ellison", "speech": [ "I would say your assumption is correct on the ratio between Pro and DIY, relative to a composition change, not so much. I mean this is a unique environment. And most of 2019, our Pro comps outperformed DIY. The shift occurred, obviously, during this COVID-19 crisis, where customers are spending more time at home.", "And in some cases, they're still a little apprehensive to allow contractors in their home. So we think those combination of factors is driving the resurgence in DIY. We have to be more penetrated from a DIY perspective as a company. Our Pro business is growing, but DIY has always been a strength, and we think that we're benefiting from the current trends." ] }, { "name": "Mike Baker", "speech": [ "OK. Makes sense. One more follow-up on indoor versus outdoor. So you gave us the indoor comp.", "Could you just share with us the outdoor comp or percent of indoor versus outdoor and then we could back into the outdoor comp? But more importantly, how does that percent change as we go through the back half of the year? How much bigger does indoor get relative to outdoor?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, what I would say is we've given plenty of competition information. So we're not going to give you any more specifics on ratios because we think we've given enough to provide context and color. But going into the back half of the year, this shifts inside versus outside just due to weather and seasonality. I'll let Bill talk a little bit about what our focus is on the inside and the back half because it's something that we've been working quite a bit on." ] }, { "name": "Bill Boltz", "speech": [ "Yes. I think to play off of Marvin's comments, as we shift to the fall business, it naturally shifts indoor. But in the southern parts of the country, there's still a lot of outdoor projects that get done as the weather cools. But for the northern markets, the pro moves inside, the consumer moves inside, flooring, kitchens, bath, those types of projects, all about getting the home ready for the holidays is where the customers focus.", "And then you have your natural fall businesses. Right? So fall businesses continue to play. Those are a little less seasonal than the spring time frame. And they're all really driven based on what Mother Nature brings.", "So that's really what drives the back half of the year." ] }, { "name": "Mike Baker", "speech": [ "OK. One more which might be helpful for everyone, if I could. You talked a lot about COVID. Where we've seen the COVID spikes, business remained strong.", "I guess I'd be concerned about the opposite, where COVID is sort of calming down, are we seeing people move away from the home?" ] }, { "name": "Dave Denton", "speech": [ "We have not actually seen our business in those areas actually improve." ] }, { "name": "Marvin Ellison", "speech": [ "And the last point I'd make, we have 15 geographic regions. All 15 were 30% comp or higher. I mean that's a pretty unprecedented number. And that illustrates the consistency of demand across rural, urban, and all types of geographies in the country.", "And we think that is also consistent with really good execution by the merchandising and stores team to drive the business, as well as outstanding work from our store leaders out there every day, doing an incredible job for customers and communities." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2019-05-22	[ { "description": "President and Chief Executive Officer", "name": "Marvin R. Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "William P. Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joseph M. McFarland", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "David M. Denton", "position": "Executive" }, { "description": "Wolfe Research, LLC -- Analyst", "name": "Siddharth Dandekar", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS Securities -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Zachary Fadem", "position": "Analyst" }, { "description": "JP Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Oppenheimer -- Analyst", "name": "Brian Nagel", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning everyone and welcome to Lowe's Company's First Quarter 2019 Earnings Conference Call. This call is being recorded. (Operator Instructions). Also supplemental reference slides are available on Lowe's Investor Relations website within the investor package. Well management will not be speaking directly to the slides, these slides are meant to facilitate your review of the Company's results and to be used as a reference document following the call.", "During this call, management will be using certain non-GAAP financial measures. The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks and the Company can give no assurance that they will prove to be correct. Those risks are described in the Company's earnings release and in its filings with the Securities and Exchange Commission.", "Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President Stores; and Mr. Dave Denton, Chief Financial Officer. I will now turn the program over to Mr. Ellison for opening remarks, please go ahead, sir." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you, Regina. Good morning everyone. Our first quarter comp performance is a clear indication that our focus on retail fundamentals is gaining traction. Despite solid top line results, our gross margin performance in Q1 highlights that we still have work to do as we continue our transformation. We are taking the necessary short and long-term actions to improve our gross margins, which I'll discuss in more detail in a moment. But first let me highlight what drove our sales performance in Q1, specifically our commitment to improving in stock and customer service coupled with our focus on winning with (inaudible) improved sales performance.", "For Q1, we delivered total Company comps of 3.5% and our US home improvement comps grew 4.2% for the quarter, while there was challenging early in the quarter given that we experienced the second what is February on record. In fact unfavorable weather exerted 315 basis points of top line pressure in February as well as improved we saw broad-based sequential improvement with comps of a negative 1.4% in February, positive 3.5%, in March and positive 7.2% in April. We drove increased traffic to stores and to lowes.com and generated a more balanced top line growth with increasing transactions by 2.2% and increasing average ticket by 1.3%.", "We delivered positive comps in 10 of 13 merchandizing departments, including double-digit comps and seasonal and outdoor living in high single-digit comps in lawn and garden. We drove positive comps in all geographic regions, with the exception of Tampa in Houston, which faced tough prior-year comparisons from hurricanes Irma and Harvey. For Q1, some of our best performing geographic regions were Atlanta, Charlotte, Los Angeles, Nashville, New York Metro, Pittsburgh, Philadelphia and Richmond. Our pro comps significantly outperformed DIY and we see early evidence that our strategic initiatives with a very important customer are gaining traction. Joe McFarland and will add additional color to our pro performance later in the call.", "For lowes.com we posted comp growth of 16% for the quarter, although we're still not where we'd like to be with our online business, I'm pleased with the progress our new leaders are making to improve the infrastructure of this very important channel. In Canada, we posted negative comps for the quarter as the weaker Canadian housing market exerted pressure on the business. Adjusted diluted earnings per share were $1.22 for the quarter and a convergence of factors led to gross margin pressure in the quarter. Some of these challenges are reflection of the tools and process limitations I've discussed on previous calls, but what's important is that we have our arms around the issues and have plans to improve gross margin over the course of the year. Allow me to take a moment to outline the factors that led to our Q1 gross margin shortfall. First, we recognized inventory first-in first-out. So cost increases that were agreed to by merchants in 2018 are now flowing through the P&L as we turned inventory. The majority of these cost increases that were accepted in 2018 without any corresponding offset to gross margin pressure .", "Second, as we are preparing and we're preparing for the business seasonal year, we undertook unprecedented levels of change in our merchandising organization. Over the past six months, we replaced two of our three merchandising Senior Vice Presidents, we replaced 11 of our 13 Merchandising Vice Presidents. This level change was necessary to ensure that we have the best talent in position to put our strategy for the second half of the year, Spring of 2020 and to fuel our future growth. However, as we transition from legacy merchants to new margins, there was much more disruption in Q1 than we anticipated, and this disruption was primarily driven by a lack of visibility in our pricing ecosystem.", "Our new merchant simply did not have a clear line of sight to the cost increases that were accepted by prior merchants as we transitioned. Based on the assisted -- really limited system visibility, we could not quickly analyze and offset these cost increases with appropriate pricing action . Our challenges with pricing tools and processes aren't new to Lowe's. However, we did not anticipate the impact of fully communicated cost increases, significant organizational changes with 11 new merchandising VPs and legacy ineffective pricing tools and processes.", "Now, let me take a moment and outline the decisive actions we're taking to improve our gross margin for the balance of 2019. First, our CIO, Seemantini is leading an effort to implement changes to our pricing and point of sale systems. With these changes, we will streamline who can affect costs and pricing changes in sequence those pricing actions to prioritize those that have the greatest impact to gross margin. We will also have better visibility for the merchants to understand the impact of our pricing actions without having to view multiple systems and numerous reports. We're establishing a more efficient process to systemically analyze, prioritize and implement pricing actions to offset cost pressure.", "Second, our recent acquisition of Boomerang, Retail Analytics platform, a leading pricing analytics practice is a significant step forward toward modernizing our approach to pricing, by digitizing our business processes and increasing our agility. This acquisition reflects our commitment to modernizing our systems and reinforces our philosophy to buy versus build capabilities, if that approach is more advantageous for the Company. And finally as our merchant leaders accrue more time in their roles, they have better view of the categories and assortment plans and stability in any organization is important and now we have that stability for the balance of 2019 and our merchandising organization .", "With enhanced visibility, the merchants are better able to offset cost pressure with adjusting prices within their portfolio of products. In addition, we are building improved the pricing analytics to help offset future costs crusher and protect gross margin that impact the top-line sales. It's important to mention that we believe our pricing issues hurt topline sales as well as gross margin in Q1. By not taking pricing action on our intellect (ph) SKUs to offset cost increases, we simply decremented top and bottom-line at point of sale, which we believe negatively impacted sales. As I've discussed on previous calls, this is a multi-year transformation and we're in the phase one of the three phase process. However, our first quarter results, clearly reflect two things. First, our 4.2% comp in the US clearly illustrates that customers are responding to our changes in our approach to retail fundamentals of working. They might experience the three things you hope to see the early stages of the transformation. You want to see positive customer transactions, you want to grow our average ticket, while reducing expense and improving efficiencies to leverage SG&A.", "We saw all three in Q1, which gives us confidence that we are taking the right strategic steps. Our first quarter also reflects that as we encountered systems and process limitations doing this transformation, we now have the experience and the internal expertise to address the issues and minimize the impact on future periods. The issues that impacted Lowes' gross margin in Q1 have been identified and are being addressed with process changes and system adjustments. Consequently, we expect to deliver improved gross margin performance over the balance of the year. We made a lot of progress, but our transformation is clearly ongoing.", "Our first quarter comp and our improved sales force productivity driven in large part by the pro customer gives us confidence that our strategy is working, and we are committed to making the investments and taking the actions necessary to address legacy issues and position Lowe's for sustainable long-term sales and profit growth. My most enjoyable time as the CEO is a weekly visit I spend in the stores. Our sources have demonstrated to me their passion for our customer and for this great Company. So before I close, I'd like to thank them for their hard work and their commitment to serving the customers and serving our communities.", "And with that, I'll turn the call over to Bill." ] }, { "name": "William P. Boltz", "speech": [ "Thanks, Marvin and good morning everyone. As Marvin shared with you, we capitalized on spring demand in the first quarter, post the US comparable sales growth of 4.2%. We transitioned into the spring season more efficiently. We began setting our stores from South to North three weeks earlier than last year and we adjusted our store inventory load in the 60% versus 35% last year. These actions ensured that we were ready for the spring season and positioned us to have adequate seasonal inventory on hand to capture that spring demand.", "Our teams also significantly improved sales for productivity through better use of end caps in a redefined strategy for off-shelf statistics. We leveraged our Spring Black Friday event to take advantage of the seasonal project demand with strong messaging and attractive offers, more personalized marketing and a continued shift into digital and localized marketing channels. And as Joe will share with you in a moment, our associates delivered very well in the aisles and executed a very successful event. Our success in driving strong spring sales were supported by the improved service model in our stores and a better in-stock execution .", "For the quarter, we achieved double-digit comps in seasonal and outdoor living, led by double-digit comps in outdoor power equipment, where we continue to leverage the top three brands in riding equipment with John Deere, Husqvarna and Craftsman. We also drove double-digit comps in grills through our offers from Weber and Char-Broil, the top two brands and outdoor grilling. In addition to seasonal and outdoor living, we also delivered high single-digit comps in lawn and garden, with the strength in our lawn care and landscape products through the power of the Scotts Brand and in live goods with our nationwide (inaudible) plan offers along with the extension of our Monrovia plant program, a home center exclusive .", "In the first quarter, we also saw strength in our tools and our appliance businesses. We posted but -- we posted above average comps in tools as the Craftsman reset continues to drive strength in categories like tool storage and mechanics tools. We're excited to be able to complete the Craftsman tools reset by the end of the second quarter and we look forward to introducing the brand into additional categories in the second half of the year. The Craftsman Brand, along with our proprietary Kobalt Brand continues to drive traffic and they both create a loyalty building opportunity for us. We are proud to be able to offer both brands and to be the exclusive destination in the home center channel for the Craftsman Brand. We also drove above average comps in appliances, as we continue to leverage our leading market share position through our top brands, our breadth of assortment and our stronger mix.", "The paint performed below the company average, the category still delivered positive comps even with the significant weather pressure early in the quarter. Our intense focus on our retail fundamentals, while leveraging our exclusive partnership with Sherwin Williams has allowed us to continue to drive progress in this category. And as Marvin indicated, we are in the early stages of implementing change, which did create some disruption in Q1. However, I'm very pleased with the talent and the deep retail experience, we've been able to recruit and doing views throughout our merchandising organization. Our new leaders are now firmly established in their roles. And we expect this leadership stability to drive sustainable improvement for the balance of 2019 and beyond.", "We are encouraged by the early results that we're seeing from our new merchandising service team. These teams are supported by our vendors and they're responsible for the day-to-day bay maintenance and resets in our stores along with setting the maintaining and caps and help executing off shelf displays. The MST teams are critical component to improving our merchandising reset execution in-store level as they take these important and time-consuming tasks off the shoulders of our red vest associates, so they can be freed up to serve our customers. The early results of our MST program show reductions in out-of-stocks and improved sales productivity and an increase in bay serviced per hour. The MST is also providing critical support during our successful Spring Black Friday event as well as for our Craftsman outdoor power equipment and tools reset.", "As Marvin stated, we were very pleased with our pro business in Q1 and we are focused on leveraged our improved in-stock position along with our key brands to drive additional sales with this very important customer. As an example, in the first quarter, we announced that Little Giant Ladder Systems , a leader in safety and innovation has chosen Lowe's as their exclusive home center partner. Our teams continue to work to add more key programs to our assortments as well as leveraging our existing partnerships with brands such as the DEWALT, the number one power tool brand in the industry and the new and innovative products we have from Bosch and Metabo HPT, that are all focused on saving pro, both time and money.", "In the first quarter, we also took steps to driving merchandising productivity and localization through the investment in rollout of our field merchandising teams. The teams are now in place and we expect to see the continued benefits from their work with our merchants and our stores in the second half of 2019. As we look ahead to Q2, we remain focused on carrying our momentum forward. We expect to drive sales and traffic with our compelling Memorial Day, Father's Day and July 4th events. The power of Craftsman as we complete the rollout of our Craftsman tool program and our pro categories, as we continue to capitalize on our job lot quantity investments and our focus on this very important customer segment.", "We also remain focused on driving improved growth on lowes.com, as we work to increase our online assortment, continue to improve the shopping experience and work the ship slower moving SKUs out of our stores and onto our website to improve inventory productivity. We are excited about the opportunities that are ahead of us and we're working very hard to position for the future and to capitalize on the strong demand and a healthy sector. Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joseph M. McFarland", "speech": [ "Thanks, Bill and good morning everyone. As Marvin indicated our commitment to improving in stocks and customer service, along with our focus on winning the Pro were keys to our improved sales performance in the first quarter. To improve associated engagement we rolled out the smart model, a new customer service model, which guides the way we hire, train, evaluate and coach our associates. This program models with a great experience actually looks like and drives behaviors that deliver the kind of experience that customers want. It includes comprehensive toolkit, training program and mobile devices, which are designed to provide our associates with the tools they need to deliver outstanding customer service.", "In the first quarter alone, we trained over 280,000 associates on smart customer service and we also rolled out approximately 88,000 smart mobile devices through our stores. Associates are no longer required to leave the sales floor to log into a terminal to determine the price, availability or order status of an item. The new smart device reduced the asking hours by providing associates with real-time data without ever stepping up the sales floor. For example, the smart devices have functionality processed buy online pickup in store orders. This new functionality takes us from a 12-step paper-based process to an average of two digital scans.", "In the first quarter, 60% of our online purchases were picked up in our stores, which reinforces the power of our Omni-channel model. The role of smart devices in the systematic improvements in buy online pickup in store represents a significant advancement in the partnership between our stores in IT and are really terrific early examples of what we can accomplish as an organization when we are focused and aligned. To further improve the customer experience in the first quarter, we replaced a series of non-facing customer positions with over 6,000 assistant store managers and department supervisors. These customer facing store leadership roles are focused on providing better departmental coverage and expertise as well as coaching our associates in delivering excellent service. Previously, for example, a single department supervisor was tasked with covering the lawn and garden, rough plumbing and electrical and pain department simultaneously, which simply isn't manageable.", "With the addition of department supervisors, we're ensuring that we have the proper coverage for strategic areas of focus such as paint. To that end, one of the incremental supervisors has dedicated the Pro department. As we've discussed before the pro customer is a key focus for us in 2019. In the first quarter, we were very pleased with our sales and customer service improvements in Pro. This improvement was driven by executing five key steps. First, we addressed our out-of-stock issues and for inventory presentation with a commitment to improving our job lot quantities and our product presentation under the Pro Canopy and on our end caps. Second, we improved our store level service to ensure we can get our pro customers in and out faster. This included adding dedicated loaders and establishing preferred parking under the Canopy. Remember for the pros time is money.", "Next we staffed our Pro desk with dedicated associates working at consistent schedule and we had a department supervisors to all pro areas of our store. We redesigned our field structure adding 15 new regional pro managers and recruited experienced leaders to focus on our in-store and outside pro sales. And then finally, we worked with Bill and the merchandising team to communicate a consistent volume pricing message and improved our product presentation in the area. After we felt comfortable with the execution of these five steps, we invited customers then to share improved environment with a very successful and nationally marketed pro appreciation event, which allowed us to grow our Pro accounts. In fact we opened over 40,000 new Pro accounts in the first quarter.", "We also leveraged our exclusive partnership with the NFL. We ran Pro focus national advertising during the NFL draft, this was an extension of our do it right for less campaign, reinforcing that Loews offers the job site delivery and job lot quantities Pros need as well as designated for supervisors equipped to help our customers. Although we are pleased that our first quarter Pro comp significantly outperformed our DIY comp, we are still in the early stages of our transformation with this customer. I look forward to discussing additional initiatives for the Pro in upcoming calls.", "In closing to improve staffing and better leverage our payroll spend, in the second quarter we will continue the rollout of our new customer centric labor scheduling system. This system will better predict customer demand by time of day, day of week and department, allowing us to align our labor hours with peak traffic, providing better department coverage and customer service, while ensuring that we're using our labor hours efficiently and reducing our overall payroll expense. This new system will replace our curve staffing system that doesn't effectively capture and predict sales and customer traffic patterns. We will have this new system fully rolled out in the second half of this year. Though we are in the beginning stages of change we are excited about the early results we're seeing and committed to the work ahead to fully capitalize on the healthy demand in our sector.", "Thank you, and I'll now turn the call over to Dave." ] }, { "name": "David M. Denton", "speech": [ "Thanks, Joe, and good morning everyone. Let me begin this morning with just a few housekeeping notes. First, as disclosed in our press release this quarter we adopted the new lease accounting standard using a prospective transition approach. The adoption of the standard resulted in an increase in lease-related assets of $3.6 billion and an increase in lease related liabilities of $3.9 billion. The difference between the increases in lease-related assets and liabilities, net of the deferred tax impact was recorded as an adjustment to beginning retained earnings. The standard had no impact on our debt-covenant compliance under our current agreements.", "Second as also described in our press release, in the first quarter, we realized a tax benefit in connection with our previously announced decision to exit our Mexico operations. We had originally planned to sell the operating business, however,, in the first quarter after an extensive market evaluation, we decided to instead sell the assets of this business. That decision resulted in an $82 million tax benefit, which offset $12 million of pre-tax operating costs for the Mexico operations within the quarter.", "With that, I'll turn to a review of our operating performance starting with our capital allocation program. In the first quarter, we generated over $1.9 billion in free cash and through a combination of both dividends and share repurchases, we've returned over 60% of this cash to our shareholders. In the first quarter alone, we paid $385 million in dividends and our dividend payout ratio currently stands at 37%. We also entered into a $350 million accelerated share repurchase agreement retiring approximately 3.2 million shares, and we purchased approximately 4.4 million shares for $468 million throughout the through the open market. So in total, we have repurchased $818 million of our stock at an average price of $107.60. We have approximately $13.1 billion remaining on our share repurchase authorization. In April, we issued $3 billion of unsecured bonds. The issuance consisted of 10 and 30-year notes with a weighted average interest rate of 4.1%. The proceeds of this issuance were used to refinance current year maturities and on the other general corporate purposes. And we continue to invest in our core business with capital expenditures of approximately $205 million in the first quarter.", "Now looking at the income statement, we generated GAAP diluted earnings per share of $1.31 per share compared to a $1.19 in the first quarter of last year, an increase of 10.1% . On a comparable basis, excluding the $82 million tax benefit and $12 million of pre-tax operating cost from Mexico adjusted diluted earnings per share was a $1.22, an increase of 2.5% compared to LY. As Marvin indicated, though, we are very pleased with our sales performance, we experienced significant gross margin contraction, which resulted in lower than expected earnings per share in the quarter, which I'll discuss in more detail in just a moment. Sales for the first quarter increased 2.2% to $17.7 billion, supported by total average ticket growth of 2.9% to $77.19, partially offset by a slight decline in total transactions. Comp sales were 3.5% driven by comp transaction increase of 2.2%, and an average ticket increase of 1.3%, our US comps was 4.2% for Q1.", "So looking at monthly trends, the total comps were negative 1.4% in February, positive 3.5% in March and positive 7.2% in April. Additionally, monthly comps for our US business were negative 0.9% in February, a positive 4% in March and a positive 8% in April. Now if you were to adjust for the impact of commodity deflation along with weather in February, our US comp would have been approximately 5.7% for the quarter. Gross margin in the first quarter was 31.5% of sales, a decrease of 165 basis points compared to Q1 of last year. We experienced approximately 90 basis points of pressure from the challenges with our pricing ecosystem that Marvin discussed earlier. The tools and process issues have been identified and are being addressed to mitigate this pressure going forward. As expected, we also experienced approximately 40 basis points of pressure from supply chain cost, as we added new facilities to the network that are still ramping up to full capacity, coupled with ongoing increases in transportation cost and customer deliveries. Product mix shift had approximately 30 basis points of negative impact on gross margins also in this quarter.", "SG&A for Q1 was 21.8% of sales, which levered 89 basis points. We drove 80 basis points of leverage in retail operating salaries and 70 basis points of leverage through improved advertising efficiency. We also have 34 basis points of leverage from lease assignments and terminations associated with last year's store closing activities. These items were partially offset by these leverage in incentive compensation and employee insurance. Operating income decreased 45 basis points to 7.99% of sales. The effective tax rate was 16.6% compared to 24.3% last year. This significant improvement year-over-year is primarily due to the favorable tax benefit associated with the change in approach to exiting our Mexico operations. On a comparable basis our adjusted effective tax rate was 22.9%. At $15 billion, Inventory increased $1.8 billion or 13.8% versus the first quarter of LY. This this is largely driven by inventory to support anticipated seasonal demand, adjusted presentation minimums and investments in job lot quantities, albeit, a significant increase in inventory, these are important strategic investments to drive sales performance in the coming months.", "Now before I close, let me address the 2019 business outlook, which has been updated to reflect our gross margin missed the plan in the first quarter and to adjust the remainder of the year for the expected timing and impact of our corrective actions. For 2019, we still expect total sales increase of approximately 2% for the year driven by comp sales increase of approximately 3%. However, we now accept adjusted operating margin to increase 20 to 50 basis points. The effective tax rate is expected to be approximately 24% and so, we now expect adjusted diluted earnings per share of $5.45 to $5.65. We are now forecasting operating cash flow of approximately $4.5 billion as a result of our lower operating margin expectations and an increase in inventory versus our plan. CapEx is still expect to be approximately $1.6 billion and this is expected to result in free cash flow of approximately $3 billion for 2019. Our target leverage ratio remains at 2.75 times. So with that, our guidance now assumes approximately $4 billion in share repurchases for the year.", "As Marvin mentioned, we're early in our transformation, but we now have management team in place with the expertise required to tackle the opportunities ahead of us. With the sales momentum we gained throughout the first quarter, we remain extremely excited about the future of our business and are focused on taking the necessary actions to both improve our performance and drive long-term shareholder value.", "And with that, we're now ready to take questions." ] } ]	[ { "name": "Operator", "speech": [ "(Operator Instruction) Our first question comes from the line of Michael Baker with Deutsche Bank. Michael, you may be on mute. Our next question will come from the line of Scott Mushkin with Wolfe Research." ] }, { "name": "Siddharth Dandekar", "speech": [ "Hi, this is Sid on for Scott. Thanks for taking my question. You mentioned 90 basis points of gross margin contraction from the pricing system issue, it sounds like some of these things like the FIFO inventory and the merchandise issues, they were probably -- you had some insight to that coming into the quarter. Just trying to understand how much of that was expected versus completely unexpected?" ] }, { "name": "Marvin R. Ellison", "speech": [ "I'll take the first part of that, it was primarily unexpected. As I mentioned, we see our inventory first-in, first-out and we had cost increases that were taken in 2018 with no offsetting steps to protect the gross margin, which obviously was not a great decision because of the limitations within our system and the transition of our merchandising team, we literally had no visibility to those cost increases until the inventory that was increased in cost started to hit the P&L as it layered and sold through with inventory turns. So our legacy systems really gave our merchants and our finance team limited visibility to these changes until it literally hit the P&L. So we did not have an expectation that this was going to happen. The good news is that we've upgraded our systems to provide better visibility to cost and retail pricing actions. We now have the ability to prioritize, which pricing actions to take and as Dave mentioned, we've taken mitigated steps and actions to address this. We have made the changes from pricing actions, we feel good about the year-over-year performance in our gross margin. We're just continuing to work through the issue and again it was not something we planned coming into the quarter." ] }, { "name": "Siddharth Dandekar", "speech": [ "All right, thanks for that, Marvin. And then just one follow-up for Dave. It looks like the 6 times rent calculation that you had in your leverage ratio target prior to this new standard was understating the operating lease adjustment, which is now actually on the balance sheet. So given you ended 1Q with the leverage so close to your target are you foreseeing any modification of the target going forward, some wiggle room in your capital allocation strategy for the year?" ] }, { "name": "David M. Denton", "speech": [ "Sid, I think if you look at that number it changed only modestly. So I think that our estimates were pretty spot on from that perspective. We did not anticipate changing in our cap structure of 2.75 times based on that adjustment." ] }, { "name": "Siddharth Dandekar", "speech": [ "Thank you." ] }, { "name": "Marvin R. Ellison", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Simeon Gutman with Morgan Stanley." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, good morning guys. So just to clarify, this GM weakness (ph), this was not driven by promotion. This was bad systems. There were some execution and by the logic you provided on the call, where you didn't get higher prices on inelastic items, you didn't mention elastic goods because by that logic, if you didn't push higher prices on elastic goods, why is that different from being promotional or even discounting?" ] }, { "name": "Marvin R. Ellison", "speech": [ "So this is Marvin. I'll take your question. From the promotional cadence, it was consistent with last year. So this was not driven by increased promotions. As a matter of fact, we believe strongly that not only did this dilute gross margin, but also diluted sales. So, our pricing architecture, we look at it head quartile, head items are items that are price sensitive, most often scraped by our competitors, where we have to be price competitive and so we're going to be competitive on those head items.", "Typically, what happens, if you receive a cost increase, you're not going to increase your retails of your head items because it makes you non-price competitive. So that does not happen. Instead what you do is you find items that are inelastic within that same assortment and you make the adjustments there. We didn't make any adjustments nor did we promote lower prices. So, we just basically decrement it margin at point of sale and we decremented top line at point of sale as well. Our promotional cadence was the same. We desire to be less promotional, not more promotional. Again our promotional strategy was not different from last year in terms of days, offers or intensity." ] }, { "name": "Simeon Gutman", "speech": [ "Got it, OK. I guess my follow up then is -- separating out the actual execution from these -- from fixing this from the accounting. So it seems like you're making changes now if not a lot of those are being made or have been made. How does that flow? Why -- does it take time? I guess it flows through the rest of the year or we should recoup this by the time we get to the end of 2019 or is this 2020 recoup?" ] }, { "name": "Marvin R. Ellison", "speech": [ "So I'll take the first part then I'll let Dave to provide any additional context. So as I discussed and Dave mentioned this is worth about 90 basis points and again, due to the limits in visibility we did notice that it was going to start hitting the P&L to be quite candid some of these cost increases were taken 40 or 50 weeks ago, without any mitigating actions I mentioned to offset gross margin. So as we work through making the (Technical Difficulty) adjustments, where we have implemented pricing actions, the gross margin (Technical Difficulty) additional strategic pricing actions that we have a lot of the full impact l (Technical Difficulty) 2019. We're confident it's working. We simply aren't taking the time to analyze the results to make sure that we understand the full benefit to '19 and called of that we got prudent to update the guidance because this is an ongoing effort. So, that's the operational execution side of it.", "And the good news is the partnership between finance, merchandising led by IT, we have significantly better visibility to all pricing actions, to cost increases, we have now one team responsible for approving and managing our costs in retail increases. We also have a very basic retail philosophy that is if you accept the cost increase, you need to take mitigating steps to also gross margin, that's not unique in retail, but it was unique to Lowe's until Q1. So we now have our arms around this and that's the operational execution side and I'll now let Dave speak to any of the accounting side." ] }, { "name": "David M. Denton", "speech": [ "Yes, so maybe I'll just step back and give a little color on our guidance and kind of laid out as we cycle into Q1. As we look very near term from the Q1 sales performance, we continue to see that consistent with our expectations and our gross margin trends as we cycle into Q2 are materially consistent with what we've seen in Q1. However, as Marvin indicated in the areas that we have taken pricing actions, we have began readjusting on to see some improvement performance versus trend versus LY. Now our guidance reflects the fact that we still need to implement more actions than, quite honestly we need more time to make sure that we analyze and fully understand the net effect of all the changes we are currently implementing. So you're going to see this improvement bleed also into Q2, but importantly into Q3 and Q4, and I think we won't see major trends inflection in Q2 as much as we'll see in Q3 and Q4 as we bleed this inventory pricing actions through our system as we're currently doing as we speak." ] }, { "name": "Simeon Gutman", "speech": [ "Okay, thank you." ] }, { "name": "David M. Denton", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Michael Lasser with UBS." ] }, { "name": "Michael Lasser", "speech": [ "Good morning, thanks for taking my question. Can you give us more specifics on what category the price increase is that you experienced or in and why did you not remediate or address this issue until the second half of the year, (inaudible) right now?" ] }, { "name": "Marvin R. Ellison", "speech": [ "So Mike, I'll take the first part of that and I'll let Bill jump in if he has any additional color. It is rather widespread because some of the categories that these actions were taken in, quite candidly, we're trying to understand the logic of the cost increases across multiple categories. The good news is we don't have visibility to what they were and we're putting the processes employees to go back and correct those issues. As you can appreciate Michael, we're in a very competitive environment and so we just can't go on arbitrarily raise prices. There is a degree of analysis required to make sure that we are raising prices in categories that are in fact inelastic. And so as we lay out our head quartile head being the key price sensitive categories, the tail being the least price sensitive categories. We have to be very diligent and make sure we just don't go across the entire business to just arbitrarily raise prices because at the end you're going to have a negative impact on top line.", "So, as Dave mentioned, we are doing this in a very structured, very surgical way and the good news is that the action we taking is working, but we are analyzing it as we go to ensure that we're making the right decisions for the business and that's ongoing. And so we just thought it was prudent to adjusted guidance based on the ongoing efforts with the expectation and the confidence that we're going to get this done and we're going to be successful and the good news is we think this will benefit us not only for the balance of 2019, we going to solve the problem, that's been a legacy issue here for a while and that issue will be behind us and I'll let Bill talk about any other pricing concerns in the work in the same doing to make sure that we continue to work with our suppliers to ensure that we are competitive from a cost perspective." ] }, { "name": "William P. Boltz", "speech": [ "Yes, I think just a couple of things to add. This is -- when you start to take it on and when it's across the number of categories, it's what I refer to as real pick and shovel work and so it's a SKU by SKU review, you have to look at it at the assortment level as well, so that you don't screw up fee assortment philosophy of what a merchant is trying to do. So all of that is being done and where we -- as both David and Marvin have mentioned, where we have been able to do some of that in the last few weeks, we have seen improvement happen. In addition to that, as I've shared with you on other calls, we're in the early stages of rolling out category management into the organization.", "So you want to be able to do this in conjunction with the category management philosophy, where you've got the intent of each of these product categories, so that the philosophy falls into and then it can be built into the financial planning as you move into 2020. So we're rolling into that second phase of category management in the back half of the year. We start to apply it into each one of these product categories. You take this work, you've got to roll it into together so that we don't do something stupid. So that's what we're working on." ] }, { "name": "Marvin R. Ellison", "speech": [ "And Mike, I think -- noting that we we're looking at this short, medium and long term. So, short-term we've improved visibility for the merchants on all pricing actions. We've eliminated the need to look at numerous systems, multiple reports to get basic pricing and cost information. We now have one team in place to manage cost and price. We now have the goal to prioritize, which pricing actions we take that have the greatest impact on gross margin, believe or not in Q1 we couldn't do that.", "We have a really simple philosophy, does pretty consistent in retail and that is, if you take the cost increase for any reason you got offset that within the portfolio with actions to protect gross margin . All these things are -- basically these things didn't exist in Q1, so that's short-term, by Q4 Seemantini, our Chief Information Officer is implementing a new price management systems going to be rolling out. Its cloud-based, it's agile, it's going to enhance the visibility for the entire merchant and finance team on pricing. It's going to be a single repository for pricing something we currently don't have and that's going to -- that is being developed as we speak. This will give us the clarity. Then the acquisition of Boomerang Retail Analytics platform in 2020, we're going to integrate that to this new price management system.", "This is going to give us a best-in-class system for both price -- price intelligence and price management and this is another example that, this is a multi-year transformation. So we got short-term actions, we are taking right now. We got actions later this year, that's going to get us to clarity with a pricing management system and in 2020, we believe with the acquisition of Boomerang Retail Analytics platform, we're going to have a best-in-class pricing system and that's the cadence that will follow." ] }, { "name": "Michael Lasser", "speech": [ "That's helpful .Two more quick question. Given that this surprise you. Do you think Marvin that you might have underestimated some of the depth of the challenges that the business is done there and as a result, either it's going to take longer to achieved the longer-term margin expectations that you said or the longer term margin expectation (technical difficulty) And then on the quarter your sales performance has improved, how much of the incremental inventory that you added attributed to the better sales performance in the quarter?" ] }, { "name": "Marvin R. Ellison", "speech": [ "So Micheal, it's a fair question. We still feel good about the outlook we gave at the Analyst and Investor Conference this past December. There is a lot of work to do. And my team knows that one of my favorite comments is that all the easy jobs are filled (ph). So when we came here to take this on, we knew we were working for great Company with an outstanding balance sheet, but a Company that has underperformed it's sector for a significant amount of time.", "If Q1 proved anything, it proves the just and drive sales are and so we're pleased with our sales performance and we're not going to decelerate our aggressive approach to driving sales. But when we think about what drives ourselves in what we think allowed us to be successful in Q1, we think it's about getting in stock, about the investment and job lot quantities, about improvements in customer service, about the space productivity that the MST team is helping to drive and the focus that Joe talked about in Pro.", "We are in the early stages with Pro. We understand that there are other things that we will do. We have a great platform in MSA that we going to be talking about later to you this year. We have some initiatives we're working on with same-day job site delivery. We got this wonderful, unique pilot with FedEx on the same day delivery bought that is going to change and revolutionize how you get product to Pro customers and so we have a long-term view, but we're just really pleased that the fundamentals that we put in place for our business are paying dividends in Q1 and we think that's going to continue for the balance of the year.", "We simply have to get our arms around these issues. And the last point I'll make is are we going to have surprises? I'm sure we will, but when I look around the table at the men and women that are on this leadership team we have people who have the experience, the talent and expertise to solve these issues and as devastating as the margin impact was in Q1 with these unanticipated fully thought out cost increases the team rallied, got our arms around it and we're going to be able to resolve this as the year progresses." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line Zach Fadem with Wells Fargo." ] }, { "name": "Zachary Fadem", "speech": [ "Hey, good morning. So online sales up 16%, a nice acceleration versus late 2018. Curious if you could speak to some of the drivers here, anything new you're done with respect to the website or online ads, any category call-outs? And then second part as your online sales accelerate could you speak to the margin impact and any thoughts on mitigating the fulfillment drag there?" ] }, { "name": "Marvin R. Ellison", "speech": [ "So Zach, I'll take the first part and I'll let the Bill Boltz to give you some specific information. As I mentioned in my prepared comments 16% is improvement and I am really pleased with the new leadership. We have an entirely new leadership team focused on our online business. We have a CIO, who has a deep understanding of the online space and so there is the great partnership happening right now. And there's a lot of what I call infrastructure and foundational work being done. One of the key things that we are in the middle of doing is taking this platform from a mainframe platform to cloud-based, and that's going to be significantly important to us because it's going to give us much more agility and we can create a lot more dynamic response to our customers. So I'll let Bill talk about what drove the business in Q1, but we think we're only at the early stages of what's going to be a tremendous business platform for us over the next couple of years." ] }, { "name": "William P. Boltz", "speech": [ "Yes, so a couple of other comments to make in regards to online. I think certainly we're pleased with the growth over Q4 of '18, but as we think about the big changes that we're making, we're now putting an organization in place that's dedicated and focused on this part of the business. So with that, it means online merchants -- online merchants tied into the product categories and merchandizing departments within our core merchandising groups, so that we can pull the strategies through on Lowes.com.", "The team is also in the process of working through foundation stability that Marvin mentioned to make sure that our site operates the way we needed to operate. We're also working on enhanced content with all of our supplier partners and we are ramping up the amount of SKUs and assortments that we carry on lowes.com. So a lot of work going on there. In addition, the direct fulfillment center that we opened outside Nashville a year ago working with the supply chain team to be able to leverage that and so that we're in the early innings of that, but we're ramping up SKUs into that facility, which allows that pressure to come off of our stores, where they had been the fulfillment arm in the past, all of that making it easier for our customers to shop on lowes.com. So we've got a lot of things that are in the works. SO lot of things that have been done and a lot of things still to do to improve our performance there and there's nothing, but upside for lowes.com." ] }, { "name": "Zachary Fadem", "speech": [ "Got it. And then one for David. On the change in EBIT outlook. Just want to confirm that 50 basis points, 60 basis point change or so entirely at the gross margin line and then whether you expect the impacts to be felt throughout the year or if this is more of more concentrated in Q1, Q2 with an improvement in the back half." ] }, { "name": "David M. Denton", "speech": [ "Yes,t he vast majority of the impact will affect the gross margin line. I would expect our performance to get better later as we're making -- as we said earlier, as we're taking action at the moment . That would bleed into our performance as we cycle through the year. So I think it'll be disproportionately affecting Q2 versus Q3 and Q4." ] }, { "name": "Zachary Fadem", "speech": [ "So you expect gross margin -- I'm sorry, EBIT margins to be positive in the back half of the year?" ] }, { "name": "David M. Denton", "speech": [ "Yes, we don't really guide to that level of specificity." ] }, { "name": "Zachary Fadem", "speech": [ "Got it. Appreciate the time guys." ] }, { "name": "David M. Denton", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Christopher Horvers with JPMorgan." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, good morning. Can you talk a little bit about your business outside the seasonal? Obviously, you did a lot of work to (inaudible) inventory, improve processes and drive in stocks. Can you talk about the improvement in the rest of the business, particularly as we look into the back half of the year and the seasonal really fades, how are you thinking about the improvement that you're seeing in the back half? And then more broadly, tough compare here in 2Q, easier compare in the back half, how are you thinking about cadence, especially in light of your comments that you should be able to accelerate demand because you didn't capture price and elasticity?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Hey, Chris. I'll take the first part of this and I will let Joe McFarland talk a little bit about Pro because as we look at Q2 when you separate the business from seasonal, we think the key to really driving the sales in Q1 was in the Pro customer. We mentioned that Pro significantly outperformed DIY for the quarter and the thing that the pro customer does for us, it drive sales force space productivity cost of Pro shops the entire stores. So when Bill talked about the problem MST improvements and in stock, that impacts the Pro across the entire store. But I think the Pro is really the key for us, was the key in Q1 will be the key for the balance of the year. And I'll let Joe just talk about some of the successes we saw and some of the things that we have planned moving forward." ] }, { "name": "Joseph M. McFarland", "speech": [ "Hi, great thanks, Marvin. So as Marvin mentioned, we very pleased with the acceleration of the Pro business throughout the entire quarter. And as we mentioned, Phase 1 was really the retail fundamentals and we really our arms around the retail fundamentals and Pro. I mentioned in my prepared remarks, supervisor the dedicated staffing, the loaders, the job lot quantities and so to think about that, we continue to see acceleration into Q2 in this pro business and building that we now have a foundation in place that we have ways to explore the Pro done as we accelerate that through the back half of the year with things like Pro loyalty, things that will help us capture a much larger share of the Pros wallet. You'll see that come to life through brands, through advertising and through service in the stores. We remain very, very pleased with the progress." ] }, { "name": "Marvin R. Ellison", "speech": [ "I also think it's important to add that we had positive comps in 10 of 13 merchandizing departments and we saw growth beyond the seasonal categories, in categories like merchandinzing as departments like millwork work, like flooring, some of these areas that we've discussed in the past, that have struggled that we saw positive growth on. So we're pleased, again as I I said in my comments, positive comps in paint, right where we had struggled all year last year and so that trajectory is on the right path. So we're excited about what's going on there." ] }, { "name": "David M. Denton", "speech": [ "We're going to take one more question, please." ] }, { "name": "Operator", "speech": [ "Your final question will come from the line of Brian Nagel with Oppenheimer." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning. Thank you for taking my questions. So I apologize this first one is a bit repetitive, but Marvin, I just want to go back, looking at the release in your comments, you had the 4.2% domestic comp, a nice improvement trajectory through the quarter. You laid out in the prepared comments that would have been markedly higher, had it not been for weather. And then we had the issue on gross margin with the corrective actions you take, am I hearing you correctly, those really are distinct events, meaning that the corrective actions that impacted gross margins did not contribute to the sale showing in the quarter?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Brian, it did not, if anything that hurt sales because our gross margin was negatively impacted, because we had cost increases that were taken in 2018. With no mitigating steps, also gross margin our system visibility was so limited that merchants that took position in 2018, later in the year and in some cases 2019 had no visibility that these costs increases had even been accepted and because of the first-in first-out nature of our inventory, in the layering impact of inventory we just started to recognize the cost until we turned inventory in those items where we had except the cost increase to start to flow through the stores and started to flow through transactions.", "So we had no visibility for it and so it was a discrete kind of issue of cost increases. No steps to offset it. So as we look at it, we have again a pricing architecture of head quartile and if we receive a cost increase and we accept it, what Bill will do, if Bill worked with the finance team, supporting him and Dave will take steps to fund offsetting retail increases in non-price sensitive categories i.e., tail items, those items then offset cost increases that you take, that you cannot affect retail in competitively priced items. We didn't do any of that. So in essence, we took cost increases. We took no action to raise retails and because of that we decremented our gross margin and we decremented our top line sales.", "So it was the worst of both situations. Now we're going back, as I mentioned and Dave had mentioned, we are taking very specific actions to address those issues and we're taking pricing actions. We've been taking those actions for the past weeks. And where we've taken those actions and those products are flowing through the stores and turning, we're seeing our gross margins improve on the items where we've taken pricing action. We're still working through it. And so what we're trying to do is analyze the actions we're taking, making sure that we're not negatively impacting sales and that we're solving the problem we're intend to solve and that's taking time and that's why we want to be prudent and update our guidance based on the analysis that is currently under way." ] }, { "name": "Brian Nagel", "speech": [ "Got, it's helpful. And then just a quick follow up I had. In the monthly comp cadence you gave us, the domestic comp in the month of April was 8%, recognizing it's early here in fiscal Q2, but any commentary how sales attract here into May or into Q2?" ] }, { "name": "Marvin R. Ellison", "speech": [ "What I would say is there as expected, we have some big events including this weekend coming up. We feel like our in-stock position is as good as it's ever been. We feel like our staffing levels are as good as they have ever been and we feel like that our stores are set and we are signed and we are marketing for success, as frustrated as we are by the gross margin performance and the poor decisions made and the limited systems visibility on cost increases, we're correcting that. But we want to be crystal clear that we are aggressively going after sales. And we believe that the success that we had in Q1 will carry over into the balance of the year because it was driven by in-stock improvement, service improvement, improved space productivity and driving the Pro sales, and we think we can maintain that in Q2 and for the balance of the year." ] }, { "name": "Brian Nagel", "speech": [ "Let me if I could just ask one more, it's kind of a big open-ended question, but given the comments here about you identifying this inventory flow issue, is that been surprised by it -- has that allowed you to now look elsewhere for other potential surprises that makes sense to me, this issue popped up, could your team now say well with this issue popped up something else my pop, but we are looking into that?" ] }, { "name": "Marvin R. Ellison", "speech": [ "The short answer is yes. We have taken aggressive steps. Let me rephrase that, more aggressive steps to make sure we analyze, review and do systemic review of every single thing we can imagine. So not to have another unexpected events like we experienced in Q1. And we're going to continue to be laser focused on that. And the good news is we have people around the table with deep experience and deep expertise. The good news is we changed a lot of merchants, which was disruptive. We accept that. We did it on purpose because we wanted to have the right merchant leaders sitting in position through spring of 19 so they could have put our strategy for fall, spring of 2020 and beyond. And we have merchants with deep experience. We got merchants with 30, 40 years of category experience now sitting in these Vice president role and so they are helping us identify additional issues, but they have the skill set to solve them. We now have the technical expertise in-house to get the right systemic solutions. And so, yes, we're doubling our efforts, making sure that we limit the number of surprises that will get us in the future." ] }, { "name": "Brian Nagel", "speech": [ "Thanks for all the color. I appreciate it." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, this will conclude today's call. Thank you all for joining and you may now disconnect." ] } ]
LOW	2019-11-20	[ { "description": "President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President of Merchandising", "name": "William Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joseph McFarland", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "David Denton", "position": "Executive" }, { "description": "JPMorgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Guggenheim Securities -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": "UBS Investment Bank -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Zach Fadem", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning everyone, and welcome to Lowe's Companies' Third Quarter 2019 Earnings Conference Call. This call is being recorded. [Operator Instructions]", "Also, supplemental reference materials are available on Lowe's Investor Relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call.", "During this call, management will be using certain non-GAAP financial measures. The supplemental reference materials include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks and the company can give no assurance that they will prove to be correct. Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission.", "Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President of Stores; and Mr. Dave Denton, Chief Financial Officer.", "I will now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir." ] }, { "name": "Marvin Ellison", "speech": [ "Good morning, everyone. For the quarter, total company comp sales grew 2.2%. Our US home improvement, cost was 3% despite low single digit online growth and higher than expected lumber deflation. We saw consistent growth across the business with all three US divisions in all 15 US geographic regions generating positive comps for the second consecutive quarter. These results reflect our continued progress on our transformation plan. Four of our top five performing geographic regions were in the Western Division, driven by strength in Pro, Appliances, Outdoor Project category, improved-in stocks and customer service. In addition to the West, geographic regions that outperformed the total company comp in the quarter were Nashville, Boston, Tampa, and Houston. Commodity deflation exerted approximately 95 basis points of pressure on comp sales in the quarter, however unit growth in impacted categories strong.", "Let me now take a moment and discuss what drove our success in Q3. Let's start with Pro. Our focus on the Pro continues to be a catalyst for our US sales growth and during the quarter, we continued to receive very positive customer feedback from Pro experiencing first-hand what is new and different at Lowe's and we're pleased with the Pro's willingness to grow their business with us. Our Pro comp significantly outperformed DIY in the third quarter and the Pro customers are responding very positively to our investments in job lot quantities, department supervisors and our improved in-store experience. The result of these investments in Pro not only delivered positive sales growth, they are also reflected in 700 basis point improvement in our Pro customer service scores in the third quarter. Despite this early success, we're focused on the work ahead to better serve this very important customer. And later in the call, Joe detail some of these strategic investments we have plan for the Pro customer in Q4 and in 2020.", "In addition to the Pro our success focusing on retail fundamentals is also evident as we again drove strong sales performance in merchandising departments that have historically under-performed. In total, eight merchandizing departments delivered positive comp performance above the company average and Bill will add additional color on our merchandising performance shortly.", "Turning to Canada. In the third quarter, we posted a negative comp sales, below our expectations, which exerted significant pressure on our total company comp. In the third quarter, we initiated a more detailed strategic review of our Canadian business inclusive of leadership changes with a focus on improving execution and profitability. As such, we plan to take the following steps, beginning in Q4 to improve our long-term results in Canada. We're closing 34 under-performing stores and expect to substantially complete that process in Q4 . Given that Canadian business is operating five banners with multiple legacy systems, we're undertaking a banner simplification process to reduce operational complexity and drive back office synergies. As part of simplifying operations, we plan to rationalize SKUs across the simplified banners to present a more coordinated assortment to our customers. Implementing a simplified banner strategy will allow us to gain efficiencies and marketing, supply chain and merchandising.", "We're also reorganizing our corporate support structure across Canada to more efficiently serve our stores and we plan to migrate Canada to the US IT platform to eliminate inefficiencies and unnecessary technology duplication. We're committed to the Canadian market and we are taking decisive actions to improve Canadian operations and provide a better customer experience while improving profitability through margin improvements and SG&A reduction. Dave will take you through the anticipated financial impacts of these actions in a moment. Despite pressure from lower than expected comparable sales growth in Canada, we delivered adjusted diluted earnings per share of $1.41 for the quarter, which exceeded our expectations, supported by improved merchandise category management, enhanced process execution and expense leverage. Later in the call, Dave will outline the steps we took in the third quarter to continue to improve our profitability.", "During the third quarter, Lowes.com delivered comp growth of approximately 3% and as we noted last quarter our e-commerce business is under repair and we are addressing legacy issues with the platform. Our first step in improving our online business is creating stability. To that end, we are working diligently to improve the foundation of Lowe's.com by replatforming the entire site to Google Cloud from a decade old platform. This work is critical to improve the stability of our ecosystem and increase our agility. We expect to have the entire Lowe's comp side on the cloud in the first half of 2020. With a modernized stable architecture in place, we have the ability to provide our customers with basic online functionality and address legacy e-commerce capability gaps.", "Let me give you four examples of things we're fixing while we're temporary slowing our dot-com growth. First, we're taking steps to separate freight from product cost to improve our price perception versus our competition. Second, we are improving our systems and processes to allow us to quickly add SKUs and drop ship vendors to more rapidly expand our online assortment. These enhancements will reduce on-boarding time from months to days. Third , we're building capabilities to ship certain SKUs requiring special handling, which will allow us to sell basic home improvement items like lithium-ion batteries, cleaning suppliers and fire extinguishers online. Fourth, we will improve the customer experience on our work site including a dynamic homepage, simplified search and navigation, the ability to schedule product delivery and one click checkout. We know how to repair. All of these capability gaps and we have a detailed roadmap combined with an exceptionally talented team with deep omnichannel experience. It will simply take time and proper sequencing. We expect to see our Lowe's.com growth rate start to accelerate in the back half of 2020.", "In the meantime, I am very pleased that we can deliver 3% US comp in the third quarter with virtually no benefit from Lowe's.com. This only speaks to the upside sales benefit we have in upcoming quarters when e-commerce business is repaired. Transforming our supply chain also support acceleration of our growth as we look to build a true omnichannel ecosystem. We're investing $1.7 billion to transform our supply chain over the next five years. Part of this transformation can be reflected in our opening of two new bulk distribution centers and three cross-dock terminals this year. This infrastructure improvement will be key to Lowe's transitioning from a store base home delivery model to a market-based model.", "We believe our future is bright Lowe's and as we entered the fourth quarter, we expect to deliver strong topline performance. We plan to capitalize on robust consumer project demand and excitement for the holiday season with strong holiday event execution while driving margin improvement in operational efficiency.", "Before I close, I'd like to take a moment to thank our sources for their continued hard work and commitment to the company. The best days of my week are going about visiting stores doing this business, I continue to be proud of the men and women that represent our company on a daily basis.", "And with that, I'll turn the call over to Bill." ] }, { "name": "William Boltz", "speech": [ "Thanks, Marvin, and good morning everyone. We posted US comparable sales growth of 3% in the third quarter as we continue to capitalize on robust customer demand, which drove strong traffic to our stores along with improved in-store execution, which helped to convert that traffic into sales. We also had terrific execution over Labor Day, which drove record sales within our best-in-class appliance offering during the event.", "Turning to our merchandising department performance. We delivered above average comps in appliances, the core, hardware, lawn and garden, millwork, paint, rough plumbing and electrical, and tools. Lumber and building materials comps were positive, but below the company average. Paint, which had been a serial under-performer for us outperformed the company average again this quarter. As we continue to refine our paint business, will continue to work closely with our suppliers to introduce an improved propane offering to better serve the repair remodelers who need paint to complete a larger project such as a kitchen or bathroom remodel.", "Previously, our decor department had performed below the company average for 12 of the last 13 quarters. However, in Q3, for the second consecutive quarter, the core performed above the company average with mid-single digit comp growth led by strong double-digit comps in blinds and shades. Millwork is another merchandising department which had historically under-performed. In Q3, for the second consecutive quarter, millwork performed above the company average or improved comp performance in these departments is a clear indication that the implementation of our retail fundamentals is gaining traction.", "For the quarter, we also continue to drive strong comps in areas of historical strength for Lowe's. Tools led the merchandising department growth with a continued strong customer response to our craftsman reset. We are proud to be the exclusive destination in the home center channel for this iconic brand, which continues to drive market share gains within key tool categories. We also continue to drive sales with our key Pro brands such as Dewalt, the number one power tool brand in the industry. And during the quarter, we launched an exclusive line of Dewalt 12 volt compact tools, which focus on delivering more power in a smaller and lighter-weight tool. In addition, we introduced new and innovative products from Bosch, Spider and Metabo HPT as we continue to introduce new and innovative products in our exclusive Kobalt line of tools. In appliances, we delivered solid mid single-digit comps and further increased our market share with record sales during Labor Day and drove high single-digit comps in refrigerators and freezers with great values in special buys. We also posted above average comps in hardware with double-digit growth coming from our fastener categories, supported by investments in job lot quantities and the full rollout of GRK Power-PRO One and Fasten Master, which drove Pro demand.", "Lastly, we again delivered comps above the company average in lawn and garden with double-digit comps in live goods and landscape products, benefiting from an improved in-stock position in the extended growing season. Within our seasonal and outdoor living business, we are excited about the announcement of our national home center launch with YETI, a leader in coolers equipment and drinkware. The YETI brand along with the expanded product offering highlights our commitment to providing our customers with relevant innovative best-in-class products. As part of our ongoing effort to further drive merchandising productivity, we are continuing to implement a category management process and are taking aggressive steps to improve our cross-merchandising efforts and adjacencies in our stores. We are optimizing our store layout to ensure that products typically used together to complete a project are located in the same aisle to make it easier for the customer to efficiently shop their whole project.", "Looking ahead to Q4, we are very excited about our plans for the upcoming holiday season, driven by strong Black Friday and Cyber Monday events along with a compelling tool gift center. We will continue to highlight our best-in-class appliance offerings and showcase strong values and special buys in the most sought-after brands in home improvement products this holiday season with exciting values such as select buy one get one deals across to Dewalt Cobalt, Bosch and CRAFTSMAN and the opportunity to receive a Lowe's gift card when buying two or more select major appliances. We'll showcase great gift ideas across the store including great values for both the DIY and Pro customer.", "We are also excited to be one of the first retailers to introduce the new Weber Smoke Fire Pellet Grill on Lowe's.com as part of the pre-order product launch on Cyber Monday Weber's Pellet Grill is their initial entry into this fast growing category and is built to let grill users discover what's possible with pellet drilling. We are proud to partner with Weber to introduce this exciting new product. This Black Friday, we plan to leverage our NFL partnership turning holiday shopping into a chance to win the experience of a lifetime at Super Bowl 54. As the official home improvement sponsor of the NFL, this year on Black Friday each US Lowe's stores offering its first 300 in store customers the chance to enter to win two tickets to Super Bowl 54 in Miami.", "As we look to close out the year strong, we remain focused on retail fundamentals and driving sales and margin productivity by continuing our focus on the Pro, leveraging the strong customer response to CRAFTSMAN, enhancing our space productivity improvements and expanding our brand message with our exclusive NFL partnership. Overall, we see significant upside from the initiatives that are under way and we are confident that we are building the foundation to provide home improvement solutions that will continue to drive sales and grow our market share.", "Thank you. Now I will turn the call over to Joe." ] }, { "name": "Joseph McFarland", "speech": [ "Thanks, Bill and good morning everyone. Our initiatives to improve in-stock levels and provide a better customer service experience along with our advances in serving the Pro customer contributed to our strong US execution in the quarter. We continue to build upon the actions we've taken throughout the year to further improve associate engagement and simplify our store operations and saw a compounding benefits from our work to date. Earlier this year we deployed new mobile devices for our stores as it's called smart phones. Smartphone empowers our associates by giving them access to real-time data without having to step-up the sales floor to access the terminal. Throughout the year, we've added functionality to the devices such as standard performance scorecards and the store walk application to drive a more efficient strategic store review process. These applications allow our store managers to optimize their store performance by evaluating productivity by department and by associate.", "In the third quarter, we continue to add new applications to our smart devices. During the quarter we added new pricing application that allows associates to update prices in the aisles and standardizes and simplifies the price update process such that any associate in our store can do it. The pricing applications has already driven efficiencies of over 36,000 hours per week for the company. We will complement this pricing application with new mobile printers, which will allow us to print new price labels in the aisle, creating a complete mobile pricing solution. In this test, the mobile printing process has driven an additional two hours of efficiency per store per day, which will equate to efficiency of over 24,000 associate hours per week for the company. We plan to roll-out mobile printing to the company in the first quarter of 2020. Our smart devices are a significant step toward driving operational productivity in our stores and allowing our associates to spend more time with the customer and less time on tasking.", "Near the end of the quarter, we completed the national rollout of our new customer centric scheduling system, which better predicts customer demand by time of day, day of week and department, allowing us to align our labor hours with peak traffic. Our new labor scheduling system allows us to provide better department coverage and customer service while ensuring that we're using our labor hours efficiently and reducing payroll expense. We also expanded our new one task team to over 1,000 stores in the quarter. This initiative shifts task work from our selling associates to one centralized team that is responsible for completing non-selling tasks during evenings and overnight hours. This centralized team will drive more consistent tasking execution, streamline non-customer-facing payroll and allow for improved cross training programs.", "Our investments in store process and technology paid off in the third quarter. This is evidenced by our ability to leverage store payroll expense again this quarter will drive an increase of 500 basis points on our overall customer service scores. We will continue to deliver on our commitment to improve both store efficiency and customer experience and we are very pleased with the results we are seeing so far. In fact, a recent Newsweek survey measuring customer service in home improvement recognized Lowe's as a number one among big box home improvement retailers. This is one more example of the way our customers are recognizing our improved commitment to customer service in our stores.", "Now moving onto our Pro business. As Marvin indicated, we are very pleased with our Pro performance in Q3 and the customers willingness to grow their business with us despite a noticeable increase in competitive promotions. As I've discussed on previous calls this year, our Pro strategy has been focused primarily on improving retail fundamentals for this very important customer. We have demonstrated a consistent focus on winning the Pro by executing on basic fundamentals like job lot quantities, improved service levels, dedicated loaders, Pro department supervisors and consistent volume pricing. Our commitment to retail fundamentals and continued focus drove significant improvement in the Pro customer service scores and Pro comps which significantly outperformed DIY comps.", "Once again this quarter, we invited the customers into CR improved experience was another successful Pro appreciation event. Although we are pleased with Pro performance in Q3, we are now transitioning from retail fundamentals to more strategic initiatives. Our goal is simple. We want to deepen our relationship and continue to grow our sales with this very important customer. And keeping with this more strategic approach this quarter, we launched a pilot for our Pro loyalty program. Our early results have exceeded our expectations in our test markets. We plan to launch our Pro loyalty program nationally in the first half of 2020, integrated with the CRM program, which will allow us to deploy more surgical, strategic marketing to the Pro and grow our share of wallet their improved account management and suggestive selling. I look forward to updating you on our Pro loyalty launch on future calls.", "In the fourth quarter, we plan to improve the in-store Pro experience with the rollout of dedicated point of sale terminals, the Pro Desk to allow for more convenient faster service. Believe it or not, today, most of our stores have no way for Pro to purchase product at our Pro Desk, we will solve this problem in Q4. We're also very excited for our first dedicated Black November Event for the Pro with compelling offers to drive Pro traffic. All of these Pro-related initiatives reinforce the renewed importance of the Pro customer at Lowe's.", "Thank you. And I will now turn the call over to Dave." ] }, { "name": "David Denton", "speech": [ "Thank you, Joe, and good morning everyone. Before I review the underlying operating performance of the business, let me briefly discuss the pre-tax charges taken during the quarter and importantly, our go-forward expectations related to the Canadian business. As Marvin outlined, we are taking decisive actions to set our Canadian business up for both long-term growth and improved profitability. As part of our strategic review, we evaluated certain assets for impairment, which resulted in $53 million of non-cash pre-tax charges in the third quarter. In the fourth quarter, we plan to substantially complete the closing of 34 stores, liquidating the inventory in those locations and rationalizing the inventory in our remaining Canadian locations to support our banner simplification strategy. As a result of these actions, we expect to incur additional pre-tax operating cost and charges of between $175 million to $225 million in Q4 related to the Canadian restructuring. These charges will consist of inventory liquidation, accelerated depreciation and amortization, severance and other costs. These anticipated Q4 financial impacts are reflected in our 2019 GAAP business outlook and are excluded from our 2019 adjusted business outlook.", "I'll now turn to review of our ongoing capital allocation program. In the first nine months of 2019, we generated approximately $3.2 billion in free cash flow. And through a combination of both dividends and share repurchases we've returned over $4.8 billion to our shareholders. In the third quarter alone, we paid $428 million in dividends and our dividend payout ratio currently stands at 36% over the trailing four quarters. In Q3, we entered into a $397 million accelerated share repurchase agreement, retiring approximately 3.6 million shares. We also repurchased an additional 4.1 million shares in the open market for $438 million. This brings our year-to-date share repurchases to $3.6 billion with a plan to repurchase $4 billion for the year. We have approximately $10.3 billion remaining on our current share repurchase authorization and we continue to invest in our core business with a focus on developing capabilities designed to drive long-term shareholder value. In Q3, we had capital expenditures of just over $400 million.", "Now turning to the income statement. During Q3, we generated GAAP diluted earnings per share of $1.36. Now my comments from this point forward will be on a comparable non-GAAP basis where applicable. In Q3, we delivered adjusted diluted earnings per share of $1.41, an increase of 36% compared to adjusted diluted earnings per share of last year. This solid performance exceeded expectations in large part due to improving gross margin trends, strong expense management and a favorable tax rate. Sales for the third quarter decreased 0.2% to $17.4 billion as comparable sales growth was offset by the impact of previous store closures and the exit of Orchard Supply Hardware. Total average ticket grew 3.6% to $78.71. This was partially offset by a 3.7% decline in total transactions. Consolidated comp sales were 2.2%, driven by an average ticket increase of 2.4%, partially offset by a slight comp transaction decrease of 0.1%. In the US, US comp sales growth was 3%, driven by an average ticket increase of 2.7% and a comp transaction increase of 0.2%, Now looking at monthly trends, total comps were 2.8% in August, 2% in September and 2% in October. Additionally, monthly comps for our US business were 3.6% in August, 2.7% in September and 2.7% in October.", "Adjusted gross margin for the third quarter was 32.4% of sales, an increase of 153 basis points from Q3 of last year and 94 basis points better than Q1. The improvement since the first quarter reflect the benefits from the actions we've taken including retail price adjustments that had minimal impact to units, a pivot to more strategic and targeted promotions, greater vendor partnership for key promotional activities and a continued aggressive product cost management. We are very pleased with the progress we made to improve our gross margin performance. The actions we've implemented are gaining traction, but there is additional work to be done in this important area for the balance of this year.", "This quarter we experienced approximately 90 basis points of rate improvement. The positive impact of cycling our inventory rationalization of that from last year was partially offset by 40 basis points of tariff pressure. As expected, we also experienced approximately 20 basis points of pressure from supply chain cost. We've added new facilities to the network that are still ramping to full capacity, coupled with ongoing increases in customer delivery cost. Inventory shrink exerted approximately 20 basis points of negative pressure on gross margin for the quarter. And finally, product mix shifts had a 35 basis points positive impact on gross margin in Q3. Adjusted SG&A for Q3 was 21.4% of sales, which levered 53 basis points. We drove approximately 40 basis points of leverage on payroll in the quarter and approximately 10 basis points of leverage through improved advertising efficiencies.", "Adjusted operating income increased 215 basis points 9.3% of sales. The effective tax rate was 24% compared to 21.8% last year. At $13.7 billion, inventory increased $1.4 billion or 10.9% versus the third quarter of last year, but is down $1.3 billion versus Q1. This increase was driven by strategic investments in the first half of the year to drive sales, such as in earlier seasonal load-in, the CRAFTSMAN resets, increased presentation minimums and investments in job lot quantities for the Pro. Throughout 2020, we will refine our in-stock expectations and begin to strategically reduce inventories in certain areas while protecting our in-stock position, sales, and gross margin.", "Now before I close, let me address our 2019 business outlook. As we've stated previously and as our analysis supports, the underlying macroeconomic fundamentals in the US remain supportive as the solid pace of job growth, accelerating wage increases and home price appreciation continues to be tailwinds for our industry. We are maintaining our sales guidance for 2019 and expect a total sales increase of approximately 2% for the year. Comp sales are expected to increase approximately 3%. Given our strong financial performance in Q3 and our solid outlook for the remainder of this year, we are raising our 2019 adjusted operating margin and adjusted EPS guidance. We now expect adjusted diluted earnings per share of $5.63 to $5.70 per share and we expect adjusted operating margin to increase 40 basis points to 60 basis points versus last year. This revised outlook includes approximately $20 million to $30 million of incremental investments in our existing store environment. This $0.02 to $0.03 EPS investment will allow us to accelerate key reset projects during the fourth quarter to improve sales and space productivity over the long-term without disrupting the stores during the critical spring season.", "Our business outlook also includes the impact of both waive 3 and waive 4 tariffs. The effective tax rate and adjusted effective tax rates are still expected to be approximately 24% and we are forecasting operating cash flows of approximately $4.5 billion and capital expenditures of approximately $1.6 billion. This is expected to result in free cash flow of approximately $3 billion for 2019. Our target leverage ratio remains at 2.75 times and our guidance assumes that we will complete approximately $4 billion in share repurchases for this year.", "In closing, we remain excited about the future of the company and its ability to deliver significant shareholder value over the long-term.", "Operator, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We are now ready for questions. [Operator Instructions] Our first question comes from the line of Christopher Horvers with JPMorgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, good morning guys. Can you talk about the gross margin. Obviously, some nice rate upside there. How much did the pricing pressures that you saw earlier in the year impact third quarter gross margin. It doesn't seem like it did besides the tariffs and then how you're thinking about 4Q for gross margin, I think previously you said flat. And I think the big question that we get from investors is at longer term, how do you think about getting back to that high 32%, maybe 33% rate, especially as you lap through the pricing pressures in '20?" ] }, { "name": "Marvin Ellison", "speech": [ "Hey Chris, this is Marvin. I'll take the first part and I'll let Dave and Bill add any additional color to your additional questions. Look, we feel really good about margin improvement. We talked a lot about the issues that impacted Q1 and we went through a lot of detail after Q1, providing the steps we were taking to kind of recover margin and just to create better visibility and better processes. That's been a cross-functional effort and we actually are pleased with the results, but there is a lot more work to do. One of the key things that we're going to be launching before end of this year is a new price management system. This will be for the very first time at Lowe's to have a consolidated depository of one view of all things cost retail pricing and the impact of those changes and that's going to be something we are going to put in place later this year. So we feel good about the trajectory, but I'll just remind you, as we think about out years and we think about operating income, our real focus is going to be around trying to keep margin relatively flat and creating SG&A benefit in the future and that's going to be the driver of our operating income growth in out years.", "I'll let Dave you provide more color to that and build any additional insight as well." ] }, { "name": "David Denton", "speech": [ "Yeah. I think as Marvin indicated, obviously this has been a team sport here of working between cross functionally between finance and merchandising, making sure that one, we understand the cost complement of the products that we're buying; two, that we're analyzing those effectively and kind of put -- and I will say, working with our vendors to maximize the performance from either value engineering perspectives or from a cost complement perspective to drive our costs lower over-time. Collectively, we've also been partnering with our vendors very aggressively to make sure that we develop win-win scenarios that both drive the topline, but also improve our margin performance in the near term. And then finally, I think one thing that's really come to life within the store that need some very significant enhancements from a technology perspective at point of sale was it allowed us to be more effective in the promotions that we offer at point of sale, thus improving our margin rate on those items." ] }, { "name": "William Boltz", "speech": [ "And I think Dave, the only thing I would add to that is that in addition to that I mentioned in my opening remarks around merchandising adjacencies and putting products together, the cross-merchandising program that Joe and I rolled out at the latter part of Q3 is now up and running in all of our stores and that certainly helps in addition to the promotional planning process that we put in place starting with Q2 that really puts more focused offers out there in front of the customer and less of these category wide-type offers that we've had run historically." ] }, { "name": "Christopher Horvers", "speech": [ "And so then as a follow-up, do you still expect I think gross margin rate flattish to the 31.5% last year and then can you also talk about on the e-commerce front, is that a transaction growth headwind because transactions did were up in the US, but it was sort of an easy compare, so any thoughts there as well. Thanks very much." ] }, { "name": "Marvin Ellison", "speech": [ "Yes. On the dot-com question Chris, the short answer is yes. It did have a negative impact of overall transactions. We were very transparent last quarter that we have this business under repair. The good news is we have a very talented, very experienced team that solve these problems before. It just takes time and sequencing, but in the short run, it did put some pressure on our transactions. We feel really good about our performance in our US stores. And as I've noted in my prepared comments, I mean we grow with the 3% US comp with no benefit from dot-com. If you just take a 15% to 20% dot-com growth for us, that puts that comp number north of 4% in the US. So we noted that benefit is coming in the future. But in the short run, we're going to kind of muscle through it, but we have a really good road-map and a good plan in place and we think we will be able to get this business growing again in the second half of next year.", "I will let David talk about the margin rate." ] }, { "name": "David Denton", "speech": [ "Yeah. And Chris, obviously, our objective is recover from our gross margin downdraft in Q1, I think we're making really nice progress against that. It is not our expectation that we fully recover that here in 2019. But our expectation over the longer term is to recover that downdraft that we experienced in Q1 and get back to a more stable environment in the long term." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. Have a great holiday." ] }, { "name": "David Denton", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning everyone. So you're modeling sequential improvement in the comps in the fourth quarter. Can you discuss the puts and the takes into that forecast. And then related, the EPS, it's a little bit below -- the implied is a little below the street. Can you clarify, is that the incremental store investment and how does it compare to some of the underlying results of the business for the fourth quarter?" ] }, { "name": "Marvin Ellison", "speech": [ "So Simeon, this is Marvin. I'll take the question regarding Q4. So as we've said, I mean we feel really good about the overall business trends in the US. We feel great about our internal execution. Dave talked about the macro backdrop is solid. We look at discretionary purchases things like average ticket above $500 was over 4% growth was in the quarter. Consumer project demand is strong and there is excitement rolls to the holiday season. So what I'm going to do is let Bill just provide a couple of key highlights on the merchandising side that gives us confidence in Q4. I'll let Joe also cover a couple of things in the store that also provides us with a degree of confidence that we're going to achieve our targeted sales growth. Bill?" ] }, { "name": "William Boltz", "speech": [ "Yeah, I think the piece for us for Q4 is that the team is now have full year to plan for Q4. So we've demonstrated throughout the entire year categories that have changed the trajectory from where they were a year ago, being able to plan for perimetry and to be able to plan for the gift center and to be able to plan for these Pro deals that we put out there for Black November are all different from what we did a year ago and we're seeing that pay-off as it relates to change in direction in some of these key Pro-related businesses as well as DIY." ] }, { "name": "Joseph McFarland", "speech": [ "Right. And then from a store standpoint, we're really excited about what's happening with inside of our Pro business. We continue into Q4, now we're excited about the Pro loyalty launch we have tailing. We're excited that as we continue to invite our Pro customers in, we're enjoying more share of their wallet, improved store execution, store layout. I think we feel really confident what we're doing for Q4." ] }, { "name": "David Denton", "speech": [ "Yeah. And then Simeon just from a guide perspective, let me just touch that back and just walking what we've done. We've essentially taken the bottom of the range up $0.13 to the midpoint, up $0.07 from a year perspective. Keep in mind that that includes $0.02 to $0.03 that we're investing in Q4 to improve our performance from a long-term perspective. I think this is a really constructive investment that we're making that we identified late in the quarter that were incremental investing in our store environment both for the long-term, but the same time managing the near-term financial objectives that we have as a company." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. My follow-up is for Marvin. You've been in the seat now for over a year, some ups some downs. It seems like the skeletons should be out of the closet by now. You still have a few things, executing in stores, labor scheduling. It sounds like there is no Pro systems. So is that a fair statement and does anything in your mind change about the potential margin upside. How do you think about it in the pace of margin over the next few years?" ] }, { "name": "Marvin Ellison", "speech": [ "No. Look, I think when I look back at our initial assessment of the business, I would say the only thing that we probably underestimated the level of complexity was the e-commerce business. When we did our Analyst and Investor Conference last December, we did not have our new online President on board. So although we've spent a lot of time dissecting the business across multiple channels, the e-commerce business was still a little bit of a mystery for us and that mystery unveiled itself during the holiday season when we had all the issues and we've been digging ever since then. So here they has been ups and downs, but we were very clear to digital transformation. I mean we didn't make any bones about the fact that this is a company that had great potential, but it had been under investment in supply chain, IT and also leadership development. So if I had to take a snapshot of how I feel about where we are, I think we are right on track, where we hope to be and that is taken into account, there have been a lot of uncertainties in the marketplace like tariffs as one that we did not anticipate that we've been managing as best we can. Overall, I feel great. I think that we have identified most of the quote unquote surprises because we spent a lot of time really digging deep into the areas of the business that carried most financial risk and the most financial benefit and we feel like we've got a really good plan heading to the fourth quarter in 2020." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi, thanks very much. I was actually wondering if you could give a little bit more color on how the dot-com business impacted the US comp. And then I guess looking at 4Q, wondering if you could give a little color on how the total comp will be impacted by Canada because obviously these closed stores will be less. You won't have that headwind on the US comp versus the total comp. So any color on both those would be great." ] }, { "name": "Marvin Ellison", "speech": [ "So look, I'll take care and I will take the dot-com question. I'll let Dave take Canada. So if you think about the impact of dot-com to our business, it was basically a neutral impact. We grew dot-com by 3%. For the quarter, we grew US sales by 3%. So there was really no benefit. I would argue that there is not a brick and mortar retail in the US that is our size that had such limited growth in the dot-com business. Most US retailers that announce their comp growth for the quarter typically will have a dot-com number that starts with a 20% growth, which is typical in this day and age. We're not there yet, but we know how to get there and we're trying to take the right steps to fix the root cause of the issue. It's not difficult to grow dot-com sales. It's difficult to do it correctly, meeting and make money. And so rather than having a bunch of non-productive promotions and other coupon event, we shut that down and we basically said how do we structure this business in the right way. We have a really good road-map in place. I want to be really transparent in my prepared comments just to highlight some of the fundamental things we currently don't have in place that we will have in place in the second half of next year. But obviously that's a glass half full. Again, our store productivity is strong. Anytime you can deliver 3% comp of the total benefit of your brick and mortar stores in this day and age is a very positive sign, but getting our dot-com in our omnichannel business going as a huge priority and we think we can get that going as we enter into 2020.", "Now let Dave talk about Canada." ] }, { "name": "David Denton", "speech": [ "Yeah. Karen, as it relates to stores that will be closed in Canada, I think it will be considered non-comps, so that it will not affect the comp cadence for Q4 for the company. And then I also just want to clarify, if you look at Q3, the $53 million non-cash charge that we took is exclusively within SG&A within our GAAP numbers." ] }, { "name": "Karen Short", "speech": [ "Okay. And then just a follow-up in terms of other initiatives as we look to 2020, obviously you talked about the price management system in 4Q, but can you give us an update on some other big initiatives that we should be watching for in early 2020. I think the POS upgrade is still going to be happening, but just so that we can track anything that may, we may need to be on the outlook for if there are any risks on execution." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. So let me -- I'll talk about one, and I'll let Joe give you some thoughts on some really exciting initiatives in Pro and I know Bill has a couple of really nice merchandising initiative we're excited about. But when we think about our supply chain transformation, I mentioned in my comments that we have a $1.7 billion investment over five years we're committing to supply chain. And that is to totally transform our supply chain from a distribution network design to get product from suppliers to stores, from supplier of distribution centers, etc to be a more of an omnichannel center, that's going to allow us to go from store base, deliver to market based delivery. We are opening two new bulk distribution centers this year in three cross-dock terminals, which is one of the foundational steps to helping us to build out the supply chain transformation. This will be significant for us because it's going to take enormous pressure off the stores from being the hub for all things delivery. Results are going to give us the ability to deliver to customers homes and Pro's job sites with the same efficiency that we deliver to our store. That is something that we are going to be constantly rolling out throughout the year and we're excited about that.", "And relative to the price management system, we will get that system in place by the end of this year, but in next year in the first half, we're going to integrate in that system the boomerang retail analytics will be combined with their price management system. That's going to give us for the first time machine learning and AI kind of functionality around pricing and around scraping, so that we can be a lot more dynamic. All the other initiatives are mentioned is that in the first half of next year we should be fully on Google Cloud with our e-commerce platform and again we're moving from a decade old platform to cloud which is something that is going to give us much more joy and I'll let Joe and Bill add any additional color." ] }, { "name": "Joseph McFarland", "speech": [ "Great. So we've talked a lot in the past about our Pro focus and really throughout all of 2019, we've really focused on the retail fundamentals, which we talked about. Things like for staffing, things like dedicate loaders and job lot quantities, etc and so we feel in 2019, we have largely mid-grade impact there as we move forward into next year and we're really excited, number one for the Pro loyalty test that we launched in three markets in the third quarter, the Pros reaction to the Pro loyalty has really exceeded all expectations we've had for and we continued to listen to the Pros, we have continued to make adjustments. It's why we're in test mode. We're excited that will fully rollout Pro loyalty nationwide in the first half of 2020. In addition, things like tool rental. We feel really good about testing the waters there. In the Pro business, that Pro continues to give us more share of their wallet and so really exciting prospects. I will let Bill talk about some on the merchandising." ] }, { "name": "William Boltz", "speech": [ "Yeah. And just to close on the merchandising side, in addition to the cross-merchandizing work that we are wrapping up and we wrapped up in Q3, we will finish up at the end of Q4 in January, February and the [Indecipherable] signage rollout in our stores, which allows the customer to navigate our stores easier. We'll also finish the refresh work that we started early last year, which will allow us to bring product categories and departments together to make it easier for the customer shop and to give us the kind of holding power on our end caps and in our departments that we need bringing product categories together. So really excited about all the work that the merchants have done to make our stores easier to shop." ] }, { "name": "Karen Short", "speech": [ "Great, thanks very much." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Steve Forbes with Guggenheim Securities. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. I wanted to focus on payroll leverage, right given the commentary around the completion of the labor scheduling system rollout. So maybe just remind us, I guess how that phased in throughout the year, right. I mean regions were alive I guess, in the first half relative to the end of the third quarter and then maybe discuss the expectations regarding payroll leverage in the fourth quarter and into 2020, right, because I think it would seem to appear right there sort of a chance where potential right for payroll leverage to at least remain at the current run rate as we look at the 2020. So would just like to get your sort of thoughts and updates on that." ] }, { "name": "Marvin Ellison", "speech": [ "So Steve. This is Marvin. I'll kick it off, and I'll let Joe provide some additional insight. I think as you look at the out years, it's just a very basic philosophy and what we're trying to do is we're trying to shift payroll from tax to service in the stores. Our first analysis when Joe arrived and start to look at the business is that we had a vast majority of our payroll in the store was doing something other than serving customers or driving sales and so Joe's team build out a three-year kind of project plan to ship that to be a more service-oriented store environment, where you do the technology and so what you can see in the out years is the investment in technology of reduction in total hours in addition of selling hours. And that's one of the reasons why Joe gave us really interesting statistic that in third quarter, we leverage payroll but we improved service across all categories. Pro, do serve customers in all types of surveys internal and external and that gives us really good comfortable filling that the technology implementation of working and that we're putting a payroll in the right location. So that's the out-year.", "I'll let Joe kind of talk about what we've done so far this year." ] }, { "name": "Joseph McFarland", "speech": [ "Yeah. So to give you a quick snapshot just for the third quarter. And I mentioned some things in my prepared remarks as Marvin said, when we first arrived and evaluated the percent of payroll being spent on service versus staff, it was completely inverted. So we've assembled a terrific team in our store operations group, we're ahead of schedule as far as moving the needle to more be balance of customer-facing versus tasking. And so just in the third quarter alone, we talked about the new scheduling systems. To remind you, the first quarter of this year we rolled out to one region, the customer centric schedules to make sure we listen to the associates, validated the customers and make sure that changes we are making were beneficial. In the second quarter, we launched that to three additional regions across our Northern Division, more seasonal and we want to kind of pressure test our spring and our hiring and so in the third quarter we have successfully rolled this out to every region, 100% of the stores in the US are customer centric scheduling as in the first day of the fourth quarter. In addition, in the third quarter, we took action on things like our one task team, we expanded the one task team centralizing task, just over 1,000 stores. In addition, we took action on things like our in-store assembler moving to third-party outsourcing our janitor, our new pricing apps. So there is a longer list of initiatives that we continue to execute against. And at the end of the day, making sure that we're doing the things that the customers expect and noticed and the associates appreciate it." ] }, { "name": "Steven Forbes", "speech": [ "Thank you. Maybe just a quick follow-up for Dave for modeling purposes here. If you can provide a lot more detail around the break-down of that $175 million to $225 million of cost into the various buckets. I don't know if you can split it between gross margin and SG&A at least over the three buckets that you mentioned?" ] }, { "name": "David Denton", "speech": [ "Yeah. Listen, I will come back at the end of the year and into the quarter and give a detailed reconciliation there, so you'll be able to have that from a modeling perspective. Keep in mind that all of this was non-GAAP. But I would look at this as certainly within Q4, I would say over 50% of those costs are due to inventory liquidation and therefore they would hit within the gross margin level versus the remainder kind of at the SG&A level, it's probably the best way to think about it." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "You are welcome." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Hey guys, good morning. I wanted to follow up on the cadence of the quarter and whether there are any seasonal elements to call out, obviously over-lapping hurricanes. I don't know if the extended season was a good guy and offset that. I also think there was a shift in the start of Black Friday. So anything you would call out there and in general, how you feel about exiting the quarter?" ] }, { "name": "David Denton", "speech": [ "Yeah. This is Dave here. Listen, we are still very solid about our plans for Q4 from a sales perspective, but there was a little bit of I guess weather benefit as we cycled into Q3, probably in the neighborhood of 50 basis points. We also did run Black Friday week one week earlier, so I had a very nominal probably 10 basis point impact on us. So as you cycle into Q4, that would give you some confidence as we cycle into Q4, the sales improvement from a comparison perspective looks pretty good." ] }, { "name": "Seth Sigman", "speech": [ "Okay, thanks for that. And then just in terms of the restructuring in Canada, could you just help us better understand what wasn't working there and then if there's a way to quantify the drag that Canada has had on margins this year or over the course of a 12-month period just so we could sort of understand the opportunity into next year. I think that would be helpful. Thanks." ] }, { "name": "David Denton", "speech": [ "Well, maybe I'll start. As you can well imagine, just given the performance that we've articulated over the first three quarters of this year, the Canadian business from a topline perspective struggled. It's fair to also understand in model that it is performing from an operating profit perspective below the company average. So it certainly is dragging us down and certainly dragging us down more if you were to include the charges, so even without the charges the performances are lower than the company average. With that, I'll turn to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. So look Seth, the only thing I'll add is we have great associates in Canada. We just gave them a very complex business model that inhibited their ability to serve customers while operating five banners all with legacy systems, all with different back-end systems and our initial integration process was overly complex. It made it very difficult to create synergies for marketing, merchandising sourcing perspective and even in IT systems infrastructure. So part of what we're doing here in addition to closing under-performing stores is ensure that we are just simplifying the business model, so we can give the customers a great experience and give ourselves as a more simplified operational process to manage and we think the decisions that we announced today is going to put us in a really good position to do just that. So we look forward to coming back in our February call to provide some degree of color around 2020 in our expectation in Canada and how we think these restructuring actions that we announced today is going to really put us in a position for long-term growth." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Thanks guys. Appreciate it." ] }, { "name": "William Boltz", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Greg Melich with Evercore ISI. Please proceed with your question." ] }, { "name": "Greg Melich", "speech": [ "Hi, Thanks guys. two questions. One, I just wanted to follow-up on the progress on gross margin I understand it improved sequentially from the first quarter but Dave, I want to make sure I get the numbers right. If last year the rebaseline gross margin was 32.9% and this year were sort of down 40 bps or 50 bps on a like-for-like once you add back last year's inventory charge, are we thinking about that right?" ] }, { "name": "David Denton", "speech": [ "Yeah. So maybe I'll give you just kind of a few numbers to help you model this out. If you look at our gross margin performance, we had improvements with about 150 somewhat basis points, we're overlapping the clearance events from last year, which gives kind of a tailwind if you will of about 170 basis points. We didn't have pressure from both tariffs at 40 basis point supply chain at 20 and shrink it 20. So if you think about it, we have a 90 basis point improvement just in gross margin rate, then you add on top of that improvements from a product mix perspective." ] }, { "name": "Greg Melich", "speech": [ "Got it, that's super helpful. And then maybe just a follow-up on Canada a bit. If you think about the charges in total, the $250 million. What do you guys expect the payback for that to be? Do we get that back in terms of profit in the next 12 months as it take three years, how quick do these changes really take effect on the business?" ] }, { "name": "David Denton", "speech": [ "Well, obviously these changes are going to take effect pretty quickly. But the way we've modeled this is clearly over a multiple year period of which we looked at the cash flows of the business and the net present value of that. So obviously this is a tough decision to make, but it's the right decision to make economically and we look at that over a multiyear period." ] }, { "name": "Greg Melich", "speech": [ "And last and just transition to the business a bit. I want to make sure I got the guidance rate on the comp. Understanding that the Canadian stores come out of the comp, if I use the full year guide where it is, the fourth quarter comp should accelerate to about 4% or 3.5% or 4% to make up or am I missing something there or that's a sort of trend that you're seeing so far into November?" ] }, { "name": "David Denton", "speech": [ "No, your math is correct." ] }, { "name": "Greg Melich", "speech": [ "And are we in November running at that kind of rate?" ] }, { "name": "David Denton", "speech": [ "Listen, we're about approach one of our biggest weeks in the year quite frankly as we enter into Black Friday. It was probably a little too early to comment on the quarter. I will say that we feel very strong about the programs we have in place and the things that we're executing at store level to drive our performance." ] }, { "name": "Greg Melich", "speech": [ "That's great. Good luck guys and happy holidays." ] }, { "name": "David Denton", "speech": [ "Thank you. Same to you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. So if we triangulate your progress in a couple of ways, one, looking at the US only stacks on a two, three, four-year basis, they did decelerate from the second quarter, the third quarter. And if we look at the spread in your US only business compared to your biggest competitor, it did reverse this quarter, recognizing that a big piece of that is the performance of the respective dot-com businesses. Why do you think on those measures the business did take a bit of a step back this quarter versus last quarter?" ] }, { "name": "Marvin Ellison", "speech": [ "Michael. It's a fair question. Answer is that we feel really good about our US business and to be quite honest we don't spend a ton of time thinking about our performance versus our competitor versus our performance versus our internal expectations and relative to our expectations, we were where we thought we should be, based on business investments, based over year-over-year overlaps, I mean remember Q3 plus last year was a really, really interesting quarter. We took a lot of actions around store closures, inventory liquidations and so the the year-over-year compares are really tricky and so we appropriately plan the business for Q3 at a certain level and in the US we feel really good about exactly where we landed and as we mentioned, we actually exceeded our expectations relative to operating income. So we feel good about the business. We feel good about our trends and we have a repair plan to fix dot-com. We're not trying to rush a quick fix, we're going to fix it foundationally and we think that's going to give us long-term growth potential and we feel good about the steps we've taken in the year strong as well." ] }, { "name": "Michael Lasser", "speech": [ "And my follow-up Marvin is, in the prepared remarks there was a comment the customers will -- the Pro customers willingness to grow their business with us despite a noticeable increase in competitive promotions. So can you provide more detail on that? Who and where are you seeing those higher promotions from and is there a case where as Lowe's becomes more successful and as Lowe's become -- makes more progress. The overall environment is going to become more promotional, more competitive because of that success?" ] }, { "name": "Marvin Ellison", "speech": [ "Look, I think we are very well prepared for more competitive marketplace. The comments were specifically driven based on one of our large competitors getting really aggressive, discounting large projects going through a bid room process. This is invisible to the general public, but the large customers would purchase over certain volume threshold. You can submit that for digital discount from a commodity pricing perspective and there was more discounting in that area over a consistent period of time than I've seen in my 14 years in this business. It is neither here nor there. We just continue to compete and we wanted to run our strategy, which is something that we're going to continue to do. But we want to highlight that that competitive cadence dramatically change in Q3 and we're going to be prepared to see what happens in Q4." ] }, { "name": "William Boltz", "speech": [ "We are going to take one more question, please." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey, thanks for fitting me in. Could you talk about your Black Friday and Cyber Monday offering, specifically online and just given the replatforming on the site, should we expect a temporary acceleration in dot-com sales for the seasonal uptick in demand around the holiday or do you expect similar growth versus Q3?" ] }, { "name": "Marvin Ellison", "speech": [ "So look, I'll give you some comments on dot-com. I'll let Bill just give you some of the really exciting deals we have. For dot-com, we had a pretty underwhelming performance last holiday season and so we are expecting to have better performance within that holiday period, but the holiday period does not define the entire quarters. We don't have an expectation that we're going to see dramatic dot-com growth in Q4 relative to what we've seen in the last two quarters. However, we do expect to have more stability and better performance during the Black Friday period. The only caveat to that is we gave a lot of product away online last year. We're not going to give it away this year. We had a lot of segway promotions that didn't make any sense, didn't provide any value to the customers, it gave a lot of value to the customers, now value for the shareholders into the company from a profit perspective. So we're going to be appropriately aggressive online and we're going to be aggressive them with the standpoint of running. It will be good business model, but we're not expecting robust dot-com growth in Q4, no different than what we've seen in the last couple of quarters.", "I'll let Bill highlight some of the exciting things we're going to be selling in the stores." ] }, { "name": "William Boltz", "speech": [ "Yeah. So super excited about what's going on for Black Friday. But as you know, it starts with really Black November, so we're able to do a number of deals and special values out there for the Pro. It ran for Black November, we kicked off the appliance event for Black November and then with the team having roughly a year to be able to plan this year's Black Friday, we've got to some super-door busters for Black Friday day with as I said in my prepared remarks, a chance for lucky customers to win trip to the Super Bowl and so we've got just a lot excitement that's going to drive folks to the Lowe's store on Friday, so we're excited about it." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And then on the repair and remodel overall environment. Curious to hear your thoughts on the latest round of data points, particularly with existing home sales improving and curious how you think about just overall category demand and whether you have any expectation of improvement as we enter 2020?" ] }, { "name": "Marvin Ellison", "speech": [ "So look, we feel great about the macro. All of the macro indicators that are important for our business have fallen in the right direction. Consumer confidence, unemployment is low, home price continue to appreciate, wages continue to strengthen and interest rates continue to be low to moderate. So we feel really positive about all the macro indicators. There's nothing on the horizon that gives us any pause and so that goes to our confidence going into Q4 and we hope that when we provide our guidance for 2020, we will have the same confidence looking in that time period as well." ] }, { "name": "Zach Fadem", "speech": [ "Thanks, Marvin, I appreciate the time ." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. We have reached the end of our question-and-answer session. [Operator Closing Remarks]" ] } ]
LOW	2018-08-22	[ { "description": "President, and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Chief Customer Officer", "name": "Michael McDermott", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Marshall Croom", "position": "Executive" }, { "description": " -- J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": " -- Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": " -- UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": " -- Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": " -- Wells Fargo -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": " -- Guggenheim Securities -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": " -- Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies second quarter 2018 earnings conference call. This call is being recorded. Please note, if you pressed 1 to enter the question queue prior to the start of today's call, your signal did not register. You will need to press 1 again to enter the queue.", "Also, supplemental reference slides are available on Lowe's investor relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call. During this call, management will be using certain non-GAAP financial measures.", "The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.", "Management's expectations and opinions reflected in those statements are subject to risks and the company can give no assurance that they will prove to be correct. Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission.", "Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer, Mr. Mike McDermott, Chief Customer Officer, and Mr. Marshall Croom, Chief Financial Officer. I will now turn the call over to Mr. Ellison for opening remarks. Please go ahead, sir." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Regina, and good morning, everyone. It's an honor to be here today as the President and CEO of Lowe's. Before I get started, I'd like to take a moment and acknowledge the many contributions of Robert Niblock during his 25 years of service, including 13 years as Chairman and CEO.", "Running a large public company is never easy, and Robert led Lowe's through some impressive periods of growth, doubling the size of the company and navigating through an important era of transformation in retail. I'd like to personally thank Robert for his service and his commitment to the hundreds of thousands of men and women who work for this great company.", "Now, let's turn to our second quarter results. We capitalized on a delayed spring demand to drive strong growth in seasonal businesses and achieve comp sales above the company average in lumber and building materials, appliances, rough plumbing and electrical, and delivering a comparable sales growth of 5.2% overall.", "Our US home improvement comp was 5.3%, with positive comps in all 14 geographic regions and 8 of our 11 product categories. We drove an 18 comp growth at Lowes.com. Diluted earnings per share were $1.86 and adjusted diluted earnings per share were $2.07, an increase of 31.8% from the same period a year ago.", "Taking a step back, our second quarter results represent three broad themes. Theme number one, resilience -- despite significant organizational changes during the quarter, the associates and the leaders of this company remain focused and resilient. I'd like to personally thank the more than 310,000 associates for their hard work and commitment.", "Theme number two, great marketplace -- after spending almost four years in the apparel sector, it's obvious to me that the home improvement marketplace is among the most robust in retail. We anticipate continued growth in the home improvement sector, where there is a strong demand for our products and services from a diverse group of customers motivated to invest in their homes.", "The final theme is we have work to do. Despite delivering a 5.2% comp and $2.07 adjusted EPS for the second quarter, we have a lot of opportunity as a company, specifically, we're significantly behind in our supply chain strategy, our in-store technology is dated, overall execution is impaired by complexity, we have a large number of out of stocks in our stores that must be addressed, and we need to increase the rigor with which we evaluate capital investments.", "Although it's never good to be behind, our current position presents significant upside potential for Lowe's and for Lowe's shareholders. So, the question is how do you realize this potential? Over the past 12 weeks, we've hired some of the best leaders in retail to help us address these shortcomings and I'm excited to see how great we can be as a company when we have these retail fundamentals corrected.", "Although I've only been in the position for seven weeks, my opinions on the current state of the business have been formed by the following. First off, detailed business reviews with all of our functional leaders. I've spent time with suppliers. I've engaged our customers around the country and conducted numerous town halls of our associates and visited stores in all 14 US regions.", "My aggressive travel schedule has given me the opportunity to learn from those closest to the customer. In fact, my greatest learning thus far is just how outstanding our associates are. Our frontline teams find ways to serve our customers despite some of the competitive disadvantages we've created for ourselves. Without question, our associates are our greatest asset and we must give them better tools to compete.", "Simply stated, at Lowe's, we desire to be a great omnichannel retailer. While we have the foundational elements of an omnichannel network, we need to better connect and align our systems and processes to create a truly integrated ecosystem. But fortunately, I've been down this road before and I have a clear understanding of the steps and processes required to build a world-class omnichannel environment.", "In addition, to drive value for our customers and shareholders, we must simplify the business to produce better results and more consistent results. The company has unfortunately become distracted over the past few years and specifically, we chased initiatives that did not add value and were not core to our retail business. Spending time on these non-core initiatives shifted capital, people, and attention away from being an operationally sound home improvement retailer. These distractions also created a complex environment for our frontline associates.", "We recently steps to simplify organizational structure and my experience has taught me that a simplified organizational structure is the first step to create operational excellence and allow for faster decision making.", "We also made several important leadership appointments. I'm pleased to welcome Bill Boltz as our Executive Vice President of Merchandising, Joe McFarland as our Executive Vice President of Stores, Don Frieson as our Executive Vice President of Supply Chain. Earlier today, we announced the addition of David Denton to the team as our new Chief Financial Officer. David currently serves as the EVP and CFO of CVS Health, where he's held that position for over eight years. We're very excited to welcome David to the Lowe's team.", "All of our new executive vice presidents have a strong retail pedigree and proven track records of success. Combined, Bill and Joe bring over 50 years of home improvement experience and Don and David will bring a deep technical knowledge from their related fields of supply chain and finance. All four leaders will be instrumental in helping us to establish the necessary building blocks to create a world class omnichannel environment. When you combine proven leadership with disciplined capital allocation, great things can happen.", "We're also working aggressively to fill our open Chief Information Officer position and expect to have a leader name in short order. In addition to implementing a new leadership structure, simplifying the business also means that we will shift our focus away from less effective projects. As we announced this morning, we announced a strategic reassessment of the business, which has already led us to make a series of decisive moves to refocus our financial and intellectual capital in running a great retail business.", "First, we decided to exit our Orchard Supply Hardware operations to allow us to focus on our core home improvement business. We expect to close all 99 stores, which are located in California, Oregon, and Florida, as well as one distribution facility by the end of Fiscal 2018. To ensure an orderly wind down process, we plan to conduct store closing sales and have partnered with Hilco Merchant Services to help manage the process to ensure a seamless experience for our customers. Closing stores is always difficult and we'll take all possible steps to find positions for our displaced associates in nearby Lowe's stores.", "Second, we are eliminating approximately $500 million in planned capital projects for 2018. Specifically, we are eliminating projects that were not focused on improving our core business, did not deliver productivity for our associates, and did not meet our hurdle rate. Instead, we will reallocate that $500 million to our share repurchase program. We believe this will deliver more value to our shareholders.", "Third, I've charged a new leadership team to develop an aggressive plan to rationalize our store inventory to remove clutter and reduce lower-performing inventory. This will enable us to invest in improved job-lot quantities for Pro and increase our depth of inventory in our top 2,000 high-velocity SKUs.", "None of these actions are easy to take. However, they are the right decision for our company and our shareholders. This will allow us to position our core home improvement business for continued growth. The company's strategic reassessment is ongoing as we will evaluate the productivity of our real estate portfolio and our non-retail business investments. Going forward, our goal is simple. We plan to deploy both human and capital resources to our highest and best use.", "Finally, as we work to create more value to our shareholders, we must create a true expense reduction culture here at Lowe's. No longer will we throw payroll at each problem. Instead, we will rigorously scope out the issue and implement technology to improve our processes. This will ensure that we deliver better sustained expense discipline and more effective capital allocation that will drive improvements in our return on invested capital.", "So, to summarize, our short-term priorities at Lowe's are the following. We'll simplify organizational structure, recruit outstanding leaders, improve our reset execution, rationalize store inventory while improving our in-stock position, invest in high-velocity SKUs for our Pro and DIY customers, implement more rigor into our capital allocation process, intensify our customer engagement, and develop a true expense reduction curve.", "This is what I define as sharpening our focus on retail fundamentals. I look forward to sharing more details on our long-term strategic plans at our analyst and investor conference on December 12th. With that, I'll turn the call over to Mike." ] }, { "name": "Michael McDermott", "speech": [ "Thanks, Marvin and good morning, everyone. It has been a pleasure to serve Lowe's over the past five years. Though we have a lot of work to do, I believe the business has great potential for success going forward. As Marvin shared with you, we capitalized on delayed spring demand in the second quarter, posting comparable sales growth of 5.2%. We drove increased traffic to our stores and Lowes.com and grew transactions six-tenths of a percent while increasing average ticket 4.5%.", "We leveraged holiday events designed to take advantage of seasonable project demand with strong messaging, attractive offers, more personalized marketing, and our continued shift into digital and localized marketing channels. We were positioned with seasonal inventory in place and staffing trained and ready to help customers complete their projects. In fact, we kicked off the quarter with significant outdoor recovery, driving comparable sales growth of 8.2% in May.", "For the quarter, we achieved double-digit comps in lawn and garden, driven by broad-based strength in lawn care, live goods, and landscape products. We delivered high single-digit comps in seasonal and outdoor living, with double-digit comps in cooling, where we were pleased with the results of our transition to GE air conditioning products.", "And we delivered double-digit comps in outdoor power equipment, driven largely by strength in battery-powered cordless products, as well as double-digit comps in pressure washers, following the introduction of Craftsman to the category. We drove market share gains across all major categories where we introduced Craftsman to our lineup.", "In the second quarter, we also saw continued strength in categories such as lumber and building materials, appliances, and rough plumbing and electrical. We achieved high single-digit comps in appliances, as our omnichannel offering, together with leading brands, breadth of assortment, competitive pricing, and service advantages continued to propel our performance.", "Pro demand as well as inflation drove strong comps in rough plumbing and electrical and lumber and building materials. In order to continue growing our sales to pro customers, we'll further strengthen our portfolio of pro-focused brands.", "Today, we're proud to announce the introduction of Mapei to all stores, the leading brand in tile-setting materials. We're also excited to announce the addition of Zoeller, the number one brand in pumps and a retail exclusive. Lowe's will be offering the full line of Zoeller products, including well, sump, submersible, and utility pumps.", "As we look forward, we're focused on capitalizing on the opportunity presented by a strong home improvement sector. We'll work to sharpen our execution, as Marvin noted, by simplifying the business and focusing on core retail fundamentals, improving our in-stocks, and reducing the time our associates spend on tasking so that they may focus more on serving our customers.", "We'll also streamline and simplify our reset process to improve our execution and reduce disruption for our stores. Reset challenges adversely impacted our performance in fashion fixtures, specifically light bulbs, and in paint throughout the quarter. We're working diligently to address those issues.", "We'll also continue to make advancements in our supply chain, opening our first direct fulfillment center this fall to allow for expansion of our online product offering and more efficient delivery for our customers. We're testing predictive delivering scheduling for our stores to allow them to better plan for shipment arrivals from our regional distribution centers.", "We're excited about our continued rollout of Craftsman in the second half, including individual mechanics and hand tools, power tools, and fall outdoor power equipment. Given the strong response we've seen in category introductions thus far, we're thrilled to be the exclusive destination in the home center channel for this iconic brand, offering some of the best tools, storage, and outdoor power equipment in the industry.", "We'll also leverage our expanded strategic partnership with Sherwin-Williams, one of the most recognized brands in paint, highly respected for quality products by both homeowners and pros. With this partnership, Lowe's is the only national home center to offer top-selling stain brands, Minwax, Cabot, and Thompson's WaterSeal.", "Moving beyond the reset pressure we saw in Q2, in the second half of the year, we'll deliver a simplified line design. That makes it easier for customers to select the right product for their painting needs, with exclusive HGTV Home by Sherwin-Williams and Valspar interior and exterior paints, as well as the top paintbrush brand, Purdy. We're excited to bring customers more of the top brands they trust for their next paint or stain project.", "We're also rolling out a new paint desk experience, including an updated product selector display, as well a simplified and streamlined service model, to make it even easier for customers to work with an associate to find a color, pick a paint or stain, quickly have it mixed, and begin their project. We're excited about the second half of the year, with great brand introductions, exciting marketing plans and events to drive traffic, and a focus on core retail fundamentals, we will capitalize on strong demand in a healthy sector.", "Thank you for your interest in Lowe's and I'll now turn the call over to Marshall." ] }, { "name": "Marshall Croom", "speech": [ "Thanks, Mike. Good morning, everyone. It has been a great experience for me to serve Lowe's for the past 21 years in many different capacities. I'm excited to see what the future holds for this great company.", "As a reminder, in the first quarter, we adopted the new revenue recognition accounting standard. As a result, we reclassified certain items within operating income. The most significant of which was the reclassification of the profit-sharing income associated with our proprietary credit program from SG&A to sales.", "The adoption of this standard had no impact on operating income and no impact on comparable sales. It was adopted on a modified retrospective basis, so the prior year has not been adjusted. Sales for the second quarter increased 7.1% to $20.9 billion, supported by a 1.3% increase in total transactions and total average ticket growth of 5.8% to $75.53.", "Adoption of the new revenue recognition standard provided a 74-basis point benefit to sales growth. Comp sales were 5.2%, driven by an average ticket increase of 4.5% and transaction growth of six-tenths of a percent. Looking at monthly trends, comps were 8.2% in May, 4.2% in June, and 3% in July.", "As Mike indicated, we capitalized on delayed spring demand, leveraged our strength in appliances, and drove strong comps in lumber and building materials and rough plumbing and electrical. Gross margin for the second quarter was 34.46% to sales, an increase of 25 basis points from Q2 of last year.", "Adoption of the new revenue recognition standard provided a 55-basis point benefit to gross margin. Product mix shifts negatively impacted gross margin by 20 basis points and higher transportation costs negatively impacted gross margin by 20 basis points. SG&A for the quarter was 22.45% of sales, which deleveraged 229 basis points.", "As Marvin noted, we performed a strategic reassessment of Orchard Supply Hardware during the quarter, which led to non-cash charges of $230 million and a decision to exit the business. These non-cash charges drove 110 basis points of SG&A deleverage. Adoption of the new revenue recognition standard resulted in 64 basis points of SG&A deleverage.", "In last year's second quarter, we recorded a $96 million gain from the sale of our interest in the Australia joint venture. This resulted in 49 basis points of deleverage this year. While increased demand from continued growth and appliances drove 16 basis points of deleverage and customer delivery costs, it was offset by 21 basis points of payroll leverage in the quarter.", "Depreciation and amortization for the quarter was $345 million, which was 1.65% of sales and leveraged 18 basis points. Operating income decreased 186 basis points to 10.36% of sales. Interest expense for the quarter was $153 million, which leveraged 7 basis points. Effective tax rate was 24.4% compared to 36.2% last year as a result of tax reform. Diluted earnings per share was $1.86 for the second quarter, compared to $1.68 in the second quarter last year.", "Excluding the non-cash charges as a result of the strategic reassessment of Orchard, adjusted diluted earnings per share was $2.07, a 31.8% increase over last year's adjusted earnings of $1.57.", "Now, to a few items on the balance sheet, starting with assets. Cash and cash equivalents at the end of the quarter was $2.3 billion. Inventory at $11.9 billion increased $478 million or 4.2% versus the second quarter last year. Inventory turnover was 3.85 times, a decrease of 15 basis points versus Q2 of last year.", "Moving on to the liability section of the balance sheet, accounts payable of nearly $9 billion represented a $335 million or 3.9% increase over Q2 last year. At the end of the second quarter, lease-adjusted debt to EBITDA was 2.23 times. Return on invested capital was 20%.", "Now, looking at the statement of cashflows -- operating cashflow was nearly $5.8 billion and capital expenditures were $543 million, resulting in free cashflow of $5.2 billion. In the second quarter, we paid $338 million in dividends. In May, we entered into a $550 million accelerated share repurchase agreement, which settled in the quarter for approximately 5.6 million shares.", "We also repurchased approximately 5.8 million shares for $550 million through the open market. In total, we repurchased $1.1 billion of stock in the quarter. We have approximately $5.1 billion remaining on our share repurchase authorization.", "Looking ahead, I'd like to address several updates we made to Lowe's business outlook. From a macroeconomic perspective, we maintain our positive outlook for the home improvement industry. We expect to see solid sector growth driven by gains in employment, which should boost disposable income and consumer spending. We expect housing will remain a positive driver as solid housing demand and continued home price appreciation supports home improvement spending.", "However, while we recovered approximately half of the seasonal miss in the second quarter, assortment issues in flooring, inventory out of stocks, and reset disruption continue to exert pressure on sales growth. As a result, we now expect a total sales increase of approximately 4.5% for the year, driven primarily by a comp sales increase of approximately 3%. We anticipate opening approximately nine stores.", "As Marvin shared, we are developing plans to aggressively rationalize or store inventory to remove clutter and to allow for investments in job-lot quantities for the Pro and overall depth of high-velocity SKUs. These actions may put up to 55 basis points of pressure on operating income in the second half of the year.", "Also, our business outlook reflects the $230 million non-cash charges we incurred in the second quarter related to long live asset impairments and discontinued projects for Orchard, as well as the expected $390 million to $475 million of additional charges expected in the second half of 2018 as a result of our decision to exit this business. On a GAAP basis, we now expect an operating margin decline of approximately 180 basis points.", "Effective tax rate is now expected to be approximately 25%. For the year on a GAAP basis, we now expect diluted earnings per share of approximately $4.50 to $4.60. As Marvin mentioned we lowered our capital forecast for the year by $500 million, eliminating projects that were not focused on improving our core business, did not deliver productivity for our associates, or didn't meet our hurdle rate.", "We are now forecasting cashflows from operations of approximately $7 billion and capital expenditures of approximately $1.2 billion. This is expected to result in estimated free cashflow of approximately $5.8 billion for 2018. Due to the lower capital expenditure forecast, our guidance now assumes approximately $3 billion in share repurchases for 2018.", "Regina, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "To ask a question, press *1 on your telephone keypad. To withdraw your question, press the # key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one follow-up. Our first question comes from the line of Christopher Horvers with J.P. Morgan. Please go ahead." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, good morning. Welcome, Marvin. Welcome back to home improvement. Two questions -- first question, you spent a lot of time in the field. I want to get your thoughts on the opportunity to improve the Pro performance, as it appears that this is where the strength of the market is and where the performance gap has widened. So, you're attacking in-stocks first, but what's your other early diagnosis point of areas that you can see improvement in and try to drive improved comp on the pro side of the business?" ] }, { "name": "Marvin Ellison", "speech": [ "Okay. Thanks, Chris. Pro is a huge opportunity for us. Today, we have roughly 30% of our overall sales penetration from the Pro segment. If you think about the pro for a second, they are a very important customer, but they have some very simplistic expectations on what it takes to get their business. Really, it starts first with service. We've heard often times that pros think time is money. So, they want to get in and out quickly. We'll invest more emphasis on simple things like loading, staffing the desk, and making sure we improve our delivery processes.", "Secondly, they just want to have the product there. So, I've discussed in my prepared comments how we're not only rationalizing inventory. We're also investing in job-lot quantities. That is primarily for our pro customers. Pros need to be able to walk in to see a depth of inventory that they can complete their jobs. We are very inconsistent in that today.", "The next thing that we have to do -- and Bill Boltz, our new EVP of merchandising is already working on this -- we need the brands. Pros resonate to certain brands. So, we're working to look at our assortment in our pro and building materials area and asking the question what brand gaps do we have in assortment that we need to attack. That is already under way to try to make sure we are responding to the feedback that we receive on certain and specific brands that we need to add to the assortment.", "The last thing that we feel really good about is credit and our relationship with Synchrony and how we've worked with them to create more of an emphasis around our pro customer. These are really the short-term priorities that we're going after. As you noted, it's a huge opportunity for us. We can impact this side of the business without distracting or disenfranchising our DIY customers on the garden, on the décor side. It's something that we're going to spend a lot of time on. Joe McFarland, who is our new Executive Vice President of Stores, has a deep understanding of this segment and we're excited about the short and long-term potential." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. As a follow-up, you mentioned reviewing non-retail investments. I'm curious as to what they are, exactly. As you think about the long-term here, you mentioned a culture of expense discipline. How do you think about the ability to drive operating margin expansion versus the need to invest in things like in-store technology, labor, and supply chain? Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "I think from a non-retail investment, if you look across some of the decisions we made from a capital perspective over the course of the last three to five years, we've dabbled in quite a few investments in non-retail types of formats and non-retail types of synergies and systems and services.", "So, without getting very specific because it's still really early, we're just assessing everything. We're looking at our entire real estate portfolio and looking at every capital investment where we are spending the shareholders' money asking the question, \"Are we getting an appropriate return?\"", "Equally as important -- is it consistent with our strategic long-term view of where we think Lowe's should be as a world-class omnichannel retailer. So, I'm expecting when we gather for our December investor conference, we're going to have much more specificity on where we see the future going, where we will invest and investments we're going to kind of par back. I want to just wait until that time frame before I'm going to be more specific on what opportunities or possibilities we're going to shift it from.", "Relative to operating income, it really comes down to a couple of fundamental things. We need to generate more sales per square foot productivity in our stores. If you look at where we are in the past and focus on our end caps, as an example, our end caps have been more leaning toward innovation and driving productivity.", "It's really not the merchants' fault. The merchants' have simply been following the companies' strategic plan. What we're going to do is shift away from innovation if innovation isn't driving revenue. So, we have to drive more improved productivity. While we're doing that, we have to be more disciplined on our SG&A. We have to be more disciplined on our investments of expense and capital.", "So, I mentioned in my prepared remarks that we're going to no longer through payroll at problems. In the past, when we could have what we deemed conversion issues in the stores, we indiscriminately added payroll to try to solve it without really identifying the root cause. That is not how you run a business this size. So, instead, we're going to be more prudent on getting to root cause, redefining process, and not just thinking every solution is a solution where you just kind of through more headcount at it because that's not sustainable.", "So, improving productivity on our sales per square foot, being more diligent and disciplined around SG&A, making sure that we have more rigor in our capital allocation process is going to improve our EBIT performance, operating profit, and have more sustainable EPS growth." ] }, { "name": "Christopher Horvers", "speech": [ "So, does that mean you think there's an expense reduction opportunity outside of driving the actual productivity of the business?" ] }, { "name": "Marvin Ellison", "speech": [ "I would say there's more to come on that. We are spending a lot of time looking at our strategic process around where we invest and where we cut and how we can drive productivity in our stores. As a recollection, one of the things that I am significantly focused on is how we can drive improved productivity in our stores while continuing to leverage operating profit. We can do both. We can improve service. We can improve productivity and we can also create a more profitable environment.", "That is a correlation of understanding more process discipline in addition to making the right investments. As one specific example, we have very few, if any, engineering standards in our stores. What I mean by that is that typically, for a retailer our size, there are very engineered processes on things like how you unload a truck and how you flow product from the receiving to the sales floor to drive in stock.", "We have no standards for that. It's a very random process where our stores are kind of fending for themselves trying to make it happen. That is how you destroy productivity. So, if you simply go in and build engineered processes consistent across all types of stores and volumes, you can drive increased productivity without having any kind of staff reduction action. It's just more of a process efficiency.", "So, we're going back right now to create engineering standards for everything we do, from unloading the truck to stocking the shelf to every other process. We know that's going to reap significant benefits." ] }, { "name": "Christopher Horvers", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please go ahead." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning. Welcome, Marvin. My first question is given your experience, Marvin, in this segment, you used to compete a lot against Lowe's. I'm wondering at that time how you thought about the productivity advantage that Home Depot had over Lowe's, whether it was real estate-driven, whether it was operating execution driven, any thoughts that you share from your time last in the segment of why Lowe's wasn't operating at the same level as Home Depot." ] }, { "name": "Marvin Ellison", "speech": [ "Well, Simeon, I can remember back in early 2000 where it felt like every quarter we were getting beat pretty significantly by Lowe's with those same structural disadvantages we currently have. I think for us, it's less about looking at the competition and it's about looking within and asking the questions, \"Where can we be better?\"", "Now, obviously, relative to our largest competitor, we have a disadvantage in real estate locations from a metro area, specifically in the Northeast and the West Coast. However, we believe that if we can find a better balance between serving the do it yourself customer and our pro, we can start to chip away at any competitive gaps that we have. Mike McDermott and I both mentioned in our prepared remarks about the challenges we face with our recent execution.", "That is an example of what I call a self-inflicted strategic wound that we've done to ourselves because structurally, how we execute resets puts our team at a tremendous disadvantage. From a merchandise planning standpoint, that is kind of living in the merchandising side and the actual reset execution is in-store operations. So, you have two teams working on the same process and that creates inconsistency and communication problems. So, there are process improvements that we'll make to fix areas like resets.", "In addition to that, we talk about our dotcom performance and how we delivered roughly 18% comps. Within that number is a significant systems issue where we tried to create better inventory visibility. By doing that, we drove a significant number of order cancellations that had a dramatic impact on the overall sales number of our dotcom business. That's another self-inflicted issue that created a lack of performance for us during the quarter. I also mentioned a significant number of out of stocks that we're dealing with in our stores that we have to fix.", "So, as we look within and we ask the question where can we be better as a company to drive improved productivity, improved sales performance, improved operational leverage, we think that there are a lot of things that we can correct ourselves because there are certain structural disadvantages that we cannot overcome, but what we can overcome is poor execution. That is where our focus will be.", "We think as we improve within these areas, we're going to see that gap start to close because we're going to be focused more within our own company versus looking across the street at our competitor." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. That's fair. My follow-up, I respect that it's early days, but if you're willing to share your instinct, especially given your experience in the segment and now knowing both players, whether there is some type of under-spending that had been taking place at Lowe's and whether that necessitates some type of big catch-up in order to drive those results that you're talking about or if it's more on process than it is infrastructure." ] }, { "name": "Marvin Ellison", "speech": [ "Well, I don't think it's necessarily over-spending as it was the strategic choices we made on what we spent money on. As we announced today, we're going to be moving away from our Orchard investment. In retrospect, you can argue that may not have been the most prudent use of capital. So, I think it's less about total spending and more about the strategic rationale regarding the spend.", "So, what we're doing as a team now is we're taking a really hard look at capital spending and asking a question where should we invest. Obviously, we're going to invest in supply chain. We have a very clear line of sight of exactly what we want our supply chain to look like. We recruited Don Frieson, who spent time at Walmart and Sam's Club and he brings a wealth of knowledge.", "So, we'll make the right investments and we feel very confident that we can create a modern supply chain over the short and long-term. It's an iterative process that you can't do overnight. I mentioned we're looking for a new Chief Information Officer to help us understand how we continue to modernize our in-store technology. We have the capital to spend and we have a pretty good line of sight of what we need to spend it on and now, we're going to bring a leader in that's going to build out a multi-year plan.", "So, I guess my short answer to the question is it's not a lack of spending. It's the prioritization of what we spend it on. We're going to focus on retail fundamentals. Now, it doesn't mean that we're going to think short-term.", "While we're fixing these fundamental issues like out of stocks and reset issues and customer engagement and being more specific around serving the pro, we're going to be building out our supply chain, improving our IT infrastructure, and also creating this omnichannel environment where we can leverage these wonderful stores to be more in tune to serving customers that they want to serve both in-store and online." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. Thanks, Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Michael Lasser with UBS. Please go ahead." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question and welcome, Marvin. The first question I have is Marvin, how are you going to define success, especially in light of the fact that the company has grown in earnings the last few years and benefited from what's been a fairly healthy home improvement cycle that now looks like it's in the later stages." ] }, { "name": "Marvin Ellison", "speech": [ "Well, I think for us, like any large public company, we're going to define success in a couple of ways. First, we're going to look at are we gaining market share? We're going to be very purposeful around taking share in key categories. We're going to look at our financial performance, look at our sales growth relative to our competitive set. We're going to look at our bottom line, how are we performing from an EBIT and an EPS perspective and are we continuing to deliver value for our shareholders.", "The thing that we're going to do, Michael, which is not a surprise is that we're going to be really customer focused. We have some very impressive competitors in this space. We're not denying that. But we understand that we also have to be focused on our customers. We can serve our customers at the highest possible level. We think that we're going to take market share. We think that we will see the proper levels of comp sales growth and we'll drive that sales productivity that I mentioned and you'll see overall bottom line improvement.", "There are areas that we know we can do a much better job on relative to operating profit, which will be driven through more disciplined SG&A execution, overall operating expense, but keenly focused on driving improved sales productivity in our stores. We know that we can do that. So, those are kind of the basic fundamental things we're going to look at. It's going to be really more about are we serving our customers at a level that's driving loyalty and return visits." ] }, { "name": "Michael Lasser", "speech": [ "My follow-up question is can you frame the upside and the downside you're guiding for the back half of the year? Was there any thought to a new team coming in, let's provide a downside case or a really conservative outlook to provide breathing room for some of the changes that we're going to have to make, especially in light of the fact that there have already been some execution challenges that we're going to have to confront as we begin this journey?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, Michael, I'll give you my thoughts. I'll hand it to Marshall and he'll provide you any more specifics. I think the simple answer is we have a lot of moving pieces as the earning release outlined, with our decision to liquidate Orchard and our decision to rationalize inventory. Also, we made, I think, a very prudent decision to take $500 million in CapEx and shift it to our share repurchase program.", "So, based on all of that, specifically Orchard in the inventory rationalization, we felt it was prudent to update our guidance. We feel as though we were conservative, but we wanted to also make sure that we did not under-perform what we believe the numbers should be for the second half of the year.", "With that, I'll hand it to Marshall and he may provide some more specifics." ] }, { "name": "Marshall Croom", "speech": [ "Michael, when we started the year, we were guiding to 40 basis points of pressure on our operating margin. We expanded that to 180 basis points. That's 140 basis points. Again, to Marvin's point, largely driven by Orchard, the decision to exit that business as well as taking a hard look at our inventory rationalization process that we're getting under way. So, those two items combined drive that. Again, the right thing to do so we can redeploy capital so we can invest it where necessary, but it's those two big pieces that are driving the operating margin pressure." ] }, { "name": "Michael Lasser", "speech": [ "Marshall, just to confirm, those two pieces that are what we're seeing the difference between the old guidance and your new guidance or was there pressure factored in to the operating profit margin above and beyond other factors as well?" ] }, { "name": "Marshall Croom", "speech": [ "Those were the two key drivers. Again, taking a hard look at the inventory rationalization, I felt that we needed to plan for an aggressive approach to that." ] }, { "name": "Michael Lasser", "speech": [ "Thanks very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Eric Bosshard with Cleveland Research. Please go ahead." ] }, { "name": "Eric Bosshard", "speech": [ "Good morning. I'm curious, Marvin, as you think about -- you're doing a good job of listing out the investments that are needed, the prioritization of what you're doing -- but I'm curious as you think about the resets in customer engagement and the pro-service in building out the supply chain and IT and also identifying the productivity opportunities, is your mindset and discipline to invest first in these areas to strengthen the future or is your discipline to self-fund these things along the way and measure out and meter out the implementation of these things? Which path are you more apt to go down?" ] }, { "name": "Marvin Ellison", "speech": [ "Eric, I think it's a combination of both. The best way to describe it is I think we have to work very aggressively to address what I call a lack of retail fundamentals. I mean, just basic things like reset execution, in stock improvement, sales productivity on end caps, addressing out of stocks and job-lot quantities, having more engagement with customers and not overriding and tasking versus engaging customers and understanding how we serve our pro via improved service and brands that they respond to. Concurrently, we'll be investing in a multi-year plan in supply chain.", "Concurrently, we'll be investing in a multi-year plan from an IT infrastructure improvement, and concurrently, we'll be building out our omnichannel investments in our stores so that we can continue to leverage our 2,300+ physical locations with our digital platforms. So, I think it's a combination of addressing retail fundamentals plus we think the short-term benefit is there.", "Again, you can't be a great retailer if you're not fundamentally sound, while making the strategic investments that will make us viable for the short-term and the long-term. So, it's a combination of all those things." ] }, { "name": "Eric Bosshard", "speech": [ "That's helpful. Secondly, I'm curious in terms of the timing we should be expecting regarding payback on the sales line. You talked about the importance of considering sales growth and sales per square foot and even your market share performance. When is it reasonable to expect the efforts that you're making to start to change the performance in those areas?" ] }, { "name": "Marvin Ellison", "speech": [ "Eric, what I would say to you is as you can imagine, we're spending a lot of time getting our new leaders assimilated to the company. The good news is both Joe McFarland and Bill Boltz bring a combined 50 years of home improvement experience, which I think is really important for us on the merchandising and the stores side, but they have to get assimilated. Don Frieson brings over 18 years with Walmart and Sam's Club, but he needs to get assimilated. We just announced David Denton this morning as our new Chief Financial Officer.", "So, when we come together at the investor and analyst conference in December, it is my expectation that we're going to have a high-degree of specificity around where we see the business going, not only for 2019, but over the course of the next two to three years. We'll be able to lay out those strategic investments that we're going to make that's going to deliver upon that. We're going to have probably a degree of detail that hopefully will give comfort to everyone who thought through this in a very specific fashion.", "So, I would kind of postpone answering that question more directly until we have a chance to get all these leaders assimilated and we can get together and lay out that all-inclusive strategic plan." ] }, { "name": "Eric Bosshard", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Zach Fadem with Wells Fargo. Please go ahead." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. Welcome, Marvin. Congrats on the new role. I'm curious if you can talk about your initial conversations with vendors and suppliers. Where do you think those relationships are today versus maybe what you expected? Where do you see the opportunities to improve these relationships either via expansion or consolidation of your offerings where appropriate and any additional improvement efficiencies? Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "Well, Zach, the first thing is I want to just give Mike McDermott and his team a lot of credit. There are some significant partnerships that they've created the last couple years that I think have long-term benefits, specifically if you think about being the exclusive big box home center channel for Craftsman. What an iconic brand.", "The brand is exceeding expectations of the team. We're just getting started. And also with Sherwin-Williams, another iconic brand -- having the ability to have their products, whether it's Thompson's WaterSeal or Purdy brushes in addition to their paint, this is something that we think we're just scratching the surface on the potential.", "So, I would say overall, I've been very pleased with my engagement with the suppliers I've had a chance to spend time with. Obviously, with Mike's transition and Bill Boltz coming on board, we're going to be spending more time not only with existing suppliers, but we'll be spending time with suppliers that we currently don't work with to see if there is a realistic possibility that we can add additional brands to the assortment that will resonate with our DIY and Pro customers.", "I would say overall, it's been very positive. I think they've been very encouraged by some of the changes that we've made because they now know that we're getting refocused on being a fundamentally sound home improvement retailer, which opens up the opportunity for them to drive more revenue within their own companies." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Also, just to marry up your current outlook with the plans outlined at the beginning of the year, Marshall, you had called out about $140 million of tax reform reinvestment spending for things like labor, technology, some other items. To what extent are these investments still incorporated in the current outlook today? Is there any planned reallocation in that spend being contemplated?" ] }, { "name": "Marshall Croom", "speech": [ "Zach, again, taking a look at the reduction of capital, there are expenses associated with those that's actually providing a little bit of offset in the back half of the year, but again, net-net, the incremental pressure of 140 basis points from our original guidance on operating margin." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Appreciate the time, guys." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Steve Forbes with Guggenheim Securities. Please go ahead." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. Maybe to start with the full-year comp guidance, are you assuming any flow through benefit from your inventory rationalization efforts that you mentioned today in the back-half or from the remaining seasonal recapture? I think you mentioned on the call that you got about half of it back in the second quarter. Then on the topline guide for the back half in general, can you help us quantify what you think the out of stock impact is to the business today, sort of like the run rate of it?" ] }, { "name": "Marvin Ellison", "speech": [ "So, Steve, I'll take the out of stock question. I will let Marshall take the remaining components of the question. It's hard for us to determine the upside potential of the out of stocks. Having said that, having been in retail for over 30 years, I'm keenly aware that if we have increased traffic and improve in-stock, we should see some level of sales productivity from that. So, we are optimistic that we're going to be able to drive sales improvement when we get our in-stock position improved.", "Now, the reality is that you just can't flip a switch and have inventory in your stores on the shelves. We are going to be very prudent in how we exit out and rationalize inventory that we think needs to exit the assortment, but we're going to be equally as prudent on making sure that we are selective and surgical on what we bring in. It's really more about timing than anything.", "Once we get this process completed, we're very confident we'll see sales productivity. The question is how quickly can we get it done. That's the unopen question that I have that makes it very difficult to answer your question more precisely. So, with that, I'll let Marshall take the rest of your question." ] }, { "name": "Marshall Croom", "speech": [ "Steve, just on the inventory rationalization efforts, again, in the back half, primarily, that's being driven in the third quarter and we are anticipating about 55 basis points of operating margin pressure, again, just to allow for what we believe will be an aggressive approach to remove some of the clutter of inventory in the store and potentially an effort to reinvest into job-lots for the pros and some higher turning SKUs, our future sales productivity as the company moves forward." ] }, { "name": "Steven Forbes", "speech": [ "And then just a quick follow-up -- I think there was a $1 billion increase in the free cashflow guidance for the year, 2Q over 1Q. Half of that, obviously, is the $500 million reduction in planned CapEx for the year. Where is the other half coming from, the other $500 million? Then just touch on where you think inventory ends up being at the end of the year." ] }, { "name": "Marshall Croom", "speech": [ "So, the question on where does the incremental $500 million of operating cashflow come from, it's from the liquidation efforts of Orchard and the actions we are anticipating taking in the third quarter taking with inventory rationalization. So, that's really the two drivers to that piece. Was there another part to that question?" ] }, { "name": "Steven Forbes", "speech": [ "What do you think inventory is at the end of the year as far as the balance sheet on a per store basis?" ] }, { "name": "Marshall Croom", "speech": [ "Right now, we're looking at total inventory to be roughly flat for the year." ] }, { "name": "Steven Forbes", "speech": [ "Thank you very much." ] }, { "name": "Marshall Croom", "speech": [ "Regina, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Our final question will come from the line of Seth Sigman with Credit Suisse. Please go ahead." ] }, { "name": "Seth Sigman", "speech": [ "Thanks a lot and good morning. A couple follow-up questions -- first, just in terms of Orchard Supply, any more insight into that decision to exit that business and the historical financial contribution to that business. Then I'm just curious your views on Canada and Rona specifically. Do you view that as core to the go-forward strategy? Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "Well, I would say Canada and Rona first has been a very positive benefit for the company. The good news is that the overall integration is happening well. The introduction of unique and different categories for Rona like appliances has been met with really strong response from the customers. We feel very, very good about the Canadian business performance and, again, that overall acquisition of Rona. We think that it's exactly where we want it to be, if not exceeding expectations from the original performance.", "Relative to Orchard, as the old saying goes, hindsight is 20/20. But I think there were some strategic decisions made that if they had to be done over would be different. The good news is that 86% of the Orchard stores that are closing are within a 10-mile radius of a Lowe's store. So, we're very optimistic that any associate who is an Orchard associate that's looking for a home at Lowe's, we should be able to find them a position. We're going to prioritize those individuals.", "But the business was just not running well. As we started to do the strategic assessment of where we wanted to invest our capital and where we wanted to be focused, it became really clear to me and to the leadership team that we want to be focused on our core retail business. We could grow Orchard into the most dominant, small box specialty home improvement channel in America and it will be very minimal positive impact from an EBIT, from an overall revenue standpoint to the Lowe's business.", "So, the question is do you continue to invest financial and intellectual capital in an initiative that will have very small benefit to the shareholder. We decided that we would not. So, we're going to take the intellectual and the financial capital that we would have been investing in that business and invest it in the core of Lowe's business and we think that's a better return for the shareholder." ] }, { "name": "Marshall Croom", "speech": [ "Seth, I had one other point just as a frame of reference. Orchard for 2017 generated about $600 million in sales and it was a negative $65 million in EBIT." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Thank you for that. That's helpful. My last follow-up is just around e-commerce and your assessment of the gap versus the competitors in this space. I guess in general, how are you thinking about investments required to address those gaps? Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "The good news is a lot of the investments are under way. We are building a very, very impressive team of experts that are coming in from a lot of different backgrounds and some of our very impressive competitors. I think our greatest opportunity is fundamentally making sure that our site is a lot more user-friendly, from a search, from a navigation, from a checkout. There's a very specific roadmap that is being built and being executed to deliver on all of those things.", "The second big component is how do we more seamlessly connect our digital and our physical footprints together? The great news for us is that we're in a space of home improvement, where customers still like to come to the stores. They enjoy engaging with our associates because they want some level of consultation on a purchase. In addition to that, we have products that are big, bulky, and hard to ship. Having the ability to leverage our digital and our physical stores is important.", "The good news is if you look at our business today, roughly 60% of our e-commerce transactions were picked up in a store. That's incredibly powerful even though we have a significant list of opportunities that we are addressing. That's telling me that our customers are already resonating with our omnichannel philosophy and being able to connect digital and physical. We just need to make it more seamless. So, the investments required are really already under way. The roadmap is already built and we're continuing to tweak it, but we see nothing but positive upside in the space." ] }, { "name": "Seth Sigman", "speech": [ "Thank you. Best of luck." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you. So, just a few closing remarks -- I want to make sure that I just take a moment and thank both Marshall Croom and Mike McDermott for their loving commitment to this company. More importantly, these gentlemen have been extremely professional and very, very helpful for me throughout this transition. So, I'll be eternally grateful to both of them for their support of me in this transition, their love and support of the associates of this company. I wish them Godspeed and many blessings in the next chapter of their lives and careers.", "Thank you. We look forward to speaking to you on our November 20th earnings call." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, this concludes today's call. Thank you all for joining. You may now disconnect." ] } ]
LOW	2018-02-28	[ { "description": "President, Chairman, and Chief Executive Officer", "name": "Robert Niblock", "position": "Executive" }, { "description": "Chief Operating Officer", "name": "Richard Maltsbarger", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Marshall Croom", "position": "Executive" }, { "description": "Chief Customer Officer", "name": "Mike McDermott", "position": "Executive" }, { "description": "Oppenheimer -- Analyst", "name": "Brian Negal", "position": "Analyst" }, { "description": "Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": "JP Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Wedbush Securities -- Analyst", "name": "Seth Basham", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Matt Fassler", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Mike Baker", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scott Ciccarelli", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Gregory Melich", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning everyone, and welcome to Lowe's Companies Fourth Quarter 2017 Earnings Conference Call. This call is being recorded. Please note if you press 1 to enter the question queue prior to the start of today's call, your signal did not register. You will need to press 1 again to enter the queue. Also, supplemental reference slides are available on Lowe's Investor Relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call.", "During this call, management will be using certain non-GAAP financial measures. The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks, and the company can give no assurance if they will prove to be correct. Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission. Hosting today's conference will be Mr. Robert Niblock, Chairman, President, and Chief Executive Officer; Mr. Richard Maltsbarger, Chief Operating Officer; and Mr. Marshall Croom, Chief Financial Officer. Joining during the Q&A session will be Mr. Mike McDermott, Chief Customer Officer.", "I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir." ] }, { "name": "Robert Niblock", "speech": [ "Good morning, and thanks for your interest in Lowe's. Fiscal 2017 represented the highest sales in net earnings in our company's history. In the fourth quarter, we delivered comparable sales growth of 4.1%, exceeding our expectations, through compelling consumer messaging, strong holiday event performance, and integrated omnichannel customer experiences. Our U.S. home improvement business delivered a 3.7% comp for the quarter with positive comps in 13 of 14 regions. From a product view, we posted positive comps in nine of 11 product categories while one category was essentially flat. Appliance led product category growth with another quarter of double-digit comps. We achieved above-average comps in tools and hardware, rough plumbing and electrical, and lumber and building materials.", "Internationally, we delivered another strong quarter with high single-digit comps in Mexico and mid single-digit comps in Canada, both in local currency. We've made significant process integrating RONA, delivering double-digit online sales growth, rolling out appliances to approximately 100 locations, completing five RONA big-box conversions, driving strong growth in our affiliated dealer business, and further optimizing shared supplier partnerships and procurement efforts. We're pleased with the strong momentum we've built throughout the year, culminating in RONA posting its highest comp in 13 years. We believe that we're well positioned for continued growth and remain on track to double operating profitability in Canada by 2021.", "For the quarter, we delivered adjusted diluted earnings per share of $0.74. Delivering on our commitment to return excess cash to shareholders in the quarter, we repurchased $133 million of stock under our share repurchase program and paid $341 in dividends. And our Board of Directors recently authorized an incremental $5 billion of share repurchases which further underscores our commitment.", "Turning now to our progress against our strategic priorities. I'm particularly proud of how we've grown sales with pro customers by focusing on breadth and depth of inventory, our portfolio of brands, localized assortments, and enhancing LowesForPros.Com as evidenced by our pro growth rate outpacing DIY for both the fourth quarter and the full year. The integration of Maintenance Supply Headquarters and Central Wholesaler remains on track and provides a compelling opportunity to improve and expand our ability to serve multi-family property management customers.", "On Lowes.Com, we saw strong customer response to our enhanced shopping experience and marketing efforts with comp growth of 28% for the quarter and 34% for the year. We continue to enhance our in-home selling program, providing customers the ability to now request services online, and we are centralizing our process for providing installation quotes, allowing for greater efficiency in a more consistent customer experience. Our project specialists represent a critical element in our omnichannel offering and a differentiated capability in capturing and serving project demand for the do it for me, or DIFM, customer.", "Though we are pleased with the strategic milestones we achieved this year, we recognize that we still have an opportunity to improve execution to ensure greater success in the future. Richard will speak to our efforts to improve conversion, gross margin, and inventory management in a moment.", "Looking ahead, the home improvement industry is expected to see solid growth supported by job and income gains which should drive increases in both disposable income and consumer spending. And we expect continued housing tailwinds, including favorable trends in household formation despite near-term pressure on housing availability.", "In 2018, we plan to capitalize on this strong macroeconomic environment and see an opportunity to invest much of the incremental cash flow from corporate tax reform to accelerate our strategic priorities, including investments in our people. We are focusing our resources on what is most relevant to engaging customers in the moments that matter and improving the capabilities our employees need to serve customers. In 2018, we will focus on leveraging analytics to know the customer better, changing how we engage, expanding our fulfillment options, delivering compelling product experiences, growing sales with the pro customer, and differentiating with services. These strategic areas of focus and investment will be instrumental to further strengthening our competitiveness and enhancing our position as the omnichannel project authority. Richard will provide additional details on each of these focus areas in a moment.", "And of course, as we look at our results, along with the additional investments we're making, it warrants reevaluating our long-term targets. Marshall will address those in a moment. But let me be clear that our entire leadership team and board are focused on working together to continue to analyze our performance and business expectations, and we are moving forward with urgency to improve our results.", "Before I close, I would like to express my appreciation to our employees for their dedication to serving customers and living our purpose-driven mission to help people love where they live. We recently announced plans to expand our employee benefits and a one-time bonus of us to $1,000.00 for our more than 260,000 hourly employees in the U.S. Our employees are the foundation of our success, and we are investing in them to support our bright future and reward them for their unwavering commitment to serving customers in the communities where they live and work. It's their dedication that makes this company great.", "Thanks again for your interest, and with that, let me turn the call over to Richard." ] }, { "name": "Richard Maltsbarger", "speech": [ "Thanks, Robert. Good morning, everyone. As you just heard, we've achieved some important milestones this year and identified actions necessary to drive future success. First, we refined our marketing strategy, successfully launching a new campaign, start with Lowe's, which has captured mind share and improved measured campaign effectiveness. We've also continued our evolution from analog to digital marketing, delivering more personalized, targeted messages. And we've optimized our messaging content, driving critical improvements and value perception. Together, with our incremental marketing investments, these improvements have increased awareness leading to robust traffic growth.", "Second, we capitalized on customer excitement for the holiday season. We provided cohesive decorating solutions as well as compelling gift ideas across our product assortment, connecting our in-store display with digital access such as Pinterest, Facebook, Instagram, and YouTube, and delivered a seamless shopping experience on Lowes.Com. In fact, we drove double-digit comps in appliances, leveraging our investments in customer experience both in store and online as well as our best-in-class selection of leading brands and our services advantages of next-day delivery, haul-away, and facilitation of repairs and maintenance.", "As cold temperatures and winter storms hit, our never-out strategy ensured that we were in a strong position to serve demand for critical items customers needed. Combined, our strong holiday performance and never-out strategy drove above-average comps in tools and hardware and rough plumbing and electrical. We also continued to execute on our strategic priorities, driving comp growth of 28% on Lowes.Com, the result of strong customer response to our enhanced online shopping experience. We have optimized functionality and displays for touch-screen devices to support a better mobile experience, improved product content recommendations, refined search algorithms, improved click-to-chat capabilities, and optimized our assortment informed by digital line reviews.", "And we have releveraged our MyLowe's platform to drive brand loyalty and build deeper relationships with customers, important because MyLowe's members spend approximately 35% more on average than non-members. In 2017, we added more than 4.5 million new MyLowe's members, and we used the platform to simplify our military recognition program, allowing active-duty personnel and veterans to register through MyLowe's and receive 10% off their purchase every day.", "However, not all the actions we took during the year delivered on expectations. While we were pleased with our traffic growth, we are actively working to improve conversion and gross margin while better managing inventory. Earlier in the year, we recognized a need to improve our sales floor coverage, especially during key weekend and holiday events. We made an investment in Q3 to bolster conversion rates but did not realize the full value of this investment in the second half of 2017. We ultimately determined that while necessary, payroll actions alone will not deliver the conversion rates we expect. Therefore, we must accelerate associate readiness and knowledge through training programs and reengineer key processes in order to better serve customers.", "We must also stabilize gross margin by leveraging new pricing and promotion analytics tools to ensure that we are competitive on highly elastic traffic-driving products while driving profitability across less elastic items and through our continuing value improvement efforts, work closely with our vendors to improve first costs. Finally, we've made the required inventory investments to support key categories such as appliances, flooring, and tools, as well as depth and breadth in critical pro categories. Now we must drive greater working capital efficiency.", "We enter 2018 with a plan to address these challenges and accelerate the investments that will improve our execution and our ability to serve rapidly evolving customer expectations. As Robert outlined, there are six planks to this strategy. First, we are working to know customers and their homes on an even deeper level, understanding their plans and designing better solutions to help navigate their project journey. We're integrating our analytics capabilities, bringing together terabytes of customer data, connecting many different touch points throughout our omnichannel platform, supplementing that data with third-party information and leveraging our talented global workforce to translate this information into actionable insights.", "Second, we're changing how we engage, connecting with customers and associates through relevant tools and messages. We'll deliver more refined, personalized messages to customers through our enhanced marketing management platform that went live in Q4, and we'll better empower associates by deploying more user-friend interfaces, beginning with our Point of Sale upgrade in Q1 which will allow our associates to better serve customers with a touch of a button. Later in the year, we'll significantly improve our associate connectivity, expanding the functionality of our in-store handheld devices to improve the efficiency of our order staging and management, daily tasking, and inventory processes.", "Third, as customers demand an increasingly broad set of fulfillment options, we're transforming our supply chain to better service their needs and expectations. We're investing in a new direct fulfillment center which we expect will be operational in the third quarter of 2018, allowing for the expansion of our online product offering and faster parcel shipping. We're also investing in delivery capacity to meet increased demand, and we're advancing our pickup in store experience during Q1 to allow customers and our installation service providers to pick up product within five minutes of arrival.", "Fourth, we'll continue to deliver compelling product experiences to provide inspiration and personalized choice through a combination of strategic brands and differentiated in-store experiences. We previously announced the introduction of Craftsman in store and online in the second half of 2018. Today, we're proud to announce our expanded partnership with Sherwin Williams. Paint continues to be a top home improvement project, and we will partner closely with Sherwin Williams to deliver a simplified line design that makes it easier for customers to select the right product for their painting needs. Sherwin Williams will now be the exclusive national supplier to Lowe's U.S. retail outlets for interior and exterior paints, including the Valspar and HGTV Home brands. Sherwin Williams is one of the most recognized brands in paint, highly respected for quality products by both homeowners and pros. Under this expanded strategic partnership, Lowe's will become the only U.S. national home center to offer top-selling stain brands, Minwax, Cabot, and Thompson's WaterSeal, as well as the top paintbrush brand, Purdy. We are excited to bring consumers more of the top brands they trust for their next paint or stain project.", "We're also investing in our paint service model to improve the associate and customer experience across the entire paint project. We are rolling out a new paint desk experience in select stores beginning in the first quarter, with plans for a nationwide rollout in the second half of 2018. The improved experience will include an updated project selector display, as well as a simplified and streamlined service model to make it even easier for customers to work with associates to find a color, pick a paint or stain, quickly have it mixed, and begin a project.", "Fifth, while our pro penetration has grown over the last five years, we have further opportunity to continue growing sales to pro customers and expanding our market share. To that end, we're investing to improve the pro experience. We're building on our strength in the MRO space by optimizing our Maintenance Supply Headquarters business, launching a streamlined product catalog this spring, followed by branch expansion beginning later this year. We're also testing improved pro jobsite delivery in select urban markets with an expectation of rolling out the best concept nationwide in the second half of the year. And in order to build a stronger generation of skilled trade professionals, we are launching our Track to the Trades program, a new workforce development initiative that provides innovate career alternatives and financial support for our employees as they pursue a skilled trade.", "Finally, as the DFIM opportunity continues to grow, we're providing a differentiated services offering, delivering complete home improvement project solutions through our in-home sales platform which we are proud to note has grown to over $2 billion in sales annually. Across all project types, our installation services team completes approximately 60,000 in-home installations each week, and we continue to push forward in this space where we are currently testing the commercialization of Lowe's Vision Pro with our in-home project specialists, allowing customers to use augmented reality to visualize their kitchen or bathroom remodel and feel confident proceeding with their project. Through this and other work, we have earned recent recognition by Fast Company as the most innovative company in augmented and virtual reality.", "Together, these six planks build upon our strong foundation and further strengthen our competitiveness, positioning us to continue capitalizing on helping project demand. Thank you for your interest in Lowe's, and I will now turn the call over to Marshall." ] }, { "name": "Marshall Croom", "speech": [ "Thanks, Richard, and good morning, everyone. Let me start by reminding you that last year's results included an extra week, which contributed approximately $950 million in sales. That extra week also caused a calendar shift this year which had no impact on comp sales but negatively impacted fourth quarter total sales growth by approximately $1 billion, or 7%.", "Sales for the fourth quarter were $15.5 billion, a decrease of 1.8% compared to last year's fourth quarter. Total transaction count decreased 7% while total average ticket increased 5.2% to $73.44. Main Supply Headquarters contributed 40 basis points of growth in the quarter, while new stores contributed 60 basis points. Comp sales were 4.1% driven by an average ticket increase of 4.9%, partially offset by transaction decline 0.8%.", "Looking at our monthly trends, comps were 1.1% in November, 7.7% in December, and 3.4% in January. Hurricane recovery efforts in Texas and Florida aided fourth quarter comps which offset the impact of cold temperatures and winter storms across the country in the latter part of the quarter as well as the comparison to Hurricane Matthew and Louisiana flooding last year. We estimate that the net benefit of weather in the quarter was approximately 65 basis points. For 2017, total sales were $68.6 billion, and comp sales were 4%. Gross margin for the quarter was 33.73% to sales, a decrease of 68 basis points from the fourth quarter of last year. Two-thirds of the decline was attributable to rate while the balance was mix and shrink. As we've grown our market share in appliances, gross margin has been impacted from both the mix and rate perspective. We also continue to take competitive actions, which were partially offset by the benefits from value improvement as well as early results from pricing optimization efforts.", "SG&A for the quarter was 24.28% to sales which deleveraged 29 basis points. In last year's fourth quarter, we recorded severance-related costs for organizational changes, which drove 53 basis points of leverage this quarter. In the fourth quarter of '17, we experienced 21 basis points of leverage related to employee insurance, and 32 basis points of leverage related to incentive compensation due to lower attainment levels versus last year. Offsetting these items were the one-time cash bonus for eligible hourly employees in the U.S., which resulted in 42 basis points of deleverage, as well as 21 basis points of deleverage in delivery costs due to increased demand from continued growth in appliances.", "We also had 14 basis points of deleverage in advertising, primarily as a result of our efforts to amplify our consumer messaging. And lastly, the 53rdweek in the fourth quarter of 2016 drove approximately 65 basis points of deleverage this quarter.", "Depreciation and amortization for the quarter was $367 million or 2.37% to sales flat to last year. Operating income declined 97 basis points to 7.08% of sales. The 53rdweek in the fourth quarter of last year drove approximately 90 basis points of deleverage this quarter.", "Interest expense for the quarter was $154 million which leveraged three basis points. The effective tax rate for the quarter was 41.3% compared to 40.3% last year. The higher rate this year was driven by tax reform. The change in our Federal statutory rate triggered remeasurement of our deferred tax assets and liabilities resulting in a charge in the fourth quarter.", "Earnings per share was $0.67 for the fourth quarter. The tax reform negatively impacted earnings per share by $0.02 while the one-time cash bonus reduced earnings per share by $0.05. Adjusted earnings per share was $0.74, a 14% decrease compared to last year's adjusted earnings per share of $0.86. Last year's extra week contributed approximately $0.08 to last year's quarter which negatively impacted adjusted earnings-per-share growth this year by 9%. For 2017, earnings per share was $4.09 while adjusted earnings per share was $4.39.", "Turning to the balance sheet, cash and cash equivalents at the end of the quarter was $588 million. Inventory at $11.4 billion increased $935 million or 8.9% versus the fourth quarter of last year. This is primarily driven by investments in key categories as Richard mentioned, such as appliances, flooring, and tools, as well as investments across pro categories. Part of the increase is also attributable to the acquisition of MSH and new store growth.", "Inventory turnover was 3.9 times, a decrease of 15 basis points over last year. The extra week in 2016 negatively impacted inventory turnover by approximately six basis points. Asset turnover increased five basis points to 1.9 times. Accounts payable of $6.6 billion represented a $61 million or 0.9% of a decrease over fourth quarter of last year. At the end of the fourth quarter, lease adjusted debt to EBITDAR was 2.33 times. Return on invested capital was 18.8%.", "Now looking at the statement of cash flows, we generated strong operating cash flow of nearly $5.1 billion and free cash flow of $3.9 billion. In the fourth quarter, we paid $341 million in dividends and we repurchased approximately 1.7 million shares of stock for $133 through the open market. For the year, we paid $1.3 billion in dividends and repurchased $3.1 billion of stock for the year.", "In January, our board of Directors authorized a new $5 billion share repurchase program. The new program has no expiration date, therefore, our combined purchasing power under the share repurchase program, we have a total authorization of approximately $6.9 billion.", "Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. As Robert and Richard indicated, we've made meaningful progress this year against our strategic priorities. While we are pleased with the strategic milestones, we do recognize that we have an opportunity to improve execution to ensure greater success in the future. We are focused on improving conversion, gross margin, and inventory management. In addition, customer expectations in the retail landscape are rapidly evolving, and corporate tax reform provides incremental cash flow. As a result, we are accelerating our investments to enhance our ability to serve customers.", "We'll be taking the necessary actions to transform our supply chain, better empower our associates, and continue to deliver compelling product experiences. In 2018, we expect a total sales increase of approximately 4% driven primarily by comp sales increase of approximately 3.5%. We do anticipate opening approximately ten stores. On a GAAP basis, we are expecting operating margin decline of approximately 30 basis points. While we expect flat gross margin for the year as we improve execution, incremental expenses associated with our strategic investments will pressure SG&A.", "Factoring in the benefits of tax reform, which are approximately $750 million in 2018, effective tax rate is expected to be 25.5%. For the year, on a GAAP basis, we expect earnings per share of approximately $5.40 to $5.50. We are forecasting cash flows from operations of approximately $6.5 billion and capital expenditures of approximately $1.7 billion. This is expected to result in estimated free cash flow of approximately $4.8 billion for 2018, and our guidance assumes approximately $2.5 billion in share repurchases.", "As we look at our results, along with our decision to accelerate strategic investments, we are reevaluating our long-term targets. We plan to provide a full update on our business strategy and long-term outlook at our analyst and investor conference in December. Until that time, I'd like to share some parameters that we're applying as we reevaluate our long-term targets. First, the outlook for the home improvement industry over the next few years remains solid. As such, we continue to expect an average annual sales increase of at least 4%. Second, we expect operating margin to improve after 2018 even while we continue to invest in the business and we are diligently working to improve productivity in order to provide greater confidence in the operating margin targets we plan to communicate in December. Finally, we remain committed to our current shareholder distribution target, returning approximately $14 billion to shareholders through 2019.", "...", "Regina, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "To ask a question, press *1 on your telephone keypad. To withdraw a question, press the # key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one followup.", "Our first question will come from the line of Brian Negal with Oppenheimer. Please go ahead." ] }, { "name": "Brian Negal", "speech": [ "Hi, good morning. A couple of questions. First off, with respect to the investment plan or the strategic plan you laid out on the call, how should we think about, as we go through 2018, the sort of -- the investment, the cadence of investments along those lines and the potential benefits in terms of sales and other metrics? How should those line up?" ] }, { "name": "Marshall Croom", "speech": [ "I'll take the top line first. This is Marshall. Basically as we think about our sales progression and comps, we would slightly expect sales to be higher in the first half of the year. As you recall, first quarter was our easiest comparison as we head into '18. So first half sales will be slightly higher than second half. But as far as capital expenditures and expenses throughout the year, we'll be leaning that throughout the year. But excuse me, we do expect -- so, we manage to stabilize gross margin that not only the capital expenditures but the expense associated with some of these initiates will put pressure on SG&A." ] }, { "name": "Richard Maltsbarger", "speech": [ "And Brian, as noted during my comments -- this is Richard -- a few of the nationwide rollouts that we have such as the paint service experience, as well as some of the enhancements to the digital tools in the hands of our associates are back-loaded." ] }, { "name": "Brian Negal", "speech": [ "Got it. Then the second question, more of as a followup, if you look at the cadence of comps through the quarter, it was weak to start, weak to end, and stronger in the middle. Is there something that explains that, that basically what we saw through the quarter?" ] }, { "name": "Richard Maltsbarger", "speech": [ "Yes, it's largely function of the holiday sales that we experienced. So as we mentioned, we were pleased with the appliance sales growth. A majority of our appliance sales are scheduled to be delivered. They're not take-with. As a result, a lot of those sales over Black Friday and that holiday period were delivered in December, and it's not until they're delivered or customer takes possession that we recognize that revenue. So that creates some lumpiness of the 1.1 comp in November to the 7.7 in December." ] }, { "name": "Brian Negal", "speech": [ "Is there a way that -- just that one piece, can we quantify it, the shift between those two months?" ] }, { "name": "Richard Maltsbarger", "speech": [ "Yes, Brian. As another way to think about it, is you look at the comp progression not including the impact of deferred sales. It was roughly kind of mid-three comp in November and January and roughly mid-four comp in December." ] }, { "name": "Brian Negal", "speech": [ "Got it. Thanks a lot. Good luck." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Eric Bosshard with Cleveland Research. Please go ahead." ] }, { "name": "Eric Bosshard", "speech": [ "Thank you. Sorry about that. Thank you. Sorry about that. Two questions for you. First of all, the 4Q margin I think was below the guidance you had given 90 days ago, so just curious if you could summarize again the moving pieces with the MAT. And then secondly, excited to hear about the incremental investments to grow the business in '18, and you talked about taking advantage of the tax savings of $750 million, but I wondered if you could just quantify the amount of incremental investment that you're making in 2018." ] }, { "name": "Mike McDermott", "speech": [ "Eric, this is Mike McDermott. I'll touch on the gross margin question. In the fourth quarter, we meaningfully exceeded our expectations in the appliance category, growing significant market share. As a result of that, that had an impact on both our mix and our rate from a margin perspective. The other thing we did, as you recall, in the second quarter of 2017, we focused on getting more competitive and improving our value perception to make sure that we could take advantage of the available market opportunity. Those actions continued in the fourth quarter, and yet we're only partially offset by our value improvement initiatives, working closely with our vendors on first cost, and some early price optimization benefits as we're in early innings of rolling out analytics tools and capabilities to drive that optimization. As we look into the new year, I think we're in a solid competitive position to continue to offset the impact of any competitive pricing actions through the rollout of those tools that I mentioned a moment ago, and we'll continue to work on value improvement with our vendors, ultimately delivering flat gross margin in 2018." ] }, { "name": "Marshall Croom", "speech": [ "Eric, this is Marshall. Just one other factor for fourth quarter gross margins is as we were going through out integration process with RONA, we did have some accounting harmonization that impacted gross margin in the quarter. So that was just another small factor of the pressure we experienced there. To your second question on the incremental capital that we plan to expend in 2018 as a result of tax reform, it's about 85% of that we will be investing in 2018. So we recognize this as an opportunity, and largely where we're spending that, if you think about our capital expenditures going from roughly $1.1 billion in '17 to $1.7 in '18, 45% of that $1.7 billion will be on strategic initiatives. That's almost triple of what we spent in 2017. So again, the opportunity to lean into the omnichannel capabilities that we need to build to expand customer reach and relevancy, and to further drive the six planks that Richard spoke to earlier." ] }, { "name": "Eric Bosshard", "speech": [ "Great. And then just one last question if I could circle back with Mike McDermott. How do you think about the balance between the incremental promotional spending, getting a bit more aggressive on price and effective, and then the market share performance? And I know that, you know, looking at you relative to Home Depot is just one way to look at it, but how do you -- how do you look at the incremental spend and then the market share performance?" ] }, { "name": "Mike McDermott", "speech": [ "Well, Eric, look. When I take a look at incremental spend, I look at both price as well as traffic. And we had some incredible performance as it relates to our efforts to improve our customer awareness as well as drive traffic and engagement through that awareness through optimizing our marketing spend and better balancing our digital and mass media approach to make sure we're engaging customers at the right time with the right content. As it relates to both promotional and pricing spend, we simply have to be competitive, and that is our focus. The opportunity to continue to drive optimization is what we see ahead of us in 2018." ] }, { "name": "Robert Niblock", "speech": [ "Eric, this is Robert. I would just add on that I think we're pleased with the work that Mike and his team have done from a promotions standpoint. The additional traffic has driven the consumer awareness, those types of things, as Richard and I both outlined. Opportunity is to take that traffic and drive a greater conversion. And that's what Richard and his team are working on with some of the strategic investments that he talked about with focusing on investing in our associates to make sure that they have all the tools, the training, the capability. We have the right coverage for day part hours, those types of things, to ensure that we're then converting that traffic into sales. So that's a big focus area that we're -- that Richard and his team are focused on as we head into 2018." ] }, { "name": "Eric Bosshard", "speech": [ "That's helpful, thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Christopher Horvers with JP Morgan. Please go ahead." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, and good morning. Can you talk about the appliance category? It sounds like you did extremely well in that category. Any further quantification of what double-digit growth is? Is that closer to the 20 than to ten? And somewhat related to that, traffic was down in the fourth quarter. What do you think the drivers of the down-traffic were?" ] }, { "name": "Richard Maltsbarger", "speech": [ "I'll just reinforce that we had double-digit comps in appliances and feel good that the combination of our messaging, our assortment, our brand partnerships, and our product offering continue to resonate very, very well with the customer. We are the leader in that space and continuing to drive leverage as a result of that leadership position with fantastic displays and great engaged associates. So I continue to see runway in the appliance space as we lean into that market share opportunity that exists." ] }, { "name": "Robert Niblock", "speech": [ "Chris, this is Robert. Just to clarify, it was not traffic that it was down, it was transactions that were down. As I just indicated in my followup with Eric on the earlier question, we're driving the traffic. It's the conversion of that into transactions. And as we mentioned, as Richard said in his comments, we put the labor there. We realize we've got to put more than just the labor there. So we've made the labor investments. Now we need to make the incremental investments to ensure that we convert that traffic into transactions." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. That's a great segue. As you think about the labor model and the change that you've made, are you thinking about structurally changing how you allocate labor whether it's full-time versus part-time, the algorithms that you've put in place with the new system last year. How does the overall labor strategy shift going forward?" ] }, { "name": "Richard Maltsbarger", "speech": [ "This is Richard. The reality is that over the last couple of weeks, I've had the opportunity to go into stores across five different states, speak directly with our associates, understand some of the challenges that are happening in our aisles every day, and the emphasis I would put on are a few areas. First and foremost, it's really the mix of our selling and tasking hours. How do we go about getting the work done in our stores every day to enable our red-vest associates to be in front of the customer when it's time to serve. Second focus we have on, as Robert noted, is having the labor hours in the store necessary, having associates ready through our training and our knowledge programs to be ready to serve is just as necessary. So reinvestments in actions that we are taking right now during spring hiring to bolster that area. Third, reengineering some of our key processes as noted during my comments and Robert's. Our pick-up in store experience as an example. We have an upgraded experience both in the physical layout as well as in staffing and training model going out in Q1 as well as to Robert's comment on centralized quoting, an opportunity to speed up our process by centralization and greater support for our in-store associates to allow them more time to serve the customers that are with them every day. And then finally, upgrading our digital management tools, giving a chance for our associates to get more productive with the hours that we invest into tasking. So when you look across those investments from the mix of tasking to selling to our associate readiness to reengineering key processes to better empowering our associates with the right tools, those are some of the initial focus areas as we move into the year." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Seth Basham with Wedbush Securities. Please go ahead." ] }, { "name": "Seth Basham", "speech": [ "Thanks a lot, and good morning. My question is a followup on the conversion issue. If you could just give us a sense of how conversion trended through 2017 and how much of an improvement you expect in 2018, and what the biggest driver of that is going to be. Is it the training and knowledge programs or something else? Thank you." ] }, { "name": "Richard Maltsbarger", "speech": [ "Absolutely. As I just noted, the challenges we have had from conversion have steadily been a challenge as we move throughout the year. In fact, it really is an opportunity, as we have driven the traffic, we know that the customer is interested in our offer. There is the demand for what we're bringing to the marketplace. Really, the conversion challenge has grown as the traffic has grown. We have begun to address it, and the steps that we had to take necessarily in the payroll action in the back half of the year, and now it is simply a matter of ensuring that our associates are more ready to field that traffic." ] }, { "name": "Seth Basham", "speech": [ "And a followup on that. In terms of the readiness, is the fact that you had a lot of employees that weren't quite qualified for their jobs or weren't trained for their jobs, or were in the wrong places?" ] }, { "name": "Richard Maltsbarger", "speech": [ "The biggest focus that has come from my conversations with our teams in the field right now is greater role clarity and greater understanding of who's going to field what particular aspects of the project cycle and being able to improve the execution of that." ] }, { "name": "Seth Basham", "speech": [ "Thank you, and good luck." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Matt Fassler with Goldman Sachs. Please go ahead." ] }, { "name": "Matt Fassler", "speech": [ "Thanks a lot. Good morning. I want to follow up on gross margin. So, gross margin I think was down all four quarters of this year, and I know there's been some mix issues and Canada coming into the mix earlier on probably impacted that as well. But given the commitment to deliver a comp that's level with what you've been putting up in a pretty strong backdrop, and given the fact that value improvement has been part of the agenda for quite some time, why the confidence that with mix moving against you and with the desire to continue to hold or gain market share, at this moment, the gross margin is -- can stabilize while you achieve everything else you're trying to get done here?" ] }, { "name": "Mike McDermott", "speech": [ "Hey, Matt. This is Mike McDermott. Obviously we have seen gross margin decline throughout 2017. Most of the actions we put in place started in the second quarter of '17, so we're going to have the ability to lap those activities. We've been working to optimize throughout the year to improve our promotional effectiveness and reduce our spend while continuing to drive traffic. We've seen some pretty good results in the third and the fourth quarter there. And then we've got some new tools to really focus on price and promotional optimization that would give us the ability to offset any inflation impacts that we're experiencing primarily in the lumber and building material space while at the same time making sure that we remain competitive and minimize the spend to do so. Value improvement is an ongoing initiative of us working closely with our vendor partners to make sure that we've got the most efficient and effective way to deliver value to our customers moving all the way through our supply chain to the prices and promotions that we offer to close the sale. I think the combination of all of those activities give me confidence that we'll deliver flat gross margin in 2018." ] }, { "name": "Matt Fassler", "speech": [ "And just a quick followup on that. You know, obviously inventory has the potential to be a factor here, and inventory growing faster than a fairly health sales rate I know doesn't make it any easier to drive gross margin improvement. So can you talk about your expectations for inventory growth relative to sales growth over the course of the year and whether working that down will require any measures that would impact gross margins as well." ] }, { "name": "Richard Maltsbarger", "speech": [ "Absolutely, Matt. This is Richard. I'll talk about some of the actions we're taking to manage inventory and then allow Mike if he wants to weigh in further with any estimated impact. But as noted in our guidance, right, we are going to focus on the improvement of our inventory management. We believe we've made the investments in the inventory, in our system, to support the strong sales growth we're seeing in categories such as appliances and tools. Right? Now the onus is on me as I get into the role to continue working with our teams to understand what changes in the flow of our supply chain, what changes in the interactions between our supply chain and our stores, and what changes in specifically having inventory in a shopable position for customers when they come in to demand the purchase are necessary to continue to manage at roughly a flat to slightly up inventory that is less than our rate of sales growth during 2018." ] }, { "name": "Matt Fassler", "speech": [ "Much appreciated, guys. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Mike Baker with Deutsche Bank. Please go ahead." ] }, { "name": "Mike Baker", "speech": [ "Hi, guys. Wondering if you could tell us how you measure traffic and conversion and share some trends on that metric over the year?" ] }, { "name": "Richard Maltsbarger", "speech": [ "Yeah, absolutely, Mike. This is Richard. We leverage video analytics and the tracking of the movement of customers into our stores and measure that up against the transactions that we are able to execute through our registers and the rest of our activities with customers." ] }, { "name": "Mike Baker", "speech": [ "So can you share some metrics on that? So you're saying traffic was up. Frankly, we don't see it in the data that you provide in terms of the number of transactions. So again, if you could help give us confidence in that metric and then also what that would imply for conversion, how that has changed throughout the year." ] }, { "name": "Richard Maltsbarger", "speech": [ "Not at this time, Mike." ] }, { "name": "Mike Baker", "speech": [ "Okay, then I'll ask just one more quick followup. Marshall, you talked about CapEx going from 1.1 to 1.7, then you said 45% of that is on initiatives. Is that 45% of the incremental $600 million or 45% of the total $1.7 billion?" ] }, { "name": "Marshall Croom", "speech": [ "It's 45% of the total $1.5 billion. The 85% was reference to kind of the proportion of the tax reform benefits that we're going to see in 2018." ] }, { "name": "Mike Baker", "speech": [ "Understood. So if it's 45% of the total and then that's up three times versus last year, so the incremental CapEx accounts for most of that 85% of the tax reform, I guess then my question is, is there an SG&A component? Why would SG&A be down 30 basis points on a 3.5% or 4% comp, or sales growth number, where, you know, you'd otherwise expect that to be up with the typical leverage that you get?" ] }, { "name": "Marshall Croom", "speech": [ "With a lot of these programs and initiatives, there are expense components to deliver some of the strategic initiatives that we do have going on in 2018. So that's just noted pressure that we would expect in SG&A." ] }, { "name": "Mike Baker", "speech": [ "Above and beyond the investment in CapEx from the tax reform?" ] }, { "name": "Marshall Croom", "speech": [ "Yes, there's a CapEx component and an expense component." ] }, { "name": "Mike Baker", "speech": [ "Understood. Okay. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Scott Ciccarelli with RBC Capital Markets. Please go ahead." ] }, { "name": "Scott Ciccarelli", "speech": [ "Good morning, guys. Are you -- have you made any chances in your terms with any of your vendors? I guess I'm trying to understand the payable and inventory ratio a little bit better." ] }, { "name": "Richard Maltsbarger", "speech": [ "There's no significant changes. Part of this was just due to timing, kind of comparing this year to last year. We're still looking at terms and where it makes sense to extend terms where we can. But it's all part of the balance that we have with our value improvement process and ongoing vendor negotiations. We do expect to improve that in '18, but it was just really a matter of timing of some of the seasonal build and buy toward the end of the year." ] }, { "name": "Scott Ciccarelli", "speech": [ "So one of the things that I know that kind of gets negotiated between vendors and retailers is, you know, kind of pricing or gross margin targets, if you will, coupled with kind of payment terms. Is there any change in thought process regarding what is a more important aspect or metric to Lowe's?" ] }, { "name": "Richard Maltsbarger", "speech": [ "Not at this point in time. We'll always kind of factor in net what we think is beneficial for us and beneficial for our ongoing relationships with the vendors." ] }, { "name": "Scott Ciccarelli", "speech": [ "Okay, got it. Thanks guys." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Gregory Melich with MoffettNathanson. Please go ahead." ] }, { "name": "Gregory Melich", "speech": [ "Hi, thanks guys. I just had two questions. One was on the reinvestment of the tax savings, just to make sure I got that right. It sounds like there's maybe 30 BIPs on the income statement which would be about $200 million, and then a portion of the CapEx of that increase from 1.1 to $1.7 billion is because the tax reform has given you more money. But it probably -- CapEx probably would have gone up at least several hundred million anyway. Is that a fair way to think about it?" ] }, { "name": "Marshall Croom", "speech": [ "Yes. I mean, you know, first and foremost, as we think about our capital allocation philosopher is to first invest strategically in the business to maintain the run and improve and enhance the business. So that is always going to be the first pillar. So one is we're reflecting on where we were in the marketplace, the initiatives we need to get under way. This provided a good backdrop to be able to enhance and ramp and accelerate our capital investment as we lean into 2018." ] }, { "name": "Gregory Melich", "speech": [ "So it sounds like out of that $600 million increase in CapEx this year, a portion of it, you know, maybe half of it, was related to the tax reform, and you would have been doing a lot of these things anyway, you're just accelerating things that were coming? That's fair?" ] }, { "name": "Marshall Croom", "speech": [ "Yes. Correct. Accelerating as actually it was about 85% of the tax reform benefit that we're going to see in '18 that is helping fuel the incremental CapEx." ] }, { "name": "Gregory Melich", "speech": [ "Got it." ] }, { "name": "Marshall Croom", "speech": [ "But yes, we would have accelerated the CapEx spend to get after our strategic initiatives." ] }, { "name": "Gregory Melich", "speech": [ "Regardless. Perfect. So then the second question was on RONA. I think Robert you had mentioned in the beginning that the integration is going well and that, you know, doubling the profitability goal over the next four or five years is still there. Could you help us understand how much RONA improved or helped corporate margins last year in '17 and what is in your guidance for this year in '18 in terms of RONA Improvement?" ] }, { "name": "Robert Niblock", "speech": [ "Yeah. Like I said, you know, things are going well at RONA. We're pleased with the performance from how it blends in from margin standpoint. Marshall?" ] }, { "name": "Marshall Croom", "speech": [ "Yeah, we should be cycling from a gross margin standpoint as we anniversaried the acquisition. We did have some -- just again, some minor cleanup that put some pressure in the fourth quarter, but we are on a good trajectory to doubling the profitability of RONA or Canada by 2021." ] }, { "name": "Gregory Melich", "speech": [ "Got it. And then last, just to make sure I understand --" ] }, { "name": "Richard Maltsbarger", "speech": [ "I was going to say Greg, this is Richard. Not being too far removed from the old job yet, RONA was not a significant improvement to operating margin in 2017, nor was it planned to be. However, 2018 is when we begin to see more significant movement on the operating margin." ] }, { "name": "Gregory Melich", "speech": [ "That's great to hear. And then last, just gross margins flat this year, and on the sales standpoint, you guys think the first half is stronger. It sounds like the SG&A investments won't really build until the second or third quarter?" ] }, { "name": "Marshall Croom", "speech": [ "Well, it's just slightly higher in the first half, but from a capital expense standpoint, again, we are trying to accelerate our investments throughout the year." ] }, { "name": "Robert Niblock", "speech": [ "And part of the sales is because you think about we didn't have a strong spring last year, so being cycling against weaker numbers." ] }, { "name": "Gregory Melich", "speech": [ "Got it. Thanks. Good luck, guys." ] }, { "name": "Robert Niblock", "speech": [ "Regina, I think we have time for one more question." ] }, { "name": "Operator", "speech": [ "Our final question will come from the line of Michael Lasser with UBS. Please go ahead." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. So arguably, you made some investments over the last several quarters in areas like labor and promotions, and they produced somewhat mixed results. Now you're accelerating investments in different areas. But how do you ensure that you produce a suitable return that will be attractive to your P&L as you accelerate those investments?" ] }, { "name": "Robert Niblock", "speech": [ "I'll start, Michael. Certainly you mentioned a couple of things, labor and promotions. I think we've looked from the promotional aspect, I think we've been pleased with the investments we've made. As I said, driving the traffic, the brand awareness, those type of things. Certainly as we motioned, we have challenges from the conversion standpoint that we're working on. As Richard mentioned -- and he can further elaborate -- we've made the investments in labor. Now it is going in and supplementing those investments that we've made to make sure we have the training, the tools, the other components that are necessary so that we have the associates in front of the customer there ready to buy. And Richard, I'll let you ..." ] }, { "name": "Richard Maltsbarger", "speech": [ "Michael, all I would add to that is several of the things that we talked about investing further in in the back-half of the year for nationwide rollouts we've had under test over the past several months or weeks to be able to get the early signs of success, and that really is the approach that we're going to take. A great example is the pick-up in store experience that's currently rolling out in Q1. We've had -- actually had that and a team dedicated to that since last August testing it in a handful of stores slowly going to a greater level of investment and iterating along the way to ensure that we're getting the maximum value out of the investment we're going to make prior to going to a nationwide rollout. In fact, the iteration that is going to currently roll out is the fourth iteration of that test already in the past six months in order to make sure that we're maximizing the return from all components to physical space change, to training of the associates, to shifts in the processes, to reengineering of how we do that, and the dedicated labor before we decided to take it to a nationwide rollout during the latter part of March and April." ] }, { "name": "Michael Lasser", "speech": [ "And my followup -- yeah, please." ] }, { "name": "Marshall Croom", "speech": [ "I'm going to pile in with one more comment. It just want to make it clear that the leadership team is aligned and focused on the areas that we've highlighted on the call. You think about stabilizing gross margin, improving conversion, improving inventory management along with getting after it from the six strategic planks. So I think that's just something that I do want to reemphasize and that we are working with a sense of urgency along all of those fronts." ] }, { "name": "Michael Lasser", "speech": [ "My followup question is that I think we all appreciate the commentary you made around the longer-term guidance, and it was helpful. So if we assume kind of sales remain where they are, flat-ish gross margin, can you give us a little sense of the operating leverage in the business now with all the different changes that are going on and all the different changes that have taken place over the last few years. It's become harder to understand the way the leverage point of the business is, or in a normal run rate environment, how fast your expenses grow relative to the rate of your sales growth." ] }, { "name": "Richard Maltsbarger", "speech": [ "At this point in time, we're given the high level of sales growing at least 4%, the total shareholder distributions sticking to the $14 billion there, and then just really the improvement of operating margin from 2018 levels. We expect those to improve from where we're setting that target in '18. That being said, we do plan on updating longer-term guidance when we get to our December investor and analyst conference." ] }, { "name": "Robert Niblock", "speech": [ "And Michael, I would just add -- I would just add on that if you think about one, the investments that we're making in the business. Two, some of the investments we made last year as Richard has spoken, him and Mike are working together, diving into the investments we've made, trying to figure out how can we get better performance out of those and then ensuring, as we're doing the test and learn before rollout that they're working on, as we head into 2018. You know, before we go out and commit to additional targets like that, we want to give time for them to be able to continue to dive into the business, understand the opportunities for improvement, and be in a position to really be prepared as we get to December to provide you guidance, longer-term guidance that we think we'll have great confidence in. So at this point, we just don't want to get ahead of ourselves." ] }, { "name": "Michael Lasser", "speech": [ "That makes sense. And if I could ask more maybe qualitatively, Robert, are you looking on all these investments and in the changes in the six pillars with the lens that you're looking to take the business to be more efficient and maybe produce more leverage over time as you do grow sales?" ] }, { "name": "Robert Niblock", "speech": [ "Absolutely, yeah. Yeah, we know that certainly we've got some investment we've got to make in the business. We've talked about the supply chain investments we're making. We know that as the businesses continue to move, consumer expectations have moved, so we've got investments we're making in our supply chain. Some of those will pay dividends in 2018, some of them will be further into the future. But yeah, absolutely. That's what we're wanting to do, is making sure that we're as we're investing in the business have the right people in front of the customer at the right time, supporting that with supply chain, supporting it with technology, that we're getting greater leverage points to be able to drive improved operating margin in the future. That's what we're after. Focused on diving into that in '18 so that we can be in a good point to provide you exactly how we're going to get after it and where it's going to be delivered when we get to our analyst conference in December." ] }, { "name": "Michael Lasser", "speech": [ "Thank you so much." ] }, { "name": "Robert Niblock", "speech": [ "Great. Thanks, Michael. As always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our first quarter 2018 results on Wednesday, May 23rd. Have a great day.", "..." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, this concludes today's conference. Thank you all for joining, and you may now disconnect." ] }, { "name": "Michael Lasser", "speech": [ "More LOW analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
LOW	2021-11-17	[ { "description": "", "name": "Kate Pearlman", "position": "Other" }, { "description": "Chairman, President, and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice president, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Dave Denton", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Guggenheim Securities -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "Oppenheimer & Co. Inc. -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies third quarter 2021 earnings conference call. My name is Sherry, and I will be your operator for today's call. As a reminder, this call is being recorded. I will now turn the call over to Kate Pearlman, vice president of investor relations." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you and good morning. Here with me today are Marvin Ellison, chairman, president, and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president, stores; and Dave Denton, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2021.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the Quarterly Earnings section of our Investor Relations website.", "Before we turn to our third quarter results, I would like to announce that we will be hosting a Lowe's 2022 Financial Outlook virtual investor event on Wednesday, December 15 from 8 to 9 a.m. Eastern Time. We would like to provide greater transparency around our 2022 expectations in this still uncertain operating environment. Marvin will speak to the key growth initiatives in our Total Home strategy, while Dave will outline our 2022 financial targets and priorities to assist with your modeling.", "After our prepared remarks, we will host a Q&A session. With that, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate, and good morning, everyone. Our momentum continued this quarter with comparable sales up 2.2% for the total company and 2.6% for the U.S. on top of over 30% growth last year. This resulted in comp sales of 33% for the total company and 33.7% for the U.S.", "on a two-year basis. These outstanding results were driven by disciplined execution of our Total Home strategy, which allowed us to grow our share of wallet with both Pro and DIY customers as they gain confidence in Lowe's as the right destination for all of their project needs. Our results also benefited from the great work by our merchants and supply chain teams who delivered competitive in-stock positions as we leverage our scale and carrier relationships to build inventory in key high-demand categories despite widespread disruption in the global supply chain. Later in the call, Bill will discuss how we are navigating these unprecedented challenges in order to meet the continued strong demand for home improvement products.", "After Labor Day, we saw an increase in DIY demand on the weekends as travel activity slowed down and children returned to school. As a result, consumers were once again spending more time on projects in their homes. Our elevated product assortment across our home decor offerings are resonating with consumers, resulting in particularly strong performance in appliances and flooring and contributing to an 11% increase in ticket over $500. The strength in the higher-ticket categories reflects the continued consumer confidence in their homes as a sound investment and reflects the early success of our Total Home strategy.", "We're also making significant progress growing Pro sales. Pro once again outpaced DIY this quarter with Pro growth over 16% and over 43% on a two-year basis. Over the past two years, we have relentlessly focused on improving the Pro offering in our stores and online with better service levels, deeper inventory quantities, a more intuitive store layout combined with an increased number of Pro national brands. As we continue to drive higher Pro growth, we will increase sales productivity and operating leverage across our stores.", "Later in the call, Bill will discuss our continuing efforts to expand our Pro product offerings, and then Joe will discuss how we continue to enhance our Pro shopping experience. For the past 18 months, the home has increased in importance for all of us and perhaps especially for our baby boomer customers, who are increasingly interested in aging in place in their own homes. This morning, we are delighted to announce the launch of our Lowe's Livable Home product and installation services in a unique collaboration with AARP. We will offer affordable on-trend solutions like walk-in bathtub, grab bars, stairlifts, nonslip floors, pull-down cabinets and wheelchair ramps.", "These solutions will help our customers modify their homes to fit their lifestyle needs. Our collaboration with AARP will leverage their trusted brand and expertise as we help to educate our customers on how to approach aging in place. We look forward to updating you on this very exciting initiative on future calls. Now turning to Lowes.com.", "Sales grew 25% on top of 106% growth in the third quarter of 2020, which represents a 9% sales penetration this quarter and a two-year comp of 158%. As we modernize our omnichannel offering, we continue to gain traction with consumers who increasingly expect a seamless integrated shopping experience. And as a further indication of the strides we've made in upgrading our dot-com platform, I'm pleased to announce that we have recently launched Lowe's' One Roof Media Network. Our recognition for the first time in 17 years as Fortune's Most Admired Specialty Retailer and our inclusion as one of the top three marketers of the year in Ad Age's annual list means that we are well positioned to put our vendor partners at the forefront of the home lifestyle movement, helping them to capitalize on the shift in consumer behavior and sentiment toward the home.", "We're excited to participate in this rapidly growing segment of digital advertising. During the quarter, operating margin expanded approximately 240 basis points, leading to diluted earnings per share of $2.73, which is a 38% increase as compared to adjusted diluted earnings per share in the prior year. Our improved operating performance continues to reflect the great execution of the team, as well as the benefits of our new price management system and the success of our perpetual productivity improvement initiatives, or PPI. Dave and Joe will provide further details on both of these initiatives later in the call.", "Now turning to our results in Canada. While our performance lagged the U.S. as the Canadian business is more heavily weighted toward lumber, the Canadian leadership team remains focused on driving productivity by leveraging technology and processes that have already yielded strong results in the U.S. I'd now like to take a moment to discuss how we're expanding our fulfillment capabilities to meet the ever-increasing consumer demand for omnichannel shopping solutions.", "This quarter, we completed the conversion of our second geographic area, the Ohio Valley region, to the market-based delivery model for big and bulky product, building on the success we gained in Florida. As a reminder, in the market-based delivery model for big and bulky products flowing from our supply chain directly to consumers' homes, bypassing the stores all together. This replaces the legacy store delivery model, which is highly inefficient and relies on each store to function as its own distribution node for these products. This new delivery model is already driving higher sales in appliances, improved operating margins, reduced inventory and higher on-time delivery rates.", "We plan to complete the rollout across the entire U.S. over the next 18-plus months. Now let's talk about the importance of culture at Lowe's. This year, we're celebrating our centennial with a $10 million investment in 100 communities across the country with projects ranging from renovating homeless shelters, updating youth centers and addressing unique needs for communities all around the country.", "You can go to Lowes.com and see a full list of all 100 community projects. This is our way of expressing our appreciation for our loyal customers and paying tribute to the company's long-standing commitment to community service. In addition to commitment to the community, at Lowe's, we are proud of our relationship with and support of our military veterans and active-duty service members. This is demonstrated by the $1 billion in discounts that we give our military families in our country this year through our Military Discount program.", "Joe will discuss this program in more detail later in the call. Before I close, I would like to extend my appreciation for our frontline associates. Every week, I'm fortunate to travel across the country visiting stores, and I'm impressed by our associates' resilience and commitment to serving our customers and our communities. And I'm very pleased to announce that for the seventh consecutive quarter, 100% of our stores earned a Winning Together profit-sharing bonus.", "This $138 million payout to our frontline hourly associates is $70 million above the target payment level and reflects our appreciation for the hard work of our hourly workforce. And with that, I will now turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. In the third quarter, U.S. comparable sales increased 2.6% and 33.7% on a two-year basis as our Total Home strategy continues to gain traction with our DIY and Pro customers. This quarter, we drove positive comps across our home decor and hardlines divisions.", "Comps in the building products divisions were down slightly as compared to the prior year as we cycled over a period of extremely high DIY demand for lumber. Growth continued to be broad-based on a two-year basis with all product categories up more than 17% in that time frame. In our home decor division, appliances and flooring delivered standout performances as we leveraged our competitive in-stock positions and updated product assortments to deliver strong positive comps on top of 20% growth in these categories last year. Within appliances, sales of refrigerators, freezers and washers and dryers were particularly strong.", "In flooring, vinyl flooring remains the top-performing category supported by innovative product like the WetProtect from Pergo, which is exclusive to Lowe's. And we are pleased to see the new product offerings in our own allen + roth brand resonating with our customers, like the new allen + roth Lifestyle Performance rugs. These rugs have the appearance of an indoor rug, but they are hose-washable, which makes them ideal for busy families with kids and pets. Turning to our performance in our hardlines division.", "Customers also invested in outdoor entertainment and upgrading their outdoor living spaces, as well as holiday decorations for their homes and yards, driving strong positive comps in seasonal and outdoor living and lawn and garden, resulting in two-year comps over 43% in each category. We were also pleased with our performance in Halloween as we've sold through much earlier than in previous years. And our early sales of holiday trim and tree are tracking ahead, as well as consumers are getting a jump start on their holiday decorating. In addition to early sales of holiday, we have also seen customers purchasing cold weather products like snow throwers earlier than in years past.", "With broader awareness of potential global supply chain disruptions, we are seeing many consumers looking to purchase products as soon as they are available in our stores. In the quarter, we also leveraged our No. 1 position in outdoor power equipment to deliver over 20% growth in battery-operated outdoor power equipment. Both our DIY and Pro customers are enjoying the zero-emission rechargeable products available in the EGO, Kobalt, CRAFTSMAN and Skill brands.", "We continue to expand our brand and product assortment, building on the powerful lineup of brands that include John Deere, Honda, Husqvarna, Aaron's and CRAFTSMAN. In building products, comps were down slightly due to a decline in DIY lumber sales despite double-digit comps in electrical and strong positive comps in rough plumbing and building materials. We feel good about the traction that we are gaining with the Pro customer as we continue to build out our product assortments that are tailored to their needs. This quarter, we completed the launch of the SPAX fastener program in our stores.", "SPAX is the market leader in multi-material construction screws. We also continue to build out our Pro power tool accessory program with new launches from Spyder and DEWALT. This quarter, Spyder will be launching their new TARANTULA circular saw blades, offering seven new options to tackle a wider variety of tough construction jobs, all of which are exclusive to Lowe's. And DEWALT will be launching their new ELITE SERIES circular saw blades, which are designed to maximize productivity for heavy-duty projects, and these will also be exclusive to Lowe's.", "These new products are strong additions to our Pro brand lineup, which includes great programs like Simpson Strong-Tie, DEWALT, Metabo, Bosch, Spyder, GRK, FastenMaster, ITW, Lufkin, Marshalltown, Estwing, Eaton, SharkBite and LESCO and the recent additions of FLEX, SPAX and Mansfield. Now shifting to Lowes.com. We delivered sales growth of 25% in the quarter and 158% on a two-year basis. Following the launch of Lowe's virtual kitchen design and visual search in Q2, we enhanced our omnichannel customer experience with the introduction of our paint visualizer on Lowes.com in the third quarter.", "We are continually working to remove friction from the buying process and to fully integrate the online and in-store shopping experience. Before I close, I'd like to discuss how we're navigating the unprecedented disruptions across the global supply chain that are impacting the retail industry. As one of the largest importers in the U.S., we are fortunate to be able to leverage our scale and carrier relationships to secure shipping and transportation capacity and work to minimize the impact of cost increases. We're also taking a very proactive approach by ordering inventory earlier than the years past, including our seasonal buys for both 2021 and 2022.", "This gives us more time to manage through any unforeseen delays in either the production or the distribution of our orders. Once the product lands in the U.S., we are able to leverage our growing network of coastal holding facilities so that we can hold the product upstream from our regional distribution centers and bulk distribution centers until it's needed. From there, we can quickly flow the product to the right areas of the country. Looking ahead, we are ready to flex our seasonal pads to a variety of different winter and early spring offerings after we sell through our trim and tree product.", "The investments that we made in the U.S. stores reset last year expanded our operating capabilities and has allowed us to respond rapidly to the changing consumer shopping habits, like the early season buying that we're seeing right now. Once again, I'd like to thank our merchants, supply chain team and our vendor partners for their hard work and support, which has allowed us to manage through this changing environment. Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Bill, and good morning, everyone. As Marvin mentioned, this quarter, 100% of our stores earned their Winning Together profit-sharing bonus, resulting in a payout of $138 million to our frontline hourly associates. I would like to thank our associates not only for their outstanding execution this quarter, but for their commitment to the communities during the numerous severe weather events across the country. The current hiring environment remains competitive, and we continue to align labor to meet demand.", "Our labor management system has allowed us to serve the needs of our customers while addressing the lifestyle demands of our associates. Lowe's offers a unique opportunity for job seekers as we foster a culture that is geared toward associates' skill and career development. During the quarter, we expanded Lowe's University leadership curriculum across all of our stores. Lowe's U provides all associates with new learning and development opportunities in addition to the standard onboarding courses.", "Our program provides small digestible lessons that improve their product and how-to knowledge and is tailored to the associate's role. The additional training complements their existing knowledge and supports improved customer service and leadership development. Lowe's University is available for all store associates via our smart mobile devices on the sales floor or in the newly created Lowe's U learning labs in our stores, and we continue to expand it into our contact centers, as well as our distribution centers. In addition to competitive wages and benefits and rewarding career opportunities, Lowe's U will play a pivotal role in our efforts to retain an experienced and engaged workforce.", "I'd also like to provide you with an update on our perpetual productivity improvement initiatives, which continue to drive payroll leverage through the quarter. As a reminder, PPI is an ongoing process in a series of initiatives that scale over time instead of one large single project. One example is the simplified interface that we introduced in the checkout area last year, which allowed us to accelerate the cashier training process and improve the customer experience. We have begun introducing the simplified interface to other selling stations throughout the store, including appliances, kitchens and bath and millwork.", "This new interface will replace the primitive green screen technology that is cumbersome and difficult to learn. Associates are starting to use this intuitive modern platform for consultative selling. With more time to focus on the customer, the associate is now better able to capture the entire project. Lowe's homegrown self-checkout is another PPI initiative that will drive increased labor productivity as we scale it over time.", "This new option, which was designed specifically for the home improvement shopper, is so much easier to use that we are already seeing higher customer adoption rates. These two initiatives are fantastic examples of what PPI is all about: leveraging technology to reduce tasking and drive labor productivity while improving the associate and the customer experience. Shifting to Pro. I would like to thank our Pro team for delivering outstanding results once again this quarter, driving Pro comps of over 16% for the quarter and over 43% on a two-year basis.", "Our Pro customers are expressing appreciation for our new in-store convenience features, including Pro trailer parking, free phone charging stations and air stations for refilling tires. This helps them get in and out of our stores quickly with additional conveniences that cut down on the number of stops they need to make during the week. Time is money for this busy customer, so we're focused on helping them maximize the time they spend on the job site. We recently completed our inaugural Pro Pulse Survey, which provides great insight into what is on the Pro's mind and how they view their future business opportunities.", "We are encouraged to learn more about their optimistic outlook and their strong job pipelines. I look forward to updating you on future calls on our ongoing initiatives to grow share with this very important customer. In honor of Veterans Day, I would like to thank my fellow veterans at Lowe's for their service, 25,000 strong across our company. As a veteran, I'm particularly proud of the commitment to the 10% discount for active-duty service members and our veterans and their families every single day with no purchase limit.", "And I also wanted to mention that we offered our first responders a Lowe's discount for the first time this quarter. This recognition reflects our heartfelt appreciation for their commitment to serving others during the ongoing pandemic. At Lowe's, we remain focused on improving the communities where our associates work and live, and there is no better way to do this than to support our first responders. I would like to close by once again thanking our store associates for their continued hard work and dedication and the great results they delivered this quarter.", "With that, I will turn it over to Dave." ] }, { "name": "Dave Denton", "speech": [ "Thank you, Joe. I'll begin this morning with a few comments on the company's disciplined capital allocation program. In Q3, we generated $1.9 billion in free cash flow, driven by better-than-expected operating results. Capital expenditures totaled $410 million in the quarter as we invest in our strategic initiatives to drive the business and support long-term growth.", "We returned $3.4 billion to our shareholders through a combination of both dividends, as well as share repurchases. During the quarter, we paid $563 million in dividends at $0.80 per share. Additionally, we repurchased 13.7 million shares for $2.9 billion and have over $10.7 billion remaining on our share repurchases authorization. And today, I'm excited to announce that we are now planning to repurchase an incremental $3 billion of shares in Q4.", "This will bring our total share repurchases to approximately $12 billion for the full year, a clear reflection of our commitment to driving long-term value for our shareholders. Our balance sheet remains very healthy with $6.1 billion in cash and cash equivalents at quarter end. Adjusted debt-to-EBITDAR stands at 2.14 times, well below our long-term stated target of 2.75 times. Now I'd like to turn to the income statement.", "In the quarter, we reported diluted earnings per share of $2.73, an increase of 38% compared to adjusted diluted earnings per share last year. This increase was driven by better-than-expected sales growth, improved gross margin rate and SG&A leverage as a result of strong execution across our business. My comments from this point forward will include approximations where applicable. In the quarter, sales were $22.9 billion with a comparable sales increase of 2.2%.", "Comparable average ticket increased 9.7% driven primarily by higher-ticket sales of appliances and flooring, as well as product inflation. Keep in mind that commodity inflation did not have a material impact on comparable sales in Q3 as deflation in lumber was largely offset by inflation in other categories, including copper. Year-to-date, commodity inflation had lifted total sales by approximately $2.1 billion and improved comp growth by 300 basis points. In the quarter, comp transaction count declined 7.5% due to lower sales to DIY customers of smaller-ticket items, as well as lower DIY lumber unit sales.", "In the quarter, we once again cycled over a period where consumer mobility was limited. So many of our DIY customers were working on smaller home improvement projects. Comp transactions increased 16.4% last year, which resulted in a two-year comp transaction increase of 7.7%. We continue to gain momentum in our Total Home strategy as both Pro and DIY customers alike increasingly look to Lowe's for a one-stop solution to their project needs.", "We delivered growth of over 16% in Pro, 25% on Lowes.com and positive comps across all home decor categories. U.S. comp sales increased 2.6% in the quarter and was up 33.7% on a two-year basis. Our U.S.", "monthly comp sales were down 0.4% in August, up 1.1% in September and up 7.7% in October. Trends improved as we moved through the quarter with stronger weekend traffic post Labor Day. As Bill mentioned, we are seeing some indications of early seasonal buying, consistent with broader retail trends. Looking at U.S.", "comp growth on a two-year basis. From 2019 to '21, August sales increased 28.4%, September increased 33.3% and October increased 40%. U.S. comp transaction count improved each month of the quarter and in October, up double digits on a two-year basis.", "Gross margin was 33.1% of sales in the third quarter, up 38 basis points from last year. Product margin rate declined 25 basis points. Lumber margins were pressured, particularly toward the beginning of the quarter as we sold through the higher-cost inventory layers after the steep drop in lumber prices in early July. As our Canadian business is more heavily concentrated in lumber, the margin pressure was more acute there than in the U.S.", "These pressures were largely mitigated by data-driven pricing and product cost management strategies across many other product categories. Gross margins also benefited from five basis points of favorable product mix due to a lower percentage of lumber sales versus the third quarter of last year. In addition, higher credit revenue benefited margins by 60 basis points, while improved shrink contributed 20 basis points of benefits this quarter. These benefits were partially offset by 30 basis points of increased supply chain costs due to higher importation and transportation costs, as well as the expansion of our omnichannel capabilities.", "We are leveraging our scale and our carrier relationships to minimize the impacts of these higher distribution costs. However, we are not immune to these rising costs, and we expect that we will continue to absorb higher cost in our distribution network going forward. SG&A at 19.1% of sales levered 230 basis points versus LY due to better-than-expected sales and disciplined expense management. We incurred $45 million of COVID-related expenses in the quarter, as compared to $290 million of COVID-related expenses last year.", "The $245 million reduction in these expenses generated 110 basis points of SG&A leverage. Additionally, we incurred $100 million of expenses related to the U.S. stores reset in the third quarter of last year. As we did not incur any material expense related to this project this year, this generated 50 basis points of SG&A leverage compared to LY.", "And finally, we've generated approximately 50 basis points of favorable SG&A leverage from our PPI initiatives. We are very pleased with our operating income performance as we are driving solid growth in operating profits while significantly expanding operating margin rate. For the quarter, operating profit was $2.8 billion, adding $600 million or a 28% increase over last year. Operating margin of 12.2% of sales for the quarter increased approximately 240 basis points over LY driven by improved SG&A leverage and higher gross margin rate.", "The effective tax rate was 26.1%. This is above the prior year rate where there was a timing shift that benefited Q3 at the expense of Q4. At the end of the quarter, inventory was $16.7 billion, which is $1 billion higher than the third quarter of 2020 when our in-stock positions were pressured due to strong consumer demand and COVID-related supply constraints. Inflation did not have a material impact on inventory levels as deflation in lumber was largely offset by inflation in other categories, including copper.", "Our push to land spring product earlier than normal has increased our inventory position modestly, and this approach also limits our ability to significantly improve inventory turns in the near term. However, as both Marvin and Bill have indicated, our relatively strong in-stock positions create a competitive advantage in the current environment given the ongoing global supply chain constraints. Now before I close, I'd like to comment on our current trends and our improved 2021 financial outlook. We are seeing continued momentum in our business as reflected in better-than-expected results.", "Month-to-date, November U.S. comparable sales trends are materially consistent with October's performance level on a two-year basis as we continue to see early holiday spending trends. Our improved expectations for 2021 include sales of approximately $95 billion for the year, representing two-year comparable sales growth of approximately 33%. This compares to our prior expectations of approximately $92 billion of sales, which represents approximately 30% comparable sales growth on a two-year basis.", "We continue to expect gross margin rate to be up slightly versus 2020 levels. With higher projected sales levels and our productivity efforts taking hold, we are raising our outlook for operating income margin to 12.4% from 12.2% for the full year. We expect capital expenditures of up to $2 billion for the year. And as I mentioned earlier, we're now planning to return excess capital to shareholders via an additional $3 billion in share repurchases in Q4.", "This will bring our total share repurchases to approximately $12 billion for the full year, which is higher than our original expectations of $9 billion due to better-than-anticipated performance. In closing, we are operating ahead of expectations, expect to benefit from the secular tailwinds over the next several years. I am confident that the combination of our strong operating results and our shareholder-focused capital allocation strategies will continue to drive meaningful long-term shareholder value. And as Kate announced earlier, we look forward to providing you with our 2022 financial outlook on December 15.", "With that, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question is from Simeon Gutman with Morgan Stanley. Please proceed." ] }, { "name": "Simeon Gutman", "speech": [ "Hey. Good morning, everyone. My first question is on the Q4 guidance. And Dave, you just gave us the color on the stacks holding for now.", "Are there any reasons the stacks -- I know it's a crystal-ball question, but is there any reason the stacks won't hold through the quarter? And then on margin, is there anything to be wary of? It sounds like not on gross margin. Anything on SG&A in terms of flow-through, why the business could see anything different than how the business performed in the third quarter?" ] }, { "name": "Dave Denton", "speech": [ "Simeon, this is Dave. The short answer is no. There's no difference in the -- in Q4 versus the year-to-date performance. I would say that just -- obviously, Q4 is the lowest sales volume of the quarter.", "So obviously, the flow-through is typically compressed in that quarter. I would just also just make an observation here that, clearly, we're operating in a very uncertain environment, and the company is focused on managing those items in which we can control. And despite this uncertainty, we do have a view of the future, and we develop plans that both drive our sales performance, as well as our profit performance over time. And we believe strongly that it's best practice that we share these views and our plans with investors so that you can better access and understand our performance.", "And the company continues to really focus really on two things: one is gaining share in the marketplace; and two is improving our profit performance. And I think our outlook both for this year really demonstrates that we're focused on achieving both of those objectives. And really, as you said, off to a really solid start as we enter Q4 and look forward to December to talk about 2022." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you for that, Dave. I guess my follow-up is on December 15. And I think the point of December 15 is to talk about it then, but I'm going to make a try anyway. And so maybe this is for Marvin and for you, Dave.", "Anything that's come up as far as investment cadence that you philosophically want to expedite where you don't let margin flow? And then the part for you, Dave, is assuming that the business grows and the environment stays favorable into next year, is there any reason why the margins for this business shouldn't continue to grow?" ] }, { "name": "Dave Denton", "speech": [ "Yes. Simeon, good question. Listen, we'll go through that in depth a bit on December 15. Really, we'll give you an outlook of how we expect the markets to perform from a macro perspective and how we as a company would plan to execute our financial plan into '22.", "The short answer is we do believe the market is really constructive within home improvement. We believe that it is over the longer term. I think it's probably a little harder in the really near term to estimate exactly how we're going to perform. But I do think longer term, really nice tailwinds to the market.", "Number two, we set a very specific plan to continue to improve our operating margin rate. And we are very focused on doing that, and we have line of sight long term to continue to expand that." ] }, { "name": "Marvin Ellison", "speech": [ "Simeon, this is Marvin. And just to set expectations for everyone, we have no plans to announce any big changes to our strategy. We have no plans to announce an acquisition. This is about transparency, to Dave's point.", "Look, we noted we're operating in very uncertain times, and we have -- other retail and other larger public companies decided not to share any outlook. So we want to be as transparent as we can because we know that you all are trying to set your models for next year. So the intent of December is to do exactly what Dave says: for me to provide the strategic outlook on where we think the growth initiatives will deliver, and then Dave is going to provide our best view of our outlook for 2022. And that's the sole intent of the investor update on the 15th of December." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you. Good luck in the fourth quarter." ] }, { "name": "Operator", "speech": [ "Our next question is from Michael Lasser with UBS. Please proceed." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. The traffic has been declining as the DIY -- smaller DIY projects have been under pressure as we return to normalcy. Do you think that this is a good barometer, a good proxy for how traffic is going to unfold over the next few quarters? Or could you be in a prolonged period where traffic is going to be down for quite some time as we have this road back to whatever the new normal is? And as part of that, can you give us a sense for how much noncommodity-related inflation contributed to your performance in the quarter and recently given that you're -- it looks like you're running a double-digit comp quarter-to-date? And this is important, obviously, because to the extent that you do see a drag from DIY traffic being down and you have to lap the stimulus, perhaps some of the noncommodity-related inflation can support your same-store sales growth even in the face of those headwinds.", "Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "The 2020 was one of the most unique periods, not only in retail but in the history of our country and our globe. And we saw a significant number of low-dollar transactions for cleaning supplies, for PPE and for other around-the-house-related projects. So when we look at traffic trends for DIY and for Pro, Dave cited the numbers on a two-year basis. The reality is the only way we can really get a true understanding of the trends of our business is to look at everything on a two-year basis because last year was such a unique anomaly when it comes to revenue and traffic and, quite candidly, as it relates to operating expenses.", "At a high level, we feel great about our performance. As a company, we feel great about the macro indicators that support home improvement. And as Joe mentioned in his prepared comments, our Pulse survey with our Pro customers give us enormous confidence that they're going to continue to see growth in their business based on what they're seeing in their pipeline. And as we look at initiatives like our Total Home strategy and our Lowe's Livable Home strategy, we think that we have great initiatives to support our DIY customers to create ongoing demand." ] }, { "name": "Michael Lasser", "speech": [ "My follow-up question is -- it would be helpful to have a bit of a flavor for your gross margin over the next couple of quarters. You've got some idiosyncratic drivers that are helping given the more strategic approach to pricing and discounting. To what extent can that offset some of these very unique supply chain challenges that you're going to continue to experience over the next couple of quarters, especially because it sounds like this credit portfolio benefit that you experienced in the third quarter won't be as significant moving forward? Thanks." ] }, { "name": "Dave Denton", "speech": [ "Michael, it's Dave here. Listen, from a gross margin perspective, as we've indicated previously, is we expect gross margin to expand slightly this year in 2021. And from a longer-term perspective, it is our expectation that we were going to essentially maintain flattish gross margin over time. Keep in mind that what we're doing here is we're essentially managing and improving product margin rate, at the same time, investing in our supply chain capabilities that compress gross margin but relieve the stores with a lot of SG&A that expands operating income.", "So you should think about the algorithm from a financial perspective with that lens. And we feel very strongly that the tools and processes that we are putting in place and have in place will allow us to manage to that objective." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much, and have a good holiday." ] }, { "name": "Operator", "speech": [ "Our next question is from Christopher Horvers with J.P. Morgan. Please proceed." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks for taking my question, and good morning. So just jumping back, obviously, really strong quarter-to-date. It seems like running, say, low double-digit kind of trend, clear acceleration. You talked about some early buying of seasonal and holiday.", "If you're running low double digit and sort of implying like a flattish comp trend, I guess, and decelerating the CAGR relative to 3Q, I mean, is this sort of like a prudent estimate? Are you able to look at some of the seasonal sell-through here in November and then project forward? Like how much of a maybe divot that would -- could create in the December time frame? So just trying to understand really how you're thinking quantitatively about pull-forward risk and sort of the embedded deceleration." ] }, { "name": "Dave Denton", "speech": [ "Yeah. Chris, it's Dave. We feel very strongly that we're off to a really great start. A few of our bigger weeks are ahead of us, coming forward here from a holiday perspective.", "But let's not get totally overindexed and focused on Q4. We set a realistic and achievable forecast for the quarter. I think the merchant and store ops team are really well positioned to flex as we sell through holiday product to be able to flex into other categories to maintain momentum as we move throughout the quarter and set us up for a really strong 2022." ] }, { "name": "Marvin Ellison", "speech": [ "So Chris, this is Marvin. And look, you can appreciate how difficult it is to provide a precise forecast in this environment. And I'll just repeat what I've said. We have certain retailers that hadn't provided any outlooks.", "So we don't want to be punished for trying to provide a level of transparency around where we think the business is headed. I do want Bill Boltz to talk a little bit about the plans to flex that seasonal area because we're seeing robust sell-through, which we're excited about. But we're prepared for that, and we're prepared to transition to other areas. I'm going let Bill talk about some of those plans." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin. And just -- I think it's also important to understand that whenever you can sell through the holiday program early, that's a benefit for everybody. And so obviously excited about the early sell-through of holiday. But we do have really robust plans to transition that space.", "We certainly shifted into a gifting time frame with our tools business. We moved quickly into winter storage. [Inaudible] look to pack stuff up and put things away, and that's become a big event for us. And then we've also built this winter bath and flooring event that is very, very successful, especially in our [Audio gap] where spring comes a little later.", "And then in our deep south markets, we'll transition to spring. And so we've got really good plans on how to rotate the floor and make it seasonally relevant across the country." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. That makes sense. And just -- can you talk a little bit about in terms of the average ticket? Maybe disaggregate that into sort of AUR, UPT mix and so forth. And is there any area in your assortment that you're seeing price -- negative price elasticity as you've passed through price increases?" ] }, { "name": "Dave Denton", "speech": [ "This is Dave. Probably that's a level of detail we won't go into specifically. But I would just say one area that we continue to see really solid performance is in our appliance business. That's the business that, as you know, historically, has been a very high-load business.", "We've been moving to more of an everyday competitive price profile in that category, and it continues to perform quite well for us, both top line and bottom line." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Have a great holiday. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from Chuck Grom with Gordon Haskett. Please proceed." ] }, { "name": "Chuck Grom", "speech": [ "Thanks a lot. Great quarter. The one metric that stood out to us as being a little bit light was just inventory, which is counterintuitive. You usually want to be light, but right now, you want to be heavy.", "So just wondering about how you're thinking about your inventory balance throughout the quarter and your ability to chase sales here in 4Q." ] }, { "name": "Dave Denton", "speech": [ "This is Dave. We feel that we're -- we feel very good about our position from an inventory perspective. Obviously, there are areas that we would love to be a little bit deeper in that global supply chain has some constraints around. But relatively speaking, if you look at where we stand from an in-stock perspective and our depth of inventory relative to others in the marketplace, we feel like we're very nicely positioned.", "I feel like we'll have a really strong Q4, nicely positioned from a spring perspective as we cycle into '22." ] }, { "name": "Chuck Grom", "speech": [ "OK. That's great. And then, Marvin, I was wondering if you could share some color on the Pro Pulse Survey that you guys conducted in the third quarter. In particular, just wondering what you're hearing from Pros on the backlog.", "And then bigger picture, penetration is much lower than Depot. Do you think over time you can grow it? And do you want to grow it? Just some thoughts on that front. Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "No. Thanks for the question. So I'll take the penetration question, and I'm going to let Joe just provide a little bit of detail on what we learned from the Pulse survey. The thing that we talk a lot about here is the importance of being customer-centric.", "What I learned from past mistakes is when you set penetration targets for customer segments, you tend to make decisions to support the target versus decisions to support the needs of the customer. So we have every expectation that, that penetration number is going to grow. Any time you deliver a 16% comp number, which equates to a 43% growth on a two-year basis, it gives you at least confidence that the business is headed in the right direction. So at a high level, we expect the penetration to grow.", "We know when it grows, it provides great operating leverage throughout the whole store and space productivity, but we are not setting targets that we're trying to chase. So let me let Joe give just a little bit of detail on some of the key learnings from the Pulse survey." ] }, { "name": "Joe McFarland", "speech": [ "Chuck, thanks for the question. Listen, we put this Pro Pulse Survey out and really got some great responses and insights for 2022. And so things like 80% of Pros expect the increased home improvement demand seen in the pandemic is going to greatly improve and continue into 2022. They're more reliant on their teams than ever.", "We've got insight into the top five projects in 2022 that the Pros will be focused on. And a lot of our Pros are saying this is the time of year to take advantage of all the holiday deals. They're planning on a lot of tool purchase, supply purchases. So we feel really good about the capabilities we have increased in the Pro and what the Pros are telling us." ] }, { "name": "Chuck Grom", "speech": [ "Great. Good luck. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from Steven Forbes with Guggenheim. Please proceed." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. I wanted to focus on opex productivity. So Dave, I think you mentioned 50 basis points of leverage during the quarter from your PPI initiatives. I'm curious if you can expand on how the initiatives are progressing relative to the original time frame provided last year.", "And the idea, right, is just trying to get an understanding of how much opportunity is still ahead of us?" ] }, { "name": "Dave Denton", "speech": [ "Steven, in general, the PPI efforts are tracking along fairly consistent with our plan for 2021. I would say the one area that you think really over the next 18 months that we have opportunities to continue to improve from an opex perspective is really around our market delivery rollout. Keep in mind, we have that now, as Marvin indicated in his remarks, in two markets today. We're working to roll that out over the remainder of our markets over the next 18 to 24 months.", "When that is fully operational, that will put -- that will dampen a bit on gross margin but really relieves the store with a lot -- from a lot of labor and SG&A, ultimately enhancing our flow-through. That's probably the biggest area over the next couple of years where we're leaning in to really drive operating profit improvement. And we feel really bullish about where we stand today and optimistic about the outlook of that program." ] }, { "name": "Steven Forbes", "speech": [ "Thanks. And then just a quick follow-up. Because if I remember correctly, another large opportunity was store inventory management systems. So maybe just provide an update on where the business is in sort of rolling out and optimizing the line of sight into inventory location at the store level." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Steve, we're excited. Joe and his team have done great work with our IT team to just give our associates and our customers better visibility to inventory. I'm going to let Joe just give you a couple -- two or three of the key points to this new inventory management system and why we're so excited about the productivity that we're going to gain from it." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Marvin. Listen, we've been laser-focused on trying to improve the accuracy of our on-hands in the store. It helps greatly when customers are searching online from different products they want to pick up in the store. And a big challenge for the last 30 years, I can remember, in home improvement is where the overstocked product is, where the product is in multiple locations in the store.", "And we're very, very pleased, number one, with the ease of use for our associates, the adoption of the tools that we're giving them. And it's just great partnership through the store operations team, as well as the IT team. And we feel really good about the productivity enhancement that's going to continue to drive." ] }, { "name": "Marvin Ellison", "speech": [ "And Steve, when Joe and team surveyed our associates' activity during the day, we found out that one of the most nonproductive activities in advance that happens on a daily basis is looking for product. Because, as Joe said, it is very difficult historically to put a location system in the overhead, and home improvement has a lot what we call off-shelf locations for attachments. Now we have the ability to do that, and we think it's going to unlock incredible customer service benefits and also productivity for our sales -- for associates." ] }, { "name": "Steven Forbes", "speech": [ "Thank you. Best of luck." ] }, { "name": "Operator", "speech": [ "Our next question is from Brian Nagel with Oppenheimer. Please proceed." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning. Great quarter. Congratulations. So first question I have, just with regard to the Pro and the efforts.", "Clearly, a lot of emphasis from the management team over the past several quarters to really improve the Pro offering. And you've talked about it in prepared comments, but the question I have is as you look at it now, is the infrastructure basically built? Or are there still tweaks you have to make in order to sort of, say, make your offering even more compelling to the professional customers?" ] }, { "name": "Marvin Ellison", "speech": [ "It's a really good question, Brian. I would say the short answer is that the foundation of the infrastructure is built. If you think about it, we started with what we call retail fundamentals in Pro. And Joe and his team started with basic things like staffing at the desk, loading assistance, something as simple as having the ability for the Pro to actually check out at the Pro desk.", "We had no point-of-sale terminals at the Pro desk where Pro even check out. And so those things were just problematic. Then Bill, and in partnership with supply chain -- and Joe has tried to work on things like job lot quantities. And then Bill and his team have been working tirelessly on improving the number of national brands.", "Over the past 10 years prior to coming here, Lowe's had diluted most of their national brands out of the assortment, supplementing them with proprietary brands. And we know that Pros are more attracted to national brands. And so Bill and his team -- Bill gave the list that we're adding, and we're continuing to build on that. Now we're building our loyalty platform.", "And now we're building our CRM platform. And now we're going to be building fulfillment platform. So the foundation is in place. We just have to earn the Pros' trust and respect.", "Because for so many years, they would show up, service was terrible, were out of stock. And we couldn't allow them to get in and out quickly or to grow their business. Now that we have the foundational elements in place, it's all about consistent execution and reaching out and engaging the customers. And I give Joe, Bill and our Pro teams a lot of credit for getting us where we are thus far." ] }, { "name": "Brian Nagel", "speech": [ "Marvin, that's very helpful. I appreciate it. And then the second follow-up question I have, just with regard to supply chain. So Lowe's has been managing the headwinds extraordinarily well as evidenced by the sales or gross margins.", "The question I have is as you look out in all the different moving pieces of the ongoing supply chain crisis around the world, are there potentially incremental risks that you see as you move into '22?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, the short answer is yes, but I don't know that the risks are more pronounced than anything that you've heard about or that's been discussed in the marketplace. You said another way, when Bill and I talk about spring, the risk that he's looking at is no different than the broader risk of any merchant looking at it from a supply demand standpoint. When I talk to Don, who's our supply chain leader, I mean, we have similar risk. The good news is, as Bill mentioned in his prepared comments, we have scale because of size.", "And because of that, we've been able to leverage our carrier relationships and also just strategic initiatives like these coastal holding facilities that Bill talked about to land product early, get it in country and then distribute it where needed. So we're going to continue to do that. But it gives us the ability to buy early, land it early so that we can have possession of it. And that has worked for us.", "But again, we're not immune. I couldn't be more proud of the team's efforts, to your point, to increase gross margin, increase operating income and also sustain competitive in-stocks in the midst of the most complex global supply chain environment that any of us have operated in." ] }, { "name": "Joe McFarland", "speech": [ "Yeah. And Brian, just to add one thing. We mentioned the Pro Pulse Survey. And over 80% of our Pro customers are citing pervasive supply chain issues is a challenge, but they're also very, very optimistic about all their 2022 projects.", "Sherry, this is Joe. We have time -- Thank you Brian. Sherry, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Our next question is from Liz Suzuki with Bank of America. Please proceed." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you for squeezing me in. Just on the subject of product innovation, I mean, what are the most exciting or highest-growth product categories that you think could be game changers for the next years, like LED lighting was several years ago or LVT in the flooring category? And what's the next innovative product that's going to take over its category?" ] }, { "name": "Marvin Ellison", "speech": [ "So I'll give it to Bill. What I'll tell you is we're really excited about a lot of innovation in outdoor power equipment, in flooring, power tools. I'll let Bill just highlight [Audio Gap] excited about that's coming our way." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. So thanks, Marvin. I think there's -- across the store, there's innovation all across the store. You think about smart product, whether that's in lighting, whether that's in lightbulbs, whether that's in appliances or even just smart home products in general; when you think about the new launch of our FLEX brand in power tools, new lithium battery technology, innovation in flooring with WetProtect from Pergo; you think about the battery technology in outdoor power, and that continues to expand; and what Eagle has done in their categories with zero-turn riding mowers that operate off of a battery; then you go into categories that you may not think there's innovation in, but you get into building materials and building products.", "There's innovation in -- that's coming in ZipWall, there's innovation in drywall, there's innovation all across the store. So we're very excited and very pleased with what the merchants have done to continue to probe for new. We found innovation in our private brands, as I was able to mention, on allen + roth with the Lifestyle Performance rugs. Literally, you can take a garden hose and hose these rugs down.", "And you think about pet spills, you think about kids, you think about crayons and you can just hose it off with your garden hose, pretty cool stuff. So a lot of stuff going on." ] }, { "name": "Marvin Ellison", "speech": [ "And Liz, We'll be talking more [Audio gap]" ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2021-05-19	[ { "description": "Vice President of Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Dave Denton", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "R5 Capital -- Analyst", "name": "Scott Mushkin", "position": "Analyst" }, { "description": "Oppenheimer & Co. -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Guggenheim Securities -- Analyst", "name": "Steven Forbes", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies first-quarter 2021 earnings conference call. My name is Melissa, and I will be your operator for today's call. As a reminder, this conference is being recorded. I would now like to turn the conference over to Kate Pearlman, vice president of investor relations." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning, everyone. Here with me today are Marvin Ellison, our president, and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president, stores; and Dave Denton, our executive vice president, and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2021.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties, and important factors, including those discussed in the risk factors, MD&A, and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release in our investor relations website.", "With that, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Good morning, everyone. I'd like to begin by thanking our frontline associates for their continued hard work and commitment to the company. We would also like to extend our thoughts and prayers to our associates in India, who are grappling with an aggressive resurgence of COVID in the country. At Lowe's, we have associates in Bangalore, India in our digital information technology and finance functions, who played a key role in our transformation efforts over the past two years.", "To help our team in India safeguard their health, we sent personal protective equipment to our team members there. We've also made financial commitments to support nonprofit organizations in India that are working to respond to this humanitarian crisis. As we have moved into the second year of the pandemic, we remain focused on our No. 1 priority, which has always been protecting the health and safety of our associates and communities.", "And with that in mind, in Q1, we invested nearly $60 million in support of COVID safety protocols. Now turning to our results. Our outstanding performance continued this quarter with total company comparable sales growth of 25.9%. Our U.S.", "comps were 24.4% with broad-based growth across all geographic regions and divisions. In fact, for the quarter, comp sales for all 15 U.S. regions exceeded 18% and all U.S. divisions exceeded 20%.", "During the quarter, operating margin expanded 313 basis points on an adjusted basis, leading to diluted earnings per share of $3.21, which is an 81% increase on an adjusted basis over the prior year. Our outperformance in operating margin was supported by our continued transition to an everyday competitive price strategy, as well as our disciplined pricing and product cost management strategies. Our improved operating margin also reflects the progress of our operational transformation driven by our perpetual productivity initiatives or PPI. Bill will discuss our everyday competitive price strategy, pricing, and product cost management, and Joe will provide details on our PPI initiatives later in the call.", "On Lowes.com, sales grew 36.5% on top of 80% growth in the first quarter of 2020, which represents a 9% sales penetration this quarter and a two-year comp of 146%. With customer demand for an integrated omnichannel shopping experience only increasing, we continue to invest in our omnichannel capabilities. Pro comps outpaced DIY comps with over 30% comps in the quarter. Although this has been a two-year journey, I'm very pleased with the progress that we made with our Pro customer.", "We began by addressing the basics, ensuring that we were carrying the brands and products that Pros need in the job life quantities, and also provided the excellent service this busy customer expects. And now, we've shifted to the more strategic phase of growth in the Pro by resetting the layout of our stores with the Pro in mind and deepening our relationship with the pro through a loyalty program that provides them with members-only benefits. Joe will discuss more about the specific initiatives that we're undertaking to serve the Pro, both online and in-store later in the call. The small and medium-sized Pro is our target customer.", "This customer is a frequent shopper who purchases products in multiple departments, which drives increased productivity throughout the store. And I'm confident that we have a compelling growth opportunity as we continue to improve our engagement with this highly valued customer. In addition to the strength in Pro, we delivered over 60% comps along with significant increase in customer satisfaction in our installation services business. We've overhauled this business and improved the service offering by consolidating our provided network and implementing industry-leading technology.", "And although all of us are looking forward to a post-COVID world, our research tells us that the importance of the home will remain elevated for many years to come. And given the increased importance of the home, this quarter, we launched SpringFest, our new reimagined approach to the season. Our campaign provided inspiration for home projects, so our customers could transport themselves to the destination of their choice without ever leaving the sanctuary of home. In a moment, Bill will discuss the outstanding results that we're able to generate from this reimagination of spring.", "Now turning to Canada. We delivered comp growth that outpaced the U.S. despite several COVID-related operating restrictions. I'd like to thank the new Canadian leadership team for all of their hard work, as well as the frontline associates in Canada for their resilience and commitment to continuing to serve our customers in this challenging operating environment.", "This quarter, we also announced the acquisition of STAINMASTER brand, which is the most recognized and trusted carpet brand on the market today. With this acquisition, we're building on our decade-long exclusive position as the only national home improvement retailer to carry STAINMASTER carpet. This is an important step in our Total Home strategy as we seek to elevate our product assortment and provide consumers with the products and brands they trust for every project across the entire home. We see great potential to extend the STAINMASTER brand in other product areas, where we can continue to leverage its high-performance characteristics.", "This acquisition also expands our private brand portfolio joining the family of private brands, including allen + roth, Kobalt, and Project Source. We're focused on expanding our private brand penetration with a balanced brand strategy that includes a powerful national brand portfolio that appeals to both Pro and DIY customers. At the same time, we'll offer a select number of high-value private brands, building consumer loyalty for these products. Our results in the first quarter continue to give me confidence that we're making the right investments to accelerate our market share gains through our Total Home strategy by enhancing our investments in Pro, online, installation services, localization, and elevating our product assortment.", "These initiatives will allow us to drive sustainable growth as we deliver a total home solution for our Pro and our DIY customers. Before I close, I'd like to once again extend my appreciation to our frontline associates. In the first quarter, I had an opportunity to visit stores in nine of our 15 geographic regions. As I observed, our associates hard at work serving customers through very challenging circumstances, my respect and admiration continues to grow.", "In recognition of these efforts, we decided to close our stores and distribution centers on Easter Sunday for the second year in a row to give our associates a much-deserved day off to spend with their families and loved ones. I'm also pleased to announce that for the fifth consecutive quarter, 100% of our stores earned a winning together profit-sharing bonus, a record $152 million payout to our frontline hourly associates. This represents an incremental $70 million above the target level. While the near-term macro outlook remains uncertain, we're confident that we will continue to outperform the market driving both market share gains and improved operating efficiency.", "Our two-year-plus journey to transform Lowe's has given us improved operating capabilities and a technology infrastructure that's dramatically enhanced, which in turn makes us more agile and able to respond quickly to any potential changes in the business environment. And with that, I'll turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. We delivered U.S. comparable sales growth of 24.4% in the first quarter. Our compelling offerings, great values, and improved in-stocks allowed us to capitalize on the continued strong demand for home improvement products.", "Consistent with recent trends, growth was broad-based across Pro and DIY customers, in-store, and online, and across product categories. In fact, 13 of 15 merchandising departments generated comps over 15% and all merchandising departments were up more than 20% on a two-year comp basis. As Marvin described, we were extremely pleased with how consumers responded to our SpringFest event. Similar to our approach to the winter holidays, we extended this event across four weeks to create a new sense of excitement and to prompt return trips, while also avoiding congestion in our stores.", "We offered four different weekly giveaways of garden-to-go kits that provided everything needed for a fun spring project, and also strengthen our customer connection through a required MyLowe's activation online. The success of this event was due to the great organizational alignment across our stores, marketing, and merchant teams. Turning now to our top-performing categories. Lumber again delivered the highest comp driven by strong Pro demand and unprecedented inflation in the category.", "Over the past year, as lumber products have been in tight supply, our merchants have worked closely with our suppliers and successfully secured new sources and additional product to ensure that we can maintain a competitive in-stock position in the category. Strong in-stocks in this tight market have allowed us to continue to strengthen customer relationships, especially with the Pro. In addition to lumber, we delivered comps exceeding 30% in electrical, decor, kitchens, and bath, and seasonal and outdoor living. Our electrical category posted strong comps in the quarter, driven by inflation in copper, as well as solid demand from the robust repair/remodel market.", "In support of our total home market share acceleration strategy, we drove strong engagement with our customers as reflected by increased sales in decor, and kitchens, and bath. The strong sales in our decor category were driven by great performance in home accents as we continue to elevate our product assortments, especially with our recently refreshed allen + roth brand. In fact, this quarter, our merchant teams launched new spring collections that span across a broad array of product categories through a lifestyle point of view with inspirational on-trend designs that gives our customers the confidence they need to decorate their homes in style. Our kitchens and bath department outperformed in the quarter as homeowners continue to enhance their living spaces and economic stimulus supported bigger-ticket projects.", "Finally, seasonal and outdoor living benefited from the early demand in patio and grills as homeowners embrace the arrival of spring. We also saw strong sales in the newly launched battery-powered EGO and SKIL brands as consumers are attracted to the convenience and the quality of their zero-emission rechargeable outdoor power equipment. In fact, during the quarter, EGO delivered some of their largest weekly sales results in the history of their brand. The addition of EGO and SKIL has only strengthened our No.", "1 position in outdoor power equipment and truly complements the leading brands we carry such as John Deere, Honda, Husqvarna, Aaron's, and CRAFTSMAN. And during the quarter, we continued to see strong demand for our other powerhouse brands like Weber and Char-Griller, which remain the top two brands in outdoor grilling. We were excited to add new brands to our arsenal, including the exclusive launch of FLEX cordless power tools. The FLEX brand is known by the most discerning builders, contractors, and trade professionals.", "And this new lineup of power tools offers the latest innovation, more power, and faster charging than the competition. We are also excited to bring the Lesco brand of fertilizer to Lowe's this spring. A brand that is trusted by landscape pros and knowledgeable homeowners alike. The addition of FLEX power tools and Lesco fertilizer further complements our powerful Pro brand lineup, which already includes Simpson Strong-Tie, DEWALT, Spyder, Bosch, Eaton, and SharkBite.", "As Marvin mentioned, we delivered strong sales growth of 36.5% and a two-year growth of 146% on Lowes.com. We continue to enhance the online customer experience with improved search and navigation functionality that allows consumers to easily shop for products across categories. Additionally, we continue to see strong download rates of our mobile app as we are working to enhance our customer loyalty through a great mobile experience. As Marvin mentioned, we delivered a solid improvement in our product margins this quarter, driven by disciplined vendor cost management, improved and enhanced pricing systems, and our continued transition to a more relevant everyday competitive price strategy that is complemented by targeted seasonally relevant promotions.", "All of these initiatives are part of our ongoing merchandising excellence strategy. We will continue to leverage and refine these capabilities as we deliver strong everyday values to our consumers, while we continue to manage our product margins by taking a data-driven portfolio approach to pricing. Our Total Home strategy will continue to allow us to expand and elevate our product and brand assortments and take market share. Before I close, I want to thank our vendor partners and our merchants for their continued focus on taking care of our stores and our customers.", "Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Bill, and good morning, everyone. In the first quarter, our associates were laser-focused on providing excellent customer service, supporting a safe store environment, and delivering record sales volumes. As Marvin mentioned, 100% of our stores earned a \"Winning Together\" profit-sharing bonus, a record $152 million payout to our frontline hourly associates. I would like to thank our associates for their continued dedication in providing world-class customer service.", "As Marvin mentioned, our focus on perpetual productivity improvement, or PPI, initiative continued to yield results during this quarter as we leverage store payroll by using technology to reduce tasking hours, improve customer service, and increase sales productivity. For example, we rolled out digital signs, first in appliances, and most recently, in our lumber department. These signs cut down on associate tasking labor, and they also support better product margin performance as we can now more rapidly implement price changes in line with the market. We're also leveraging an improved freight flow app, creating a fully digital process that gives our associates better line of sight to when products will arrive at our stores.", "The app, which was developed in-house, even helped store associates to prioritize the incoming merchandise so they can quickly and efficiently position the product on the sales floor for our customers. And we launched secure mobile checkout, which we are using to improve the speed of service in high traffic areas inside the store and on the exterior of the store in areas such as outside lawn and garden and under the Pro canopy. This checkout app developed in-house is allowing us to take care of customers from scanning items, tendering payment, and printing or emailing receipts before they even join a line. Our customers are delighted with the solution, especially on busy weekends.", "We are also driving productivity in our in-store fulfillment. This quarter, we expanded our contact with shopping options by completing the rollout of BOPIS lockers to 100% of our U.S. stores in April. Customers really enjoy these touchless easy-to-use lockers.", "In fact, this has already become the highest-rated store fulfillment options. Having built these lockers in 100% of our U.S. stores will allow us to expand our omnichannel capabilities, further improve customer satisfaction, and limit customer congestion at our service desk. Turning to our Pros.", "As Marvin mentioned, Pro outpaced DIY in the quarter with over 30% comps. We continue to gain momentum with the Pro through our improved in-stock inventory levels, our enhanced service offerings, and our new Pro loyalty program. Our Pro sales associates have also begun to leverage our new CRM platform to proactively engage with our Pro customers and sell the entire project to them. Our most compelling growth opportunity with the Pro is expanding the share of wallet with our existing customers.", "Our new CRM platform, as well as the redesigned store layout that aligns product adjacencies, enable us to more effectively serve their needs for the entire project across all of their jobs. And we continue to enhance the shopping experience for our Pro customers, small to medium-sized businesses who are always pressed for time. We are launching a tailored shopping experience created specifically for Pros to ensure that the time they spend away from their job site is efficient and productive. We're introducing new convenience products at checkout and services like dedicated Pro trailer parking and phone charging stations, all designed to help add value to each trip the Pros take, thus cutting down on the number of stops they make throughout the day.", "We're also enhancing their online experiences with the ongoing migration of LowesForPros to the cloud. This will give our Pro customers access to incremental options that our DIY customers already have on lowes.com, and it will allow us to more quickly add new Pro-only features in the future, including a personalized app experience. Both in-store and online, we continue to demonstrate that Lowe's is on a mission to be the new home for Pros. As Marvin mentioned, we are seeing terrific momentum in our installation business, with over 60% comps this quarter.", "As a reminder, just two years ago, this was a money-losing business and poor customer satisfaction. Although we are lapping Q1 2020 results that were pressured by COVID, we are very pleased with the overall execution and the trajectory of this business. In closing, I cannot be more pleased with the improvements we are making in our stores as reflected in our strong net promoter scores in a recent third-party study. Our executive officers, senior officers, merchants, and field leaders are out visiting stores on a weekly basis to ensure that we are listening to and supporting our frontline associates.", "This remains a very difficult environment to operate retail stores in, and I could not be prouder of the accomplishments of this team and their commitment and hard work from our frontline associates. With that, I'll turn it over to Dave." ] }, { "name": "Dave Denton", "speech": [ "Thank you, Joe. I'll begin this morning with a few comments on the company's robust capital allocation program. In Q1, we generated $4 billion in free cash flow, driven by improved operational execution and continued strong consumer demand. We returned $3.5 billion to our shareholders through both a combination of dividends and share repurchases.", "During the quarter, we paid $440 million in dividends at $0.60 per share. We also repurchased 16.8 million shares for $3.1 billion at an average price of approximately $182 a share. We have approximately $17 billion remaining on our share repurchase authorization. Capital expenditures totaled $461 million in the quarter as we invest in our strategic initiatives to drive the business and to support our growth.", "We ended the quarter with $6.7 billion of cash and cash equivalents on the balance sheet, which includes proceeds from our $2 billion notes offering in March. In addition, we entered into a $1 billion term loan facility in April, which remains undrawn. Our balance sheet remains extremely healthy with adjusted debt to EBITDA at 2.07 times at the end of the quarter, well below our long-term target of 2.75 times. Now, turning to the income statement.", "In Q1, we generated diluted earnings per share of $3.21, an increase of 81% compared to adjusted diluted earnings per share last year. This growth was due to strong sales growth, improved gross margin rate, and SG&A leverage as a result of strong execution across many facets of our business. Please note that in the prior-year quarter, there was a very modest impact on diluted earnings per share related to the Canadian restructuring effort. My comments from this point forward will include approximations when appropriate and comparisons to certain non-GAAP measures where applicable.", "Strong sales growth was driven by several factors, including a continued consumer focus on the home, a favorable weather backdrop across the country, commodity inflation, especially within the lumber category, consumer support from the March government stimulus package, and our improved execution as we continue to elevate our product and service offerings. Q1 sales were $24.4 billion, driven by a comparable sales increase of 25.9%. This was a result of a balanced contribution from both ticket and transactions as comparable average store ticket grew 14.1% and transaction count grew 11.8%, with strong repeat rates from both new and existing customers. While a little difficult to measure, we estimate that the March government stimulus checks drove 300 basis points of growth, while commodity inflation benefited comps by 460 basis points in the quarter.", "Lumber and other commodity prices remained at elevated levels versus last year. U.S. comp sales were up 24.4% in the quarter, consistent with results from the past few quarters. Growth was well balanced across DIY and Pro customers, selling channels, geographies, and nearly all merchandise departments.", "Our U.S. comps were 24% in February, 35.9% in March, and 13.9% in April. February comps were negatively impacted by the harsh winter storms that hit Texas and several other states, while March were positively impacted by storm recovery and the third round of stimulus. Additionally, we began cycling last year's COVID-related spikes in the band in the second half of April, and those more difficult comparisons impacted April comps.", "Looking at U.S. comp growth on a two-year basis from 2019 to '21, February sales increase 30.3%, March increased 48.1%, and April increased 37.1%. Gross margin was 33.29%, up 19 basis points from last year and up 183 basis points as compared to Q1 of '19. Product margin rate improved 165 basis points.", "As Bill mentioned, our teams effectively leveraged our merchandising excellent strategy to manage product cost and retail pricing throughout the quarter. While we are seeing inflation in some product categories, our merchants work to diligently mitigate and minimize vendor cost increases. Additionally, our supply chain team leveraged our scale and carrier relationships to minimize distribution cost pressures experienced throughout the retail sector. On the pricing side, our shift to an everyday competitive price strategy continued to benefit our margins in Q1 as we leverage enhanced pricing tools to improve margin across the array of products that we sell.", "We began to see improving trends from our increased focus on shrink control this quarter, with shrink improving sequentially from Q4 of 2020. However, results pressure gross margin by 15 basis points versus last year. We expect that our shrink performance will continue to improve as we move throughout the year. These benefits to product margin rate were partially offset by 90 basis points of pressure from product mix shifts due to lumber inflation and a less favorable product mix, 20 basis points of pressure from supply chain costs as we continue to invest in our omnichannel capabilities, and 20 basis points of pressure from credit revenue.", "SG&A of 18.4% levered 288 basis points, compared to adjusted SG&A in LY, driven primarily by lower COVID-related costs, as well as operating costs leverage resulting from strong sales and our ongoing productivity from our PPI initiative. As anticipated, we incurred nearly $60 million of COVID-related expenses, as compared to approximately $320 million of COVID-related expenses last year. The $260 million reduction in these expenses generated 140 basis points of SG&A leverage. Additionally, strong sales and a focus on efficiency and productivity allowed us to generate leverage of 100 basis points in operating salaries, 35 basis points in occupancy expense, and 5 basis points in advertising.", "Now, operating profit was $3.2 billion, an increase of 63% over LY. Operating margins of 13.3% of sales for the quarter was up 317 basis points to the prior year, driven by both improved operating leverage and improved gross margin rate. The effective tax rate was 23.5%. The tax rate was slightly lower than expected, primarily due to a tax benefit related to divesting of certain employee stock options.", "We continued to build up our inventory levels throughout the quarter to meet the sustained high levels of customer demand while improving our in-stock position. At quarter-end, inventory was $18.4 billion, up $2.2 billion from Q4 levels, in line with seasonal patterns. This reflects an increase of $4.1 billion from Q1 of 2020 when inventory levels were pressured due to unexpected spikes in demand, as well as COVID-related supply disruptions. Of note, this includes a year-over-year increase of $780 million related specifically to inflation.", "Now, before I close, let me comment on our current trends and how we are planning our business for the balance of 2021. Our year-to-date results are tracking ahead of the robust market scenario that we covered in our December Investor Update. The underlying drivers of home improvement demand appear to be more resilient and stable than we originally forecasted. Those factors build our confidence in our ability to deliver strong results on top of an exceptional year in 2020, including 12% operating margins and flat gross margin rates for the year.", "We remain confident that our total home strategy will enable us to capture market share. We are very encouraged by our performance in Q1, including our strong sales volume even as we begin to cycle last year's mid-April surge in demand. Month to date, May U.S. comp sales trends are materially consistent with April performance levels on a two-year comparable basis.", "Looking forward, year-over-year comparisons remain difficult throughout the remainder of the year. Also, we continue to see COVID restrictions in some areas across Canada. As markets reopen, we are closely monitoring consumer behavior, anticipating a potential modest shift in spending away from the home. We remain agile and ready to respond to whatever environment we face this year with our focus on gaining market share throughout 2021 while improving operating margins.", "With regards to our quarterly performance, please note that we are cycling particularly high gross margin levels in Q2 of LY. In the prior quarter, there was an industrywide pullback in promotions and a more favorable product mix. As a result, we currently anticipate a moderate decline in gross margin rates in Q2. Despite this moderate year-over-year decline, our gross margin rate is expected to expand nicely over pre-pandemic 2019 levels.", "Investments and pricing, vendor cost management, and our everyday competitive promotional strategy have been driving improvements in our gross margin performance over the past two years. As I stated earlier, we continue to expect to deliver flat gross margin rates for 2021. Further, we expect the business to generate robust levels of free cash flow. We plan to invest $2 billion in capex this year to drive future growth and returns as we continue our disciplined approach to capital allocation with $9 billion in planned share repurchases this year while also supporting our dividend.", "In closing, we're very excited about the momentum in our business and our ability to deliver significant shareholder value over the long term. With that, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We are now ready for questions. [Operator instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Hey, good morning, everyone. My first question is can you provide an update on where Pro penetration can move to over time? And maybe some level of growth that you expect going forward. And I'm asking because I think part of the margin story is getting higher sales per foot and I think Pro seems to be a big opportunity there. So curious, I don't know, Marvin or David, if you update us in that in that area." ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Simeon. This is Marvin. You know, we purposely have not set a target for Pro penetration. As I mentioned in my prepared comments, we really started focusing on the basics and now we're elevating to a more strategic phase in Pro.", "We also stated a while back that we estimate our Pro penetration today is between 20% and 25%. Now having said that, based on my history in this business, in this space, in Joe's history, and experience in this space, we can see over time, our Pro penetration getting between 30$and 35%. And we think that's the trajectory that we're currently on. But we have purposely not set a target because I've learned in the past when you set a target, then you can, oftentimes, hit the target but you do it at the expense of running a good business and we're just really focused on serving the customer right now." ] }, { "name": "Simeon Gutman", "speech": [ "OK. Fair enough. Can I ask you a macro question until whoever and I wanted to ask, there's this school of thought that this industry, this home improvement industry, is a mid-single-digit grower, right, that did four or five X stat over the last four quarters. And so that school of thought says, hey, this industry needs to digest this growth.", "We may not grow going forward, maybe in '22, or maybe flattish at best. And the other side is that people have spent more on their homes, there's more invested capital so there's more maintenance repair that we could sort of complete. And then maybe there's a housing cycle on top of this. Curious where you shake out, what's your best guess, or what some of the debates you're having on these topics are?" ] }, { "name": "Marvin Ellison", "speech": [ "Simeon, that is a good question. I'll take the first part. I'll let Dave provide any financial perspective. I mean, we are we're very excited and we're very bullish on the home improvement industry in general.", "If you look at the macro factors that really impact this business and have historically impacted this business is things like low mortgage rates, rising home prices, the age of housing stock, improve household formation trends, and also strong consumer balance sheets. I mean, all of those specific macro factors are pointing in the right direction for us. In addition to that, when there's home price appreciation that actually benefits home improvement. It may not benefit the overall housing market but when consumers decide to stay in their existing home and make investments in upgrading the home, that correlates to really strong home improvement sales.", "And as the housing stock continues to age -- we're in a repair maintenance business. That's a significant part of what we do. So when we look at home improvement, we see really robust year-over-year growth potential relative to the macro. And then if we look at just the things that we control, I mean, we've been very transparent that there have been many strategic mistakes made in this business over the past five-plus years.", "And so we have what we believe is enormous upside in revenue and operating income by continuing to invest in really smart strategic initiatives that we think will drive the business for that. And we think Q1 reflects our ability to do that with our gross margin and operating income performance. I'll let Dave add any additional comments if he has them." ] }, { "name": "Dave Denton", "speech": [ "Hey, Simeon. The only other thing that I would add is that, obviously, over the next several years, we anticipated that the millennial customer would begin to migrate into the homeownership position. I think what has happened through COVID is that the macro trend has probably accelerated. So probably given the industry segment a bit more tailwinds, we think about the next several years." ] }, { "name": "Simeon Gutman", "speech": [ "OK. Thank you. Good luck." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Liz Suzuki with Bank of America. Please proceed with your question." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you. So if sales are running above the robust market scenario, do you think the sales upside could be reinvested into your additional initiatives aimed at gaining market share and deepening the competitive moat? Or should we think about there's potentially being an upside to the 12% operating margin that was discussed in that robust demand scenario?" ] }, { "name": "Dave Denton", "speech": [ "Hey, Liz, this is Dave. I'll start with that question there. I think what you're looking at here is we have a very specific investment thesis. As we watched it in 2020 and into '21, I think if you look at the thesis that we have and all the priorities that we have, we feel like we're very well-positioned to make the right investments to grow our business long term and improve our operating performance.", "I do think we're also very focused on the fact that we can't really predict the macro in the back half of this year, but we are very committed to doing two things. One, we're going to grow market share this year, and two, we're going to improve our operating margin performance. And we do expect that to be if the market holds up at that robust or above robust, around 12% operating margin. And that's our focus for this year." ] }, { "name": "Liz Suzuki", "speech": [ "Great. And just one quick follow-up, which is that -- which of the two categories comp below 15%? And what was the two-year growth there?" ] }, { "name": "Bill Boltz", "speech": [ "Hey, Liz, this is Bill. So you know, all categories achieved plus 20% on a two-year basis. But the two categories below the company were the paint and our hardware business, driven largely because of, you know, everybody painting last year during the pandemic. And then the hardware business is driven by safety and masks and some of that business that spike last year." ] }, { "name": "Liz Suzuki", "speech": [ "OK, great. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Michael Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "OK, thanks. A couple and I hate to be short-term focused here but the -- first of all, April did fall off versus March on a two-year basis a little bit. Do you think that's because of the stimulus that occurred in March? And then playing that forward, if we take that two-year trend into May and for the rest of the quarter, you should be about flat in the second quarter. Is that a fair way to think about the expectations for the quarter?" ] }, { "name": "Bill Boltz", "speech": [ "Yeah. First, if you look at, I guess, our performance by month through the quarter, if you look at it on a two-year stack basis, yes, March was somewhat inflated, if you think about tax recovery from the storm in Texas and other states, as well as the stimulus hitting that period. So I think we feel very good about kind of how we've ended the quarter and the trends as we cycle into May from a sales perspective. And I think, you know, listen, we're not giving guidance for the quarter.", "We continue to be focused specifically on making sure that we have great service. We have -- that we're in stocks in the right categories and we're supporting our consumers across our marketplace. And I feel like we're gaining momentum as we think about our business both in 2020 and here as we cycle into '21." ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Michael, this is Marvin. The only point I'll add to that is we were up against a 20.4% comp in the month of April in the U.S., and we comp almost 14% on top of that. So we feel really good about that. That exceeded our expectations, it exceeded our internal plan, and it also demonstrated to us that even going up against some of the spiking demand from last year, we still can perform at a high level.", "So we actually felt great about our performance in April. But it demonstrates when you're up against a significant surge in demand, you're going to see sales comp pressure and that's to be expected." ] }, { "name": "Michael Baker", "speech": [ "Yeah, sure. OK, that makes sense. And to follow up and not ask a tough question, particularly, you know, on a 25% comp against the 12% last year, it was really, really incredible and strong. But can you talk about market share gains? A simple look at the growth of the market using the NAICS, you know, sales for building materials, garden equipment, and supply source, that did grow a little bit faster than you did this quarter.", "So I wonder how you think about what market are you looking at or what numbers are you looking out to underpin your market share gain comments for the quarter in the year?" ] }, { "name": "Marvin Ellison", "speech": [ "You know, Michael, coming from someone who has worked in a couple of different retail formats, I've always said that home improvement has probably the most suspect market share data on a short-term basis of any retail segment. So to be quite candid, when we look at the amount of growth we delivered in the sales revenue to regenerate it and we look at it on a one-year or two-year comp basis, we can't quibble about losing market share. We really focus on a broader market and we've said consistently that in this COVID environment, and this is on the current and post COVID, the retailers are -- they're most capitalized and can make investments in omnichannel and omnichannel fulfillment and creating different channels for customers to shop and can lean into technology and also leverage the supply base as our merchants and supply chain were able to do over the past quarter. We will win and we will take a broader market share.", "I mean, we believe that we did that and so we feel very, very comfortable in our market share position and performance prospects." ] }, { "name": "Michael Baker", "speech": [ "Yeah. Fair enough. Appreciate the time. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Christopher Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, everybody. So a couple of questions. My first question is on the product margin benefits that you're seeing on the pricing side, should these accelerate over the year, given that some of the learning builds somewhat -- sort of to say in the systems, and to what extent is it more sensitive to sort of highly seasonal and markdown prone quarters like Q2 and Q4 versus the third quarter?" ] }, { "name": "Dave Denton", "speech": [ "Yeah, listen. I think -- this is Dave. We have made a lot of investments from a product cost management and pricing perspective infrastructure here at Lowe's and we feel very confident between the merchant and advanced team of kind of managing that. It is not necessarily seasonally related.", "This is really about managing our everyday pricing costs in a more effective manner over time. I do think that we're still in the early stages of this journey as we think about the next several years to improve our performance here. Clearly, at the moment, we are -- as we said in our prepared remarks, there are some inflation pressures in our business that we're managing through. I do believe that we have -- we'll continue to invest in these tools and technologies to enable us to improve our margin performance over the longer term.", "Now keep in mind, Chris, I just want to go back to what we said of our long-term financial algorithm here is really to maintain kind of flattish gross margins over time with the fact that we would improve product margin, but we will reinvest some of that product margins in the supply chain to drive performance and growth over the long term." ] }, { "name": "Chris Horvers", "speech": [ "Got it. Understood. And then in terms of -- as a follow-up on the 12% margin question, if you do end up beating that minus 2% sales outlook, I guess, why wouldn't you be above a 12%? Is there an offset, perhaps, bonus and employee incentives? Is it a headwind from lumber inflation that creates a rate headwind that more than offsets in the natural leverage of beating the robust scenario sales guide?" ] }, { "name": "Bill Boltz", "speech": [ "Yeah. Hey, Chris, I just want to get ourselves focused. Listen, first and foremost, we've said about the fact that we're going to gain some market share. We've got to improve operating margin performance here, and we'll try to get to our 12% in the short term here.", "Beyond 12%, we have objectives, and we believe we can expand it further. But let's at least get to our 12% margin first. And so, we're just kind of laser-focused on making sure that we're delivering upon our commitments from that perspective." ] }, { "name": "Marvin Ellison", "speech": [ "Hey. And, Chris, this is Marvin. You can appreciate the challenge we have looking at the overall macro outlook for the business with all the dynamics occurring in the marketplace. The good news is the better the macro performs, the better we'll perform.", "We feel great about the things that we control and some of the tools, and some of the processes we've put in place. And some of the decisions of the leadership team are really paying dividends. And as David said a couple of times already today, we were committed to outperforming the broader market and improving operating margins. And if the macro improves significantly above the robust scenario, then our business will perform equally as well.", "And that's how we're approaching it." ] }, { "name": "Chris Horvers", "speech": [ "Understood. Best of luck, guys." ] }, { "name": "Marvin Ellison", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey, good morning. Great quarter. You guys spoke about the big increase in lumber pricing. Home Depot said the same thing yesterday.", "Curious what you're seeing on the demand side and unit velocity over the past three months." ] }, { "name": "Joe McFarland", "speech": [ "Hey, I will -- I'll start it off. What I can tell you is, you know, we're just really pleased that the merchants were able to create such strong supplier relationships that we could keep up with demand in an unprecedented environment of unit demand. I'll let Bill talk about units and how we're performing and kind of how we feel about the rest of the year." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. You know, Chuck, I think, you know, my take on Marvin, I think, you know, demand continues to remain strong. You know, all the preparation that was done coming off of last year has certainly enabled us to, you know, to fulfill that demand going forward. All the work that's being done right now is to maintain that as we go through the rest of the year and continue to manage, you know, the needs of the Pro customer, you know, and make sure that we can take care of them first.", "I mean, that's really what we're focused on in that job-light quantity and making sure that we're right by the market. And that's been the focus of the team." ] }, { "name": "Chuck Grom", "speech": [ "That's great right there." ] }, { "name": "Dave Denton", "speech": [ "And Chuck on --" ] }, { "name": "Chuck Grom", "speech": [ "And just probably just on the installation business, you talked about a 6% comp in the quarter. I guess I'm curious like, you know, what penetration of the business is that today? How -- can you grow that? And then also just from a profitability perspective, how it compares to the rest of the business?" ] }, { "name": "Dave Denton", "speech": [ "Yeah, Chuck that business is in the mid-single-digits penetration for our business. And we do think we have a big runway here. As Joe indicated in his prepared remarks, that business was something that really wasn't invested in historically and was something that we had a really, I'd say, poor service model historically and was not the best from an operating performance perspective financially. I think we've now turned that business around and have a really nice foundation as we think about growing it.", "So, I'll ask Joe to give a couple of comments on it." ] }, { "name": "Joe McFarland", "speech": [ "Yeah. Thanks, Dave. I'll just make a few comments. You heard in my prepared remarks the performance, very, very pleased with it.", "You know, we've attracted industry veterans that really understand indeed the complexities of being inside the home, and especially in a COVID environment. You know, all the new platforms that we have been focused on, the consolidation of installers across the country, and remaining laser-focused on the programs that we really want to drive. And that's all under the same umbrella as our total home strategy. So, we're very pleased with the team's efforts.", "I'm very pleased with all of our installer partners across the country and looking forward to a great continued momentum there." ] }, { "name": "Chuck Grom", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Scott Mushkin with R5 Capital. Please proceed with your question." ] }, { "name": "Scott Mushkin", "speech": [ "Hey, guys. Thanks for taking my questions. So, I had a more long-term strategic question when you guys think about your business into 2022. As you look at your strategic priorities, what do you think drives incremental growth for Lowe's kind of company-specific.", "You know, what are your top three type of things as you look out over the next 18 months? Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "Scott, this is Marvin. I think it goes directly to our total home market acceleration strategy, where we talk about continuing to invest in online, which is really more omnichannel-focused, making sure that we're investing in our installation services business, and also improving our overall performance with the Pro. As I mentioned in my prepared comments, I mean, all of our customer segments are really important, and we are focused more intently on being a customer-focused business. The Pro adds a different dimension because of the frequency of how the pros shop and also how to Pro shops throughout the entire store.", "And one of the strategic mistakes made in the past here is not understanding that customer and understand the economic value of that customer. So, we're going to continue to stay really focused on that customer. But I would say those three things, omnichannel, ensuring that we can continue to have a really robust and seamless installation service business, and focusing on the Pro are three of our priorities. But the whole total home strategy encompasses what we're going to be leaning into for the next couple of years." ] }, { "name": "Scott Mushkin", "speech": [ "That's great. And then just like looking out the back half of this year, are you seeing any signs that there's been -- this very high level of inflation is creeping demand at all? Or is that not something you're seeing?" ] }, { "name": "Marvin Ellison", "speech": [ "You know, we're not seeing it. I'll give you thoughts and I'll let Dave give a more financial perspective. I mean, we feel really good about this business and this business model. You know, as I look at home improvement as an overall retail sector, I just think that even though we're all just totally fatigued both mentally and physically with the pandemic and there's nothing that we can say positive about operating through all of the health and safety issues that we've all dealt with both business and personal, when you look at the macro for home improvement, it's a very positive backdrop.", "And as we look at, you know, forward-looking quarters and into next year, even with the inflation we're seeing in certain areas specifically lumber and copper, we just don't believe that that's going to create an impediment for growth or significant headwinds, you know, for this business sector. I'll let Dave add any other comments." ] }, { "name": "Dave Denton", "speech": [ "Yeah. The only thing I would add is just to reconfirm what Marvin said. We see no slowdown in demand at this point in time across our business and our categories. And I think if you can speak to our Pro customers, we're hearing from them that they, one, are very busy at the moment; and two, have extremely long backlogs at this point in time.", "So, I think this demand will continue for some period of time." ] }, { "name": "Scott Mushkin", "speech": [ "Thanks, guys. Appreciate it." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Brian Nagel with Oppenheimer and Company. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning. Congrats on a nice quarter. The first question I wanted to ask, you've talked a lot about, you know, the various scenarios for 2021 and the operating margin and markets, your opportunities for Lowe's. How do you look at the expense levers? I think you may have talked about this a bit in your prepared comments, but how do we think about the expense levers to the extent that sales prove choppier, you know, through the balance of 2021?" ] }, { "name": "Dave Denton", "speech": [ "Yeah. Obviously, this is Dave, obviously, the biggest expense lever we have is how we manage operating salaries across our business, and probably labor, a little bit in the supply chain. I think what we've done is we've -- we have invested in tools and processes to really allow us to effectively manage that labor component and really adjust it based on demand that we're seeing from a profile perspective. With that, I'll turn it over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Yeah. Bryan, thanks for the question. And I really would point out the three major points of the PPI initiative that we talked about. First is the investment in technology to reduce the tasking hours, and we've been doing that very effectively.", "Secondly is the improvement in customer service with those changes. And then finally, the overall sales productivity and sales-per-square-foot productivity of the stores. And I think as, you know, we've given some examples, the digital signs in appliances, digital signs in lumber. You know, the investments we're making in the Pro area, the investments we've made on the front end.", "And so, I think the overall investment thesis that we have in driving this PPI really speaks to choppy times or good times that we have deleveraged the business." ] }, { "name": "Scott Mushkin", "speech": [ "Got it. Very helpful. And my follow-up question with regard to sales. You know, clearly, you know, for Q1 and given the commentary with regard to May, I mean, sales have stayed very strong and rather broad-based.", "But as you look at your business on a kind of a market-by-market basis, are you seeing any difference in sales trends in regions of the country, markets of the country that have opened up faster? You know, presumably, consumers are getting back to what their normal lives quicker." ] }, { "name": "Bill Boltz", "speech": [ "You know, Brian, it's Bill. When we talk about broad-based, it's more consistently broad-based in any time I can remember in my career. I mean, we have 15 geographic regions and three divisions. And as I had said in my prepared comments, I mean, all of our regions, you know, were -- in the north of 18%, all divisions north of 20%.", "And when we look at, you know, top 40 markets, we look at our -- and so, that points to us that there are just good underlying financial, you know, metrics in the balance sheet, you know, positive aspects for customers that is showing up in how they spend in our business. It also demonstrates that we're running a more consistent business. But the short answer is we're not seeing any negative outliers. When we look at customer mobility, with -- and even when we were seeing COVID spikes around the country and vaccination rates, we still didn't see any major differences in overall revenue performance in those pockets of the country.", "So, we feel good about that and it points to what we believe will be very positive signs for the rest of the year. And that's what we're hoping and praying for." ] }, { "name": "Brian Nagel", "speech": [ "Got it. Appreciate all the color. Thank you." ] }, { "name": "Dave Denton", "speech": [ "We're going to take one more question, please." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question this morning comes from the line of Steven Forbes with Guggenheim Securities. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning and thanks for taking the question. I wanted to focus on the Pro. You mentioned 30% sales growth in the Pro. Curious if you could sort of remind us or speak to the contributions from existing versus new customer growth.", "And if there's any sort of quarter -- quarterly variation in the Pro sales penetration rate that we should be cognizant of as we work our way through 2021." ] }, { "name": "Marvin Ellison", "speech": [ "Steve, the results from Pro is equally balanced between new and existing customers. You know, as Joe mentioned in his prepared comments, the key for us will be just continuing to get a larger percent of the wallet of our existing customers. If we didn't attract one new customer and we were able to get a greater percent of spend from existing customers, that would solve our Pro penetration for the next, you know, two-plus years. So, that tells you that our greatest opportunity is just getting our existing customers to buy more.", "But at the same time, with the loyalty program that Joe and his team launched, we're seeing incredible growth in new customers, and we're seeing also customers being very attracted to our new credit program. And that's a great sign for us to see the acquisition of new customers. Joe, I don't know if there's any other point you'll make." ] }, { "name": "Joe McFarland", "speech": [ "Yeah. Thanks, Marvin. The only thing I would add, you know, we started our journey in the Pro over two years ago. We've talked a lot about the basics, the price service, the right brands.", "And that we're focused on that strategic phase of the, you know, Pro growth. So, you know, things like building out our Pro loyalty database, the new CRM, the redesigned store layout, and the tailored shopping experience. So, we believe that, you know, we have attracted a lot of new customers, we're growing the wallet of our existing customers. And again, I'm very pleased with the Pro team, their focus, and everything that that team has accomplished in the last two years." ] }, { "name": "Steven Forbes", "speech": [ "Thank you. And then just a quick follow-up, right, regarding Pro wallet share, you know, based on the CRM data that you have, right. Any sort of color or current data that you can share as it relates to the wallet share, right, or trip share of the small and medium-sized Pro customer that you're focused on?" ] }, { "name": "Joe McFarland", "speech": [ "You know, Steve, we're not going to publicly share a lot of that detail. Obviously, we're tracking it, you know, but for competitive reasons, we typically don't share it externally. What I can tell you is that we've been pleased with the launch of loyalty and CRM. Both programs are exceeding expectations.", "We had some delays, or I say pauses in the rollout due to COVID. We're now leaning into it, we are excited about the amount of data that we're collecting, and we're more excited about the feedback from our customers on how they feel about the visibility of what they're buying, how they're buying it, and just the overall connectivity. So, we look forward at some point in the future to sharing more details. But for now, I mean, we're not going to share a lot externally other than to say we feel great about the progress we're making and the trajectory of the business specifically with that customer." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Joe McFarland", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2023-03-01	[ { "description": "Vice President, Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "Brandon Sink", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Patrick Hollander", "position": "Analyst" }, { "description": "", "name": "Unknown speaker", "position": "Other" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": "Robert W. Baird and Company -- Analyst", "name": "Peter Benedict", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steven Forbes", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies fourth quarter 2022 earnings conference call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, vice president of investor relations and treasurer." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning. Here with me today are Marvin Ellison, chairman and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president of stores; and Brandon Sink, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2023.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website.", "Now, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate, and good morning, everyone. In the fourth quarter, our total company comparable sales declined 1.5%, while U.S. comps decreased 0.7%. For the quarter, commodity deflation impacted U.S.", "comps by 75 basis points. Our investments in the Pro customers continue to pay dividends for the company reflected by our continued strong Pro sales in the fourth quarter. In fact, this is the 11th consecutive quarter that we've driven double-digit Pro growth in the US, despite stronger-than-expected commodity deflation. And while there was continued solid DIY demand in core home improvement categories, as expected, we saw a DIY pullback on holiday gift buying.", "Despite a modest decrease in sales, we once again improved our adjusted operating margin by maintaining our disciplined focus on productivity. During the quarter, adjusted operating margin expanded approximately 88 basis points leading to adjusted diluted earnings per share of $2.28, a 28% increase compared to last year. These results cap off solid financial performance for fiscal 2022 with sales of $97.1 billion, adjusted operating margin of 13%, and adjusted earnings per share of $13.81, up 15% over the prior year. With these results, we're awarding $220 million in discretionary and profit-sharing bonuses to our associates, which includes an incremental $70 million to our assistant store managers and supply chain supervisors who hold two of the most critical frontline leadership roles in the company.", "This builds on our recent $170 million investment in permanent wage increases for our frontline hourly associates, which went into effect in December. Since 2018, we've invested over $3 billion in incremental wages and share-based compensation for our frontline associates, including increasing associate wages by over 20%. And as we mentioned at our December Analyst and Investor Conference, we are committed to additional frontline wage investments over the next several years, which are contemplated in our long-term targets. These compensation investments are just one reflection of our commitment to becoming the employer of choice in retail, which Joe will discuss in more detail.", "Throughout the quarter, we continued to gain traction with our Total Home strategy as consumers remain engaged in home-related activities. In Pro, we delivered U.S. growth of 10% and 36% on a two-year basis. We are capitalizing on our momentum with our Pro by growing our MVPs, Pro Rewards, and partnership program, building relationships through our CRM tool, and continuing to enhance our product assortment to meet Pro needs.", "One example of enhancing our Pro product assortment is the exciting news that Klein Tools will be coming back to Lowe's. We know that our Pros are fiercely loyal to certain national brands and Klein is the number one hand tool brand among electrical and HVAC professionals. This creates immediate credibility across trades. Bill will share more detail on this exciting addition to our assortment later in the call.", "Now, one question many of you have asked is about our Pro backlog and if they're still healthy. We're in constant communication with our Pros through formal surveys, our Pro counsel and countless day-to-day conversations. In our January survey, more than 70% of Pros stated that they were booked out the same or more compared to 2022, and they remain confident in their ability to find jobs and hold on to their backlog. We believe this dynamic is being fueled by all the things we talked about at our December Analyst and Investor Conference, which includes homeowners with strong balance sheet and record levels of equity.", "On Lowes.com, sales grew 5% on top of 11.5% growth in the fourth quarter of 2021, partly due to strong appliance sales. This represents a two-year comp of 17% and more than 11% sales penetration. We continue to remove friction from the customers' online experience, which includes adding Apple Pay this quarter to improve conversion. We're also focused on removing friction from our customers' omnichannel shopping journeys, like for appliances where customers often shop our showrooms before making their purchase online.", "We also continue to make strides in the rollout of our market delivery model for appliances and other big and bulky products. We added two new geographic areas this quarter, bringing us to 10 geographic regions across the country supporting more than 1,000 stores. And as a reminder, in the market-based delivery model, big and bulky products flow from our supply chain directly to customers' homes, replacing our inefficient store delivery model. This delivery model is enabling us to further consolidate our industry leadership position in appliances and it positions us for profitable growth and other big and bulky product categories like grills, riding lawn mowers, and stock cabinets.", "Turning to Canada. We completed the sale of our Canadian retail business to Sycamore Partners this quarter. As a result, we are now solely focused on the transformation of our U.S. business, where we estimate we have a $1 trillion addressable home improvement market, enabling us to invest more into higher-return opportunities to grow our business and to take market share.", "I'd like to extend my appreciation to the entire Canadian team for their commitment to serving our customers, and I wish them the best as they move forward under new ownership. Before I close, I'd like to share my perspective on the home improvement market. And as you know, there is a wide range of conflicting opinions on what's going to happen in the macro environment in 2023. From our perspective the core drivers of our business, disposable personal income, home price appreciation, and the age of housing stock, remain supportive.", "Consumer savings are still roughly $1.5 trillion higher than pre-pandemic, with 85% concentrated in the top 40% of income owners who are more likely to be homeowners. Homeowners continue to enjoy record levels of equity in their homes, nearly $330,000 on average. Even if there is a modest decline in home prices, the level of equity built up during the pandemic would not be meaningfully eroded. And the housing stock continues to age with 50% of U.S.", "homes over 41 years old, the oldest since World War II. These factors, along with strong millennial household formation, baby boomers' increasing preference to age in place, and more widespread remote work will continue to be tailwinds for our business. And given the slowdown in housing turnover is driven by higher rates and low supply rather than demand, we continue to see a nationwide trend of trading up in place with consumers opting to upgrade their existing home to meet their evolving needs. All of these dynamics give us confidence in the medium and longer-term outlook for the industry.", "That being said, we also know that consumers are wary of a potential recession, which is reflected in some of the discretionary pullback we experienced during the holiday season. We're closely monitoring trends and we have a proven playbook to pivot quickly if the macro softens. Our results in the fourth quarter demonstrate our operational agility, which is reflected in our ability to leverage expenses and deliver productivity in a negative comp sales environment. This gives our experienced leadership team confidence in our ability to effectively manage the business in a wide variety of macro scenario.", "In closing, I'd like to thank our frontline associates for their commitment to serving customers day in and day out. As I travel to country every week visiting stores, I continue to be impressed by their passion for helping customers and their communities. And with that, I'll turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks Marvin and good morning everyone. In the fourth quarter, U.S. comparable sales decreased slightly by 0.7%, though sales were up 34.4% on a three-year basis, reflecting continued momentum with the Pro and resilience in core DIY home improvement demand. We delivered positive comps in Home Decor, fueled by key categories like appliances, paint, and kitchen and bath.", "And we delivered strong growth in our Building Products division, excluding the impacts of commodity deflation. We are particularly encouraged by the Pro strength we're seeing across categories, including rough plumbing, building materials, paint, and millwork as we continue to expand our product and service offerings to meet their needs. And consistent with our Total Home Strategy, we continue to add brands relevant to Pros, including four new partnerships. First, we're adding a portfolio of drinks from Coca-Cola to reduce the number of stops Pros make before going to the job site, which is important since time is money for these customers.", "Second, we are adding Carhartt Apparel that's popular with both our Pro and our DIY consumer, especially in our rural stores. Third, we have entered a new national partnership with Hubbell, giving us access to all of their pro-branded electrical boxes, including Bell, TayMac, and RACO. And fourth, we are excited to be bringing back Klein Tools. As Marvin mentioned, this is the number one hand tool brand among electrical and HVAC professionals.", "So this is just a big deal for us and our Pros. We are also really excited to announce that Lowe's will offer the widest selection of client products anywhere in the home improvement retail channel, which will be available in the second half of 2023. Our initial selection of client tools will include hand tools and electrical test and measurement tools, followed by a multiyear rollout of new product innovations. Klein Tools, Hubble, Carhartt, and Coca-Cola are strong additions to our Pro brand arsenal, which already includes other great brands like Bosch, DEWALT, Eaton, Estwing, FastenMaster, FLEX, GRK, ITW, LESCO, Little Giant, Lufkin, Mansfield, Marshalltown, Metabo, SharkBite, Simpson Strong-Tie, Specs, Spider and Werner.", "As we gain momentum with the Pro, we continue to see brands come to Lowe's and in many cases, come back to Lowe's because they recognize our newfound recommitment to the Pro and see the opportunity to grow with us. Shifting to our merchandising division performance for the quarter. In home decor, appliances, paint and kitchens and baths led the way. Appliances grew across both Pro and DIY as we continue to gain market share in this critical category.", "Growth was bolstered by our new instant savings capability that automatically applies supplier rebates to a customer's order, making it much easier and faster for them to take advantage of these offers, which are supported by the manufacturer. This replaces our cumbersome mail-in rebates with real-time savings, both in stores and online to remove friction for the customer and improve conversion. This innovation is another example of Lowe's leapfrogging the competition with technology that not only improves the customer experience, but also drives labor productivity. Paint was another standout category with solid pro growth fueled by our MVP's Pro Paint Rewards and Pro Job Site Delivery.", "We're also seeing an uptick in paint attachments items like applicators, paint sundries, and caulk as we upgrade our paint departments across our stores. This upgrade is strategically designed to make it easier for our customers to get everything they need in one trip. We also began the launch of Stainmaster paint, a high-quality, high-value solution for busy families looking to protect their walls from fingerprints and other messes. This is Lowe's first-ever private brand paint and early results are already outperforming our expectations.", "Our focus on driving private brand penetration is well-timed enabling us to capitalize on the nationwide trend of increasing customer preference for private brands. Another category that outperformed this quarter is kitchens and bath. We were particularly encouraged to see a strong increase in demand for custom cabinets driven by improved lead times as well as an expanded suite of digital tools, along with our team of talented virtual designers, all of which help our customers tailor the right solutions for their budgets and design preferences. Turning to the Building Products division, we delivered strong broad-based growth, excluding the impacts of commodity deflation across copper and lumber, we delivered strong positive comps across rough plumbing, building materials, and millwork driven by Pro demand and continued DIY investment in the home.", "Our performance in hard lines was consistent with broader consumer trends as we saw a decrease in holiday gift buying compared to the prior year. However, the team still delivered a solid holiday season with sell-throughs above 2019 levels. As expected, consumers reverted to more typical holiday buying patterns as compared to last year when we saw a widespread early buying due to supply chain concerns. As we look ahead, we continue to build on our customers' preference for new and innovative products with continued enhancements to our product assortments.", "We are expanding on our popular Kobalt 24-volt platform with new tools and technology that customers have been asking for, including a Cordless Kobalt Nailer that can instantly fire 1,100 nails on a single charge, eliminated the need to drag an air compressor and a hose around the job site. We're also excited about our new EGO Zero Turn Radius Mower with the industry's first e-STEER technology. With the sleek intuitive steering wheel that increases the driver's control and precision, powered by the EGO battery system that now allows this unit to mow three acres on a single charge. We are ready to capitalize on spring with the best in-stock positions that we've had in three years, right on time to support our biggest selling season of the year, in addition to an enhanced assortment and strong in-stock levels.", "We're also making strides in driving merchandising productivity as part of our enterprisewide perpetual productivity improvement initiatives. As one of the larger importers in the US, we continue to leverage our scale and carrier relationships to secure capacity and reduce our import and domestic transportation costs. As the cost of transportation and raw materials come down, we are working with our suppliers to ensure that our prices are competitive to support sales and to protect our margins. We have sophisticated cost optimization tools that track prices of the underlying components of the products we sell.", "So the teams are well-informed for these discussions. We are also holding our suppliers accountable to drive out costs through their productivity just as we are doing throughout our own organization. We are also partnering with our suppliers through our Lowe's One Roof Media Network. Some of our top suppliers have already locked in sizable contracts for 2023, and we are excited to partner with them to strategically target the home improvement shopper to drive traffic on Lowes.com and convert to sale.", "Before I close, I'd like to extend my appreciation to our merchants and our inventory and supply chain teams, along with our vendor partners for their hard work and continued support throughout 2022. I'm looking forward to what we will accomplish together in 2023, as we continue to find ways to provide value to our shared customers. Thank you. And I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thank you, Bill, and good morning, everyone. I'd like to start by thanking our associates for their unwavering commitment to serving our customers and delivering another solid year of operating results. Associates at the heart of any retailer but even more so in our industry, where customers rely on our associates' product knowledge, as they look for the right solutions to repair and upgrade their homes. That's why we are so focused on becoming the employer of choice in retail, where associates used to stay to build their careers.", "As Marvin mentioned, we've made substantial wage investments over the last four years, and we constantly review each market and monitor candidate flow to help us remain competitive and maintain a robust hiring pool in all geographic areas of the company. Beyond competitive compensation, we offer comprehensive benefits, flexible scheduling options, and bonus opportunities. As we close out the year, we are excited to award $220 million in discretionary and profit sharing bonuses. This includes $70 million for our assistant store managers and supply chain supervisors with an incremental $7,500 bonus this quarter on top of their annual incentive bonus, and we are one of only a handful of retailers to offer share-based compensation for our ASMs, which incentivizes them to build their careers at Lowe's.", "These critical leaders are undoubtedly some of the hardest working leaders in our company, and they are at the forefront of creating a culture focused on exceptional customer service. In addition to recognizing these leaders, we are also awarding $150 million to eligible hourly associates in recognition of their efforts this year. Based on continuous associate listening, we also added other improvements this quarter, including sick leave for part-time associates in revamping our store break rooms with higher quality, lower-cost food options. Our investments in our people have helped us build more than 80% of leadership positions from within over the last year, with more than 90% of our store leaders starting as hourly associates.", "As we enter spring, our busiest time of year, I'm pleased that we have the best staffing levels that we've had in three years. Our focus on associates also translates into how we're serving the Pro, which is our biggest opportunity for growth. This quarter, we launched a Know the Pro training, helping our associates understand how to better serve Pro customers across the entire store, not just at the Pro desk. This training supported storewide participation in key Q4 Pro events, including the most successful PROvember we've ever had, as well as our MVPs bonus days, which exceeded expectations.", "I would like to thank our associates, especially our Pro team, for delivering outstanding results, driving U.S. Pro comps of 10% for the quarter, 36% on a two-year basis, despite commodity deflation. We continue to leverage our MVPs, Pro Rewards, and partnership program to capitalize on this demand by engaging Pros, incentivizing purchases, and building long-term loyalty. Our program is designed to make every Pro feel like an MVP regardless of their size, giving small to mid-size pros, access to bonus points, savings, and exclusive offers that they can't get elsewhere.", "We're pleased to see the results continue to exceed expectations, as reflected in our 200 basis points increase in Pro customer satisfaction scores in Q4. Shifting gears to our focus on productivity. We continue to make progress with our PPI, or perpetual productivity improvement initiatives. One of the key objectives of PPI is simplifying our associates' jobs while removing friction for our customers.", "This approach allows us to generate productivity and cost savings in the store, while simultaneously improving customer service. One great example of this is the transition of our outdated legacy technology to our new modern omnichannel systems. We just completed the conversion at our returns desk with easy-to-use touchscreens that enable associates to quickly scan items and process to correct return value, with the system automatically accounting for return policies and promotions. This simplifies the return experience for customers, gives our suppliers more insights to improve product quality, while also making it easier for associates to enforce our policies and manage complex returns.", "We also continue to roll out new tools, including 90,000 additional Zebra smartphones by the end of June, to ensure all associates walking the sales floor have a device, including our MST associates. Our leadership team knows that when we make things easier for our associates, they make things easier for our customers. And our new returns process is just one example of the dozens of initiatives underway to do just that. And of course, none of this would be possible without our associates.", "For our associates tuning in, thank you for your ongoing focus on serving customers and driving productivity. We appreciate your hard work. And with that, I'll turn the call over to Brandon." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Joe, and good morning, everyone. Let me begin with our Q4 results. We generated GAAP diluted earnings per share of $1.58, compared to $1.78 last year. Now, my comments from this point forward will include certain non-GAAP comparisons where applicable.", "Excluding the $441 million of pre-tax transaction costs associated with the sale of our Canadian retail business, we generated adjusted diluted earnings per share of $2.28, an increase of 28% compared to the fourth quarter of 2021. This increase was driven by our continued focus on productivity, as well as disciplined capital allocation. Q4 sales were $22.4 billion, which includes approximately $1.4 billion in sales generated in the 14th week. Comparable sales declined 1.5%.", "U.S. comp sales were down 0.7% in the quarter, with comp average ticket up 4.8%, driven by product inflation and higher Pro sales, partly offset by 75 basis points of lumber deflation. This was offset by a comp transaction decline of 5.5%. Sales in Canada totaled $958 million, a decline of 18% in USD on a comparable basis, partly driven by exchange rate unfavorability due to a stronger dollar and lumber deflation.", "FX represented a 25 basis point headwind to consolidated comps. Of note, both the Canadian sales decline and lumber deflation pressured our Q4 comps more than expected. U.S. Pro sales were up 10% in the quarter despite lumber and copper deflation.", "On lowes.com, sales increased 5% in the quarter, partly driven by continued strength in appliances. Our U.S. monthly comps improved as we moved through the quarter, with comps down 3.1% in November due to DIY pullback on discretionary holiday spending. In December, comps were down 0.2%, with comps turning positive in January, up 1.4%, reflecting continued DIY investment in the home.", "Gross margin was 32.3% of sales in the fourth quarter, down 60 basis points from last year. Product margin rate improved 15 basis points versus the prior year. Gross margins also benefited from 30 basis points of favorable product mix due to a lower percentage of lumber sales. Higher product margin rate was offset by 40 basis points related to the expansion of our supply chain network, 30 basis points of pressure from shrink, and 35 basis points of pressure from our private label credit portfolio.", "Adjusted SG&A of 20.9% of sales levered 131 basis points relative to Q4 2021, despite a modest decline in sales, as we executed on our PPI initiatives across the company. Adjusted operating margin rate of 9.6% of sales levered 88 basis points, as adjusted SG&A leverage was partly offset by lower gross margin rate. The adjusted effective tax rate was 24% below prior-year levels. Inventory ended the quarter at $18.5 billion, which now solely reflects the inventory for our U.S.", "business, as we closed on the sale of the Canadian retail business on February 3rd. Inventory is up $0.9 billion from the same quarter last year, largely driven by product inflation with units down slightly to prior year. We continue to shift our inventory mix more toward Pro categories as we invest to drive future growth. Now, let me turn to capital allocation.", "In 2022, we generated $6.8 billion in free cash flow driven by outstanding operating results, and we returned $16.5 billion to our shareholders through both share repurchases and dividends. During the fourth quarter, we paid $643 million in dividends at $1.05 per share and repurchased 10 million shares for $2 billion. This brought the total to $14.1 billion in share repurchases for the year, ahead of our expectations for approximately $13 billion. This reflected better-than-expected operating performance and our commitment to return excess cash to shareholders.", "We ended the quarter at 2.44 times adjusted debt-to-EBITDA. And finally, we delivered return on invested capital of 30.4%, inclusive of an 800 basis point impact related to transaction costs associated with the sale of our Canadian retail business. Turning to our 2023 financial outlook, which we introduced this morning. As Marvin indicated, the long-term outlook for home improvement remains strong.", "However, in 2023, residential investment will be under some pressure. Given elevated levels of inflation, higher interest rates, and a more cautious consumer, we are forecasting a slight decline in the home improvement market. We expect to continue to outperform the market in 2023 with sales ranging from $88 billion to $90 billion. Comparable sales are expected to be in a range of flat to down 2%.", "Keep in mind that 2023 comparable sales will be calculated based on weeks two through 53 in fiscal 2022. Pro sales growth is expected to exceed DIY again in 2023 and as we expect to continue to outpace the broader Pro market growth by two times. We will continue to build on our momentum with the Pro with our new MVPs Pro loyalty program, CRM tools, and our expanded Pro brand lineup. We are expecting operating margin in the range of 13.6% to 13.8% as we continue to drive productivity through our PPI initiatives across the organization, in part to offset our planned wage investments.", "For 2023, we are expecting to invest $350 million in incremental wages for our frontline associates, which includes the 2023 portion of the $170 million permanent wage investment that went into effect in December. We expect capital expenditures of up to $2 billion this year and with our planned share repurchases, we also expect to reach our 2.75 times leverage target in 2023, while maintaining our BBB+ credit rating. Our strong operating performance and shareholder-focused capital allocation strategy is expected to deliver approximately $13.60 to $14 in earnings per share for the year. Keep in mind that there was an approximate $0.25 contribution to adjusted EPS from the 53rd week in our Canadian business in 2022.", "I would like to spend a moment discussing our expectations for first half performance, which is an easier comparison from a sales perspective. However, when we consider the impact of lower lumber prices, we are expecting a nearly 300 basis point headwind to sales in the first quarter and a 100 basis point headwind to sales in the second quarter. Given these impacts, we expect our first quarter sales comps to be below our full year guidance range and our second quarter sales comps to be above our full year guidance range. In closing, I'm confident that the combination of our strong operating results and our shareholder-focused capital allocation strategies will continue to deliver meaningful long-term shareholder value.", "And with that, we will open it up for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We're now ready for questions. [Operator instructions] Thank you. And our first question is from the line of Simeon Gutman with Morgan Stanley.", "Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Hey. Good morning, everyone. First, I have a macro and then a micro question. So you just comped -- roughly minus point -- minus one in the U.S.", "with some rounding and the midpoint of the guide is minus one. I know the monthlies -- when Brandon gave the monthlies that kind of answered it. But ignoring comparisons, I guess the guidance assumes that largely the backdrop holds up. And I wanted to requestion that given some of the deceleration in some of the housing metrics.", "So -- and what drives that?" ] }, { "name": "Marvin Ellison", "speech": [ "Hey. I'll take the first part, Simeon. I'll kind of go back to what I said in some of the prepared comments. When we take a look at what our demand drivers are for home improvement and just to be specific, these are historical demand drivers that have held up over time.", "They still remain supportive. And things like disposable personal income, which I mentioned, is roughly $1.5 trillion in savings above pre-pandemic levels. The average equity in U.S. homes, roughly $330,000 on average, the age of homes, and a reminder, two-thirds of everything we sell is non-discretionary.", "And there are other tailwinds, millennial household, formation trend, baby boomers, aging in place and more widespread sustainable remote work, so all of these things give us some confidence that the backdrop remains supportive. But as Brandon said, we still have some degree of caution when we think about discretionary buying, and that is factored into the guide. So I'll let Brandon add anything additional to that." ] }, { "name": "Brandon Sink", "speech": [ "Yes, Simeon. This is Brandon. I'll talk to your question specifically on Q4. As I said in the prepared remarks, inflation, interest rates, we are seeing a bit more of a cautious consumer, one that's anticipating and responding to value.", "We saw this play out in November with discretionary holiday categories, but we did see a nice progression of performance across the quarter as we hit the January exit, and we continue to see solid DIY demand in core home improvement categories like appliances. So as we turn and look at the guide in the next year, we feel comfortable with what we're seeing in Q4, very much in line with what we shared back in December in terms of the moderate scenario. And it's consistent with the market being down, call it, low single digits at 2% to 3%. So I think we got a lot of good consistency with what we're seeing again in Q4 with what we're anticipating for the full year next year." ] }, { "name": "Simeon Gutman", "speech": [ "OK. And the follow-up is more micro, within this, the long-term guidance that you gave in December, the 14.5 to 15, there's about 150 to 200 or so from opex productivity and then I think the -- some of the PPI initiatives. And I guess that's the stuff you can control. I forget if we discussed if that's ratable, meaning even across the time frame or are there things that you can pull forward this year or any year if you need it? And/or is the cost environment going up such that it makes the achievement of that bucket any different?" ] }, { "name": "Brandon Sink", "speech": [ "Yes. Simeon, I would say ratable as we look at the three-year period with what we shared in December. I mean, when we look at the algorithm for the guide for 2023, we are expecting roughly flat gross margin. So the bulk of the 60 to 80 basis points of EBIT expansion that's reflected in the guide is coming from SG&A leverage, and it's being largely driven by our productivity initiatives.", "So that's specifically just translating and transitioning from what we shared on the three-year to what we're expecting from an SG&A standpoint in 2023." ] }, { "name": "Marvin Ellison", "speech": [ "And Simeon, this is Marvin. The only thing I'll add is, if you take a look at Q4, just as an example, it just -- it shows that even in a flat to negative sales environment, we still have the ability to leverage productivity, whether that's expenses or operating margin. And I think that is consistent with the PPI initiatives not being solely focused in one functional area, but as you heard at our December Analyst and Investor Conference, it's across all functions, merchandising, supply chains, to operations. And so although it's ratable, we're very confident in our ability to deliver upon that in a variety of macro scenarios." ] }, { "name": "Simeon Gutman", "speech": [ "Great. Thanks. Good luck." ] }, { "name": "Marvin Ellison", "speech": [ "Thanks, Simeon." ] }, { "name": "Operator", "speech": [ "Next question is from the line of Kate McShane with Goldman Sachs. Please proceed with your questions." ] }, { "name": "Patrick Hollander", "speech": [ "Hi. This is Patrick Hollander on for Kate. We just wanted to ask about price elasticity. Another item discussed at the December Analyst Day was kind of the confidence in prices sticking but your competitor mentioned that they saw more price sensitivity in the fourth quarter than they had in the third quarter.", "So first, are you guys seeing something similar? And then how do you address some of the price sensitivity to prices need to come down? Will we see more markdown activity? Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Hey, Patrick, this is Brandon. As it relates to the question on elasticity, just stepping back, when we look at the last three years through the pandemic, we saw consumers who were very resilient with higher prices, not necessarily impacting demand that we were seeing for our business. As I mentioned in the last response, we are seeing more normal consumer trends with consumers anticipating and responding to value.", "So as we look at 2023, we are expecting a modest inflation lift across the portfolio. Most of that is going to be wrap of inflation that we're seeing in 2022, lapping into 2023. We're expecting that inflation to continue to slow, and we're seeing minimal activity in terms of new pipeline requests coming in from our supplier base. And that inflation is going to impact mostly first half as those benefits are expected to normalize as we move through the year next year.", "And then on the transaction side, we expect that inflation to be offset by a modest decline in transactions, which we also expect to see that improve across the year. So we're looking back half of the year and then into 2024 a more traditional balance between tuck in transaction." ] }, { "name": "Patrick Hollander", "speech": [ "Great. Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your questions." ] }, { "name": "Unknown speaker", "speech": [ "Hey. Good morning, guys. This is Joe on for Scott. I was really impressed by the Pro commentary.", "I was just wondering, is there any sort of regional thing that you'd break out whether or not people are more or less bullish on their outlooks and backlogs in areas where there's been more housing price correction?" ] }, { "name": "Marvin Ellison", "speech": [ "So Joe, good question. What I'll tell you, there are a couple of markets around the country that had a more accelerated what I would call, appreciation of home prices during the pandemic. And let's call out markets like South Florida, Phoenix, as an example. And as you can imagine, we pay really close attention to those markets.", "We've not seen any material difference in sales performance in those markets as those prices tend to come -- are coming down than in the broader US. And so when I cited the statistics that 70% of our Pros in our survey from January are very confident in their backlog being consistent to last year and being able to sustain it, that is pretty much a universal statement across all geographies. What I can tell you is that we're very pleased with the performance of our MVP loyalty program and how it's sustaining and giving us the ability to drive sales. And I'll let Joe just touch a little bit on that program and how we think that's going to allow us to build loyalty and continue to grow this very important business." ] }, { "name": "Joe McFarland", "speech": [ "Yeah. Thanks, Marvin. And Joe, thanks for the question. As it relates to the Pro and the market, Marvin made his prepared comments.", "But as you dig deeper, there's, kind of, five key areas that we look at, which is the jobs how far out the Pro is booked in the next six months, materials can they get what they need and is it the right cost? Can they get to Pro Credit? What does the labor market look like? And then just the balance of the type of work they do. So remodel versus new construction. And as we track these and as we roll out our Pro loyalty program, we're pleased with the trajectory of the business and the health of this small Pro that we're servicing." ] }, { "name": "Unknown speaker", "speech": [ "Great. Thank you so much." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hi. Good morning. I apologize. My question may sound like similar to prior questions.", "Going back to the comments made by your competitor last week, they discussed what -- they turned to broadening, if you will, of consumer normalization or consumer weakness. You called out weakness around the holiday, the gift giving, discretionary. But are you -- would you characterize also seeing that, what they discussed in this broadening or weakness in normalization across your portfolio?" ] }, { "name": "Marvin Ellison", "speech": [ "Brian, it's a fair question. And I'd start off by saying Q4 is typically our highest discretionary selling period of the year because of the holiday season. But when we look at core home improvement categories, we feel really good about the performance of the DIY customer. And I think as Brandon gave that monthly comp cadence for the fourth quarter, you notice that every month, the business performed stronger with a positive comp in January, and that was almost directly correlated to the DIY customer being stronger each month of the quarter, because we moved away from that discretionary period that was so heavily focused on the month of November, because of how they buy.", "So as we look at the overall customer, we look at the health of the DIY to discretionary spending, we don't see any really red flags that we're concerned about because the core home improvement discretionary categories held up really well for us, case in point appliances, case in point paint. So those are areas that really performed well. And I'll let Brandon add any additional comments." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Brian, I'll just connect that to the guide, Marvin highlighted with what we're seeing more with the DIY customer. But just looking at the Pro and expectations into 2023, continuing to outpace DIY 11 quarters in a row, double-digit comp, we continue to see Pro across all ticket ranges, both comp and transaction growth. And while we did see DIY lag in 2022 in the discretionary category, some of what Marvin was describing, we are seeing those overall transactions continue to improve across the year.", "So when we look at 2023, still expecting outperformance with the Pro, but expecting that gap between Pro and DIY to continue to close and tighten, and that's what's reflected in our guide for next year." ] }, { "name": "Brian Nagel", "speech": [ "That's very helpful. And then my follow-up question, just with regard to lumber prices. So you discussed here and we get it, this is kind of a pass-along dynamic when prices declined as a negative for sales. But if we've gotten to the point where lumber prices have declined so much of -- that's actually becoming a potential stimulant to demand, I don't know if you're seeing this in your business or maybe in some of your polling of your professional customers?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Brian. I'll take that and, again, kind of connect it to the guide. So our guide at the midpoint for lumber, in particular, assumes a normalized pricing environment, certainly considered to what we've seen for the last three years. And within that lumber assumption, as you heard in my prepared remarks, expecting headwind in both Q1 and Q2.", "And I'll call out also if that – when we look at lumber pricing currently, if that were to play out across the remainder of the year, it actually puts another 100 basis points of pressure on the midpoint of the guide. But to your point, within that, we are expecting an offset in units, and there's potential that, that could be a stimulant for our business. But again, right now, we're expecting and have considered at the midpoint of our guide, just more normalized pricing and a slight rebound in units in the next year." ] }, { "name": "Brian Nagel", "speech": [ "Appreciate all the color. Thanks, guys." ] }, { "name": "Brandon Sink", "speech": [ "Thanks, Brian." ] }, { "name": "Operator", "speech": [ "Next question comes from the line of Karen Short with Credit Suisse. Please proceed with your question. Ms. Short, please go ahead with your questions." ] }, { "name": "Karen Short", "speech": [ "Apologies, sorry. Thanks for that. So just on two questions. You guided to flat to down 2% comp.", "So that was kind of in between the robust and moderate scenarios that you offered. And then your margins, though, are only on the moderate range, not the robust range. So I'm wondering, if you could give any color on that. And then on the wage investments that you called out, obviously, one of your competitors also announced very sizable wage investments.", "So wondering, if you could just give a little color on your wage investment versus industry and/or one of your largest competitors?" ] }, { "name": "Marvin Ellison", "speech": [ "So Karen, this is Marvin. I'll take the wage question, then I'll let Brandon take the first part of the question. So two things. First, we feel great about the financial commitment we've made to our front line associates.", "And we're also very confident in our long-term financial plan. So since 2018, as we mentioned, we've invested over $3 billion in incremental wages and share-based compensation for front line associates, including $170 million wage investment we made last year. And over the past four years, we've increased our wage by more than 20%. And Brandon mentioned that we're going to be investing $350 million this year in frontline wages.", "And over the next three years, we're going to invest nearly $1 billion. So when you contemplate all this together, it's factored in our 2023 guidance and our long-term financial guidance. And as an investor community, sometimes we get challenged by our rural footprint of stores as a competitive disadvantage. When you discuss wage, it's actually an advantage because most of the small and rural markets where we operate, we're the highest paying retailer.", "And where we're not, the local operators have a very, very specific process to follow to get wage adjusted. So our approach to wage is our strategy, and we feel really good about it, and our associates have responded well. And what I'll do before I hand it to Brandon, I'm just going to let Joe McFarland talk a little bit about staffing levels and spring hiring, which, as you know, is a really big deal for us this time of the year." ] }, { "name": "Joe McFarland", "speech": [ "Yeah. Karen, thanks for the question. And as it relates to our frontline associates, I'm very pleased with our staffing right now. This is the best staffing we've had in three years.", "And our spring hiring, as the markets come into season, is ahead of expectations. So very pleased with the team's ability to staff and pivot wherever the challenges are." ] }, { "name": "Marvin Ellison", "speech": [ "And so, Karen, in summation on that, we have a strategy, we feel great about it. We feel like it's working for us, and we believe that our investment cycle, our commitment to our associates is something that is leading us to being truly an employee of choice in retail. And I'll hand it over to Brandon to answer the other part of your question." ] }, { "name": "Brandon Sink", "speech": [ "Yes. Karen, your first question on operating margin. We look at what we shared in December, a midpoint of the guide, down 1% and 13.7% in that moderate scenario. Our guidance is right in line, purely consistent with that, with the range that we provided just bookending those midpoints.", "So very consistent there." ] }, { "name": "Karen Short", "speech": [ "OK. Thank you, so much." ] }, { "name": "Operator", "speech": [ "The next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. So first, at the analyst meeting in December, you pointed to the most likely scenario being the robust market scenario or the moderate market scenario. The guidance now at the midpoint is squarely on the moderate market scenario, and at the low end could be closer to the weak market scenario.", "So what's changed in the last 90 days or so to moderate your expectations for 2023? And then I have a follow-up." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. So, Michael, this is Marvin. At a high level, it's lumber deflation. That pretty much sums it up.", "As Brandon mentioned, we're going to have 300 basis points of headwind in Q1 and 100 basis points of headwind in Q2. Going into 2023, we looked at the first half of the year as our easiest compares. That remains. But when you throw in that lumber deflation, that pretty much sums up what's different between what we discussed in December and what our guidance is." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. And Michael, I'll just add that the weak scenario that we called out, still very much sort of off the table for us. I think we called out at that point, it would require significant economic shock, and we don't see that playing out. So we're still very squarely in line with that moderate view.", "And just as a reminder, the downside, even in that week scenario was a 13.3% operating margin, so still 30 basis points of expansion even in that scenario." ] }, { "name": "Michael Lasser", "speech": [ "Understood. Thank you. My follow-up is on the gross margin outlook for this year. What's a realistic expectation, especially as the consumer environment gets a little tougher.", "The consumer may shop or want to shop a bit more on promotion. And how are you thinking about the private label credit card contribution to the overall P&L this year? Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Michael. I'll talk about the guide as it relates to margins. So very focused next year on delivering operating margin expansion, and that's on flat to slightly negative comps. As you mentioned, the gross margin, we are expecting that to be roughly flat in 2023.", "And there's a few different puts and takes that we're managing on the headwind side, continued rollout and expansion of our supply chain, and specifically market delivery. We're going to continue to see mix pressure from our Pro strategic initiative investments. The flip side, a number of productivity efforts. You mentioned private brand penetration, also lower commodity and transportation costs and then continued benefit from our pricing initiatives.", "So the large part of the leverage is going to come from SG&A and continued PPI productivity efforts that you've heard called out from the team. So that's sort of the formula as we look at margins and flow through next year. And, Bill, I don't know if there's anything else you want to add on private brands and some of the momentum that we're seeing there?" ] }, { "name": "Bill Boltz", "speech": [ "Well, Brandon, and for Michael, what we talked about in December, private brands certainly gives us an opportunity in categories where a national brand isn't relevant. Private brands carry a better margin. They offer the consumer some additional choices. As it relates to promotional activity, we want to continue to offer the customers value, but we're not adding new promotions for 2023." ] }, { "name": "Michael Lasser", "speech": [ "That's helpful. And just to clarify, I was referring to the private label credit card that was a drag on the gross margin in the fourth quarter." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Got it, Michael. So yes, drag in Q4, mainly given the interest rate environment that we're seeing. But as we turn into 2023, again, a number of puts and takes, but we feel like the bulk of that for the most part has been absorbed, and we have that factored into '23." ] }, { "name": "Michael Lasser", "speech": [ "Thanks, very much." ] }, { "name": "Brandon Sink", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Next question comes from the line of Greg Melich with Evercore ISI. Please proceed with your question." ] }, { "name": "Greg Melich", "speech": [ "Hi. I'll start with a follow-up on that last question before I get to mine. On other gross margin puts and takes, shrink was also I think a headwind in the fourth quarter. Could you just quantify that and give us your expectations for that into '23?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah. So sure, Greg. On shrink, in particular, it was a bit of a pressure point, a bit worse than expected. It's been approximately 30 basis point pressure.", "We saw that Q3 and Q4, largely driven by what we're seeing more broadly in retail with organized crime, but again, as we turn and look at '23 that pressure largely absorbed in 2022. We feel like we got great efforts within the team and the organization in terms of what we're doing to protect against shrink, and I'll maybe let Joe call that out." ] }, { "name": "Joe McFarland", "speech": [ "So thanks for the question. And listen, we're really pleased with the asset protection team. The entire industry has pressure from ORC. Our asset protection team has rolled out some new innovative things for safety, for shrink, and so we see the outlook good." ] }, { "name": "Greg Melich", "speech": [ "Great. And then I guess, my key question was on the traffic and inflation and how that sort of comes in through the year. So if you think about the cadence through the year, it sounds like, first quarter is below the range, second quarter is above the range. Should we assume the second half is better than the first half or worse than the first half or in line?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Second half, Greg, very much in line." ] }, { "name": "Greg Melich", "speech": [ "Got it. And the difference would be, better traffic in the second half, maybe still negative but less negative? And lessoned --" ] }, { "name": "Brandon Sink", "speech": [ "Correct. Correct." ] }, { "name": "Greg Melich", "speech": [ "Great. Thanks, and good luck." ] }, { "name": "Brandon Sink", "speech": [ "Thanks, Greg." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Peter Benedict with Baird. Please proceed with your question." ] }, { "name": "Peter Benedict", "speech": [ "Hi, guys. Good morning. Thanks for taking the question. Just wanted to hone in on the first quarter comp view that you laid out there.", "We understand the commodity impacts there. But just curious, any early season read? I know it is early, but some of your markets in the South, just curious how spring seasonal demand is starting out here? That's my first question." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Peter, as we look at February sales consistent with our guidance, we called out the Q1 being below the full year guidance range. And again, that's primarily due to the lumber pricing pressure that we're seeing. We are encouraged to see early signs of strength in discretionary seasonal categories, in particular, South and Deep South as our customers begin to prepare for spring, and I'll let Bill talk to that in a little bit more detail." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. Thanks, Brandon. And Peter, we started setting our stores in the South, Deep South, early January. And I think what's nice to see is spring start to come and the way it's supposed to come and you start to see sales of product in fertilizer, chemicals, landscape products, start to occur the way they're supposed to occur.", "And so we're encouraged by that. February can always be a wildcard month. But certainly, in these months -- in these deep south and south markets seeing it kind of progress the way it's supposed to." ] }, { "name": "Peter Benedict", "speech": [ "Got it. Thanks. And then just back to the -- maybe the promotional plan that you have laid out for the year. I mean, you mentioned in your prepared remarks that the consumer is responding to value.", "I'm just curious -- I mean, we've been through a period where there's been very limited promotion. So how do we think about the plan maybe for the first half of the year here in terms of your promotions? Things that you tend to do to drive traffic, how they compare to maybe what you've done in the last couple of years? That's my second question. Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "So, Peter, I'll take the first part of that. At the highest level, you're not going to see any increased promotional activities by us. We're very fortunate to be in a very rational industry relative to promotions. And to be quite candid, a lot of the irrational activities came from old Lowe's.", "And those practices and behaviors are along behind those. One of the first things that Bill Boltz and I discussed when we arrived four and a half years ago was getting off the high-low promotional drug that we felt was not consistent with how you should run business in this industry. And it's taken us a while to get there, but we're very fortunate that we are there. So we anticipate and see no increased promotional activities.", "Obviously, as you get out of these pandemic-driven demand cycles, customers are looking for value, but we believe we can offer value without getting to a high promotional environment. Bill, I don't know if there's anything you want to add?" ] }, { "name": "Bill Boltz", "speech": [ "No. I think the one area that the team may see different activity on is in appliances, and you guys have to remember that roughly 100,000 appliances break every day. And so there's always going to be an offer in the marketplace for appliances driven by the manufacturers, supported by the retailers. So that's one area as supply has improved.", "Those offers are out there for appliance products. But no additional promotions." ] }, { "name": "Peter Benedict", "speech": [ "Understood. Thank you very much. Good luck." ] }, { "name": "Marvin Ellison", "speech": [ "Thanks, Peter." ] }, { "name": "Operator", "speech": [ "Thank you. We have time for one final question, which will come from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning and thanks for taking the question. Marvin, Brandon, I just wanted to follow up with a quick modeling question given the exit of Canada. And so I'm not sure if you could help us think about the mix impact on gross margin because I would think the Canadian business and the exit of it has a positive impact on gross. And can you help us quantify that relative to the 60 basis point net impact and whether this is partially sort of supportive of the 2023 outlook for a flattish gross margin in 2023?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Steve. 60 basis points was a full year impact on operating margin. And when you think about the split there between gross margin and SG&A, it's roughly half and half." ] }, { "name": "Steven Forbes", "speech": [ "Thank you for that. And then lastly, the ongoing compensation related to investments that you noted during the prepared remarks, which is great to hear. I was curious, if we just take a step back and think about the dollar level of opex productivity initiatives you've highlighted at the Analyst Days in 2020 and 2022. Any contextualization about how much still remains in front of us in dollar terms.", "And Marvin, I'm not sure if you could maybe talk about some specific PPI initiatives that you're most excited about this year?" ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Well, it's a really good question, Steve. A couple of things. Number one, as you can imagine, we have been working aggressively to update our IT infrastructure.", "We still have a 30-year-old basically mainline system that we're getting ready to retire, and it's literally taken us four and a half years to get to this point. The moment that system is officially retired, it gives us the ability to create so many technology advancements that will do two things, will simplify the associate's job and limit friction points for customers, which will reduce payroll and improve customer service. And that's what Joe cited in some of his prepared comments. And so holistically, a lot of our PPI initiatives on the store and merchandising side, and candidly, the supply chain side are tied and correlates to the retirement of this 30-year-old operating system that we are excited is going to be going away over the next few months.", "And as we look at that, you'll start to see a more omnichannel type of systems available in the store at point of sale, you'll start to see pricing initiatives and pricing systems advanced on the merchandising side. You'll start to see us have the ability to do more relative to integrating gig network deliveries online in a more seamless way in addition to all the supply chain and some of the advanced sourcing logic we'll be able to do that will give us the ability to ship merchandise, aggregate merchandise, from different points of stores, distribution centers without having to go out and build these monolithic DCs that some retailers have had to do. So all of those things are tied together. But again, it's almost foundationally driven to a lot of the IT work that's been done the last four-plus years." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you all for joining us today. We look forward to speaking with you on our first quarter earnings call in May." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2022-05-18	[ { "description": "Vice President, Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Brandon Sink", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone. And welcome to Lowe's Companies' first quarter 2022 earnings conference call. My name is Kevin, and I'll be your operator for today's call. As a reminder, this conference is being recorded.", "I will now turn the call over to Kate Pearlman, vice president, investor relations. Please go ahead, Kate." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning. Here with me today are Marvin Ellison, chairman and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president, stores; and Brandon Sink, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2022.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties, and important factors, including those discussed in the risk factors, MD&A, and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our investor relations website.", "Before we turn to our first-quarter results, I would like to announce that we will be hosting an Analyst and Investor Conference in person on Wednesday, December 7, from 8 a.m. to 1 p.m. Eastern Time in New York City. For those of you who are unable to attend in person, the event will also be live-streamed on video.", "At this event, our executive leadership team will provide updates on the key growth initiatives in our Total Home strategy and our long-term financial targets. With that, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate, and good morning, everyone. In the first quarter, our total company comparable sales declined 4% with the U.S. comps down 3.8%. Excluding our seasonal category, sales were in line with our expectations for the first quarter.", "Looking at sales goals on a two-year basis, total company comps and U.S. comps were up approximately 20%. In Pro, we delivered growth of 20% and 64% on a two-year basis. We also saw solid DIY demand for core nonseasonal home improvement projects.", "However, we experienced a delayed spring selling season due to prolonged unfavorable weather that impacted spring-related categories. In fact, to put this into historical context, the past April was the coldest in over 20 years and one of the wettest in recent memory. But now, spring has finally arrived, and we are seeing the anticipated improvement in our seasonal sales in the month of May. I would like to provide some perspective on the impact that a very delayed spring has on our do-it-yourself or DIY sales.", "As a reminder, roughly 75% of our sales are to the DIY consumer in many seasonal categories like live goods, outdoor power equipment, grills, and patio furniture are more heavily concentrated in DIY. And while spring was delayed across all geographies, the season came particularly late in the north, where sales were down double digits in many of our northern markets. And at the same time, sales in our Florida, Charlotte, Nashville, Houston, Atlanta, Dallas, and Richmond regions were ahead of our sales expectations, even though spring weather was unfavorable in those regions as well. Simply stated, the further north you look, the larger the negative impact to our seasonal categories.", "Although the late spring postponed our DIY sales, our Pro customers continue to shop to fuel their strong business demand. And our recent Pro surveys indicate that the majority of our Pro customers continue to report strength in their business and a full slate of projects for the year. At Lowe's, we see spring as a first-half event. And as I mentioned, we are encouraged by the improved sales trends we're seeing in the month of May.", "We're also ready to capitalize on the increased demand with our enhanced assortment, strong inventory position, improved supply chain capabilities, and seasonal staffing in place to serve our customers. Later in the call, Bill will discuss our plans to win spring again this year, while Joe will discuss how we are serving our customers during this busy season. Importantly, our Total Home strategy has given us the agility and flexibility to deliver operating margin improvement even when sales decline. During the quarter, operating margin expanded approximately 65 basis points, leading to diluted earnings per share of $3.51, which is an increase of over 9% versus last year.", "These results reflect great operational discipline in addition to excellent execution in a number of key initiatives, including our enhanced labor management tools, our perpetual productivity improvement or PPI initiatives, and our improved pricing capabilities. Our Total Home strategy also enabled us to win with both the Pro and DIY customer in Q1 as we elevate our product assortment and provide our customers with the products and brands that they need across all of their home improvement projects. Let me now discuss the progress that we're making with our Pro customer. As I mentioned, we delivered Pro growth of 20% in the quarter on top of 36% comps last year.", "The progress with this very important customer is reflected in the nearly 600-basis-point increase in Pro sales penetration in the U.S. from approximately 19% in Q1 of 2019 to approximately 25% in 2022. Later in the call, Joe will discuss how we continue to drive growth in Pro with the early success of our Lowe's MVP's Pro Rewards and Partnership Program that was launched in the first quarter. On Lowes.com, sales grew 2% on top of over 36% growth in the first quarter of 2021, which represents a two-year comp of over 39% and nearly 10% sales penetration.", "As we enhance our omnichannel offering, we are gaining traction with consumers who increasingly expect a fully integrated shopping experience. We're also expanding our market delivery strategy by adding other big and bulky products in Florida including patio, grills, and riding lawn mowers to the appliances that we already deliver from our cross-dock terminals. By adding these incremental products, we're better leveraging our fixed costs while enhancing customer service at the same time. We've also converted our fourth geographic area, the Tennessee, Kentucky region to this new delivery model.", "And we're on track to convert our full portfolio of stores to market delivery by the end of 2023. Turning to our results in Canada where our performance lagged the U.S. in Q1. Last year, Canada's results benefited from record-high lumber prices due to the higher lumber mix in our Canadian business.", "In closing, despite some increased uncertainty in the macro-environment, our long-term outlook for the home improvement industry remains positive. Homeowner balance sheets are very strong, and their confidence to purchase big-ticket items is supported by continuing home price appreciation. Other factors like the extension of remote work, the age of the housing stock, millennial household formation, and baby boomers' preference to age in place all are long-term tailwinds for home improvement. And over the past few years, we have greatly improved our operating capabilities so that we now have the agility needed to respond in this dynamic macro environment.", "These enhanced capabilities will allow us to continue to take market share while expanding our operating margin. And as a reflection of Lowe's commitment to the community, at the beginning of the year, we announced a new community impact program called Lowe's Hometowns. This is a five-year $100 million investment to improve the communities in which we live and work and to ensure we remain committed to giving back to our customers. And before I close, I would like to welcome Brandon Sink to his new role as EVP and chief financial officer.", "Brandon brings tenure, home improvement expertise, and strong financial and operational acumen to this role, and we're excited to have him on the executive leadership team. I would also like to take a moment to thank Dave Denton for the contribution he made as CFO in the past three years. And at Lowe's, we believe that our store associates are a competitive advantage, and I would like to close by thanking our frontline associates for their hard work and dedication. And with that, I will turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. In the first quarter, U.S. comparable sales declined 3.8% but were up 19.7% on a two-year basis. This quarter, we delivered a strong positive comp in building products, driven by our momentum with the Pro, while sales in home decor came in above our expectations driven by solid DIY demand.", "However, comps and hardlines were down compared to prior year as a delayed spring season impacted seasonal categories. We are particularly pleased to see improved demand in seasonal categories over the past few weeks as the spring weather has finally arrived. In the quarter, 10 of 15 categories were above company average, while eight categories were up over 20% on a two-year basis. Within our home decor division, paint and flooring delivered the strongest comps this quarter.", "Inside our paint category, the biggest growth drivers were in interior and exterior paint and primers as our in-stocks continue to improve throughout the quarter. Also, our investments in our Pro Paint offering continue to pay off as we've enhanced our Pro service model, expanded associate training, and have built out our job site delivery capabilities. We are building on this momentum with the recent launch of our new, incremental paint reward program for our MVPs Pro customers, in addition to the other meaningful rewards they have already received. Within flooring, luxury vinyl was once again the top contributor as our consumers continue to prefer the low maintenance and stylish solutions that this product category has to offer.", "We also refreshed our Stainmaster carpet lineup, continuing to reflect current styles and consumer preferences. And in late March, we launched our first extension of the Stainmaster brand in tile. And right behind tile, we are launching new laminate and luxury vinyl products in Stainmaster as well. We're excited to have the Stainmaster brand within our portfolio and to extend its high-performance characteristics and stain-resistant warranty to these new product categories.", "With this new brand lineup, we are offering innovative and functional products for the home, all with a great value for our customers. Now, turning to building products. We continue to see broad-based strength across key Pro categories, including electrical, building materials, rough plumbing, millwork, and lumber, driven by strong Pro demand and competitive in-stock positions. Building on last year's strong performance, we delivered a positive 38% two-year comp in building products, which continues to reflect the persistent underlying strength in consumer demand for larger core home improvement projects and, to a lesser extent, commodity inflation.", "Over the past several years, we have been focused on expanding our brand and product offerings to meet the needs of our Pro customers. In this quarter, we are excited about the introduction of Owens Corning's new fiberglass rebar known as Pink bar. This Pro family product is stronger than traditional steel rebar and seven times lighter, which makes it both easier for the Pro to work with and less costly to ship. We are also excited to announce the national expansion of the APOC roof coating brand, which is a leading manufacturer in roofing and an important strategic partner to Lowe's.", "These new products and brands are strong additions to our outstanding Pro brand portfolio, which already includes other powerful brands like Bosch, Crescent, DEWALT, Eaton, Estwing, FastenMaster, FLEX, GRK, ITW, LESCO, Little Giant, Lufkin, Mansfield, Marshalltown, Metabo, SharkBite, Simpson Strong-Tie, SPAX, Spyder, and Werner. Now, looking at our performance in hardlines. As I mentioned earlier, our seasonal categories were impacted by delayed spring. As the weather has finally broken over the past few weeks, we have now seen higher demand across the seasonal categories.", "And it's important to remember that spring is always a first-half event. And while this year's spring season has started slow, the teams are focused on delivering a successful spring again this year. From the convenience and quality of the EGO, Kobalt, Craftsman, and Skill brands with their zero-emission rechargeable equipment to our other leading brands such as John Deere, Honda, Husqvarna, Aaron's, and Craftsman, we offer the products that our customers need to have the best-looking yard in the neighborhood. We are also continuing to expand our private brand lineup with new products in Origin 21, our new modern brand, as well as our popular allen + roth brand, which is tailored to the more traditional taste.", "SpringFest, which is our new approach to spring, is a multiweek event, and we leveraged several strategic promotions for popular spring items like mulch, soils, and hanging baskets to deliver great value for our customers. And we are well-positioned to capitalize on the late surge in spring demand, and I look forward to updating on this first-half event on our second-quarter call. Now, looking at Lowes.com. As Marvin mentioned, we saw a positive 2% sales growth in the quarter and over 39% positive growth on a two-year basis.", "We continue to enhance the user experience on Lowes.com and our omnichannel capabilities, which is critical for consumers who increasingly expect flexibility and seamlessness in their shopping experience. Our new paint and countertop visualizers are driving better conversion rates and we also enabled our customers the ability to order bagged goods online for in-store pickup ahead of the spring season. And as Marvin mentioned, our enhanced supply chain capabilities, including our expanded coastal holding facility network are now in place to enable us to flow product quickly to where it's needed as weather breaks across the country. And we continue to leverage our scale and carrier relationships to secure capacity and work to mitigate cost increases within our supply chain.", "Before I close, I'd like to once again thank our vendor partners and our merchants for their hard work and dedication. Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Bill, and good morning, everyone. I would like to begin by thanking our frontline associates for their continued commitment to serving our customers, especially in this busy spring season. We are laser-focused on delivering a consistent and high-quality customer experience. At the same time, we have labor aligned to demand patterns so that we effectively managed our payroll this quarter even in a lower sales environment.", "The investments that we've made over the past several years and our enhanced labor management tools are clearly paying dividends as we flex labor across stores and departments so effectively that we continue to achieve strong customer satisfaction scores. Also, the technology enhancements that we've made over the past several years enable our associates to spend 60% of their time serving customers and only 40% on manual tasking activities. As a reminder, as recently as 2018, 60% of all associated time was allocated on tasks that did not support the customer. We flipped this ratio by enabling more and more capabilities on our associates' handheld mobile devices, which eliminated many time-consuming tasks.", "This is in addition to new technology that has enhanced our point-of-sale checkout, modernized project management, improved inventory visibility, and digitized in-store pricing for appliances and lumber. This improved associate productivity has not only driven profitability, but it has also enhanced our customer service. And we continue to unlock further productivity through our Perpetual Productivity Improvement or PPI initiatives. As a reminder, our PPI initiatives are not one-time efforts but rather a series of initiatives that are scaling across our stores over time, all of which contribute to operational efficiency, as well as a culture of continuous improvement.", "As Marvin mentioned earlier, the success of our PPI initiatives contributed to our strong operating margin performance in Q1. Now, I would like to take a few minutes to discuss our strong Pro results in the first quarter when we launched our MVPs Pro Rewards and Partnership Program, which is centered around creating a business partnership with our Pro. We are really pleased to see the better-than-expected adoption rates for the new program, and we expect to build on this momentum with the Pros as we launch enhanced features to the loyalty program in the coming months. Through this program, we are also gaining valuable insight about our Pro customers that will enable us to better anticipate and meet their project needs through our Pro CRM platform and allow us to continue to expand our share of wallet with these valuable customers.", "And we're expanding our Pro fulfillment capabilities with our new Pro fulfillment center in Charlotte, where we are stocking the top SKUs that Pros consistently need in job lot quantities. As we pilot this new approach to Pro fulfillment, we are building on our existing job site delivery capabilities handled through our stores and Lowe's Pro supply branches today. Although we are pleased with our 600 basis points of growth in Pro penetration over the past three years, improving our fulfillment capabilities will allow us to accelerate this growth and continue to gain market share. In addition to the success of our new Pro initiatives, I am pleased with our strides to become the employer of choice in retail.", "As a company, we are committed to investing in continuous learning and development throughout our associates' careers through Lowe's University, as well as a new debt-free education program that we just announced. Through this initiative, more than 300,000 associates are eligible to participate in over 50 academic programs free of charge. These programs are designed to help associates excel in their jobs today and built toward their future careers within Lowe's, including pathways into supply chain, logistics, data analytics, cybersecurity, technology, and more. Finally, I'm pleased to report that we are in a better position from a hiring and staffing standpoint than we were at this time last year.", "We accelerated our associate hiring process through new technology that dramatically reduce the time it takes process applications. These new tools ensure that we capture the best candidates in the pipeline and helped us staff up quickly for spring. Looking forward, we are making the right investments to continue to drive productivity while also enhancing our customer service, and we are well-positioned to serve our customers to meet the surge in demand for spring products. As I close, I would like to once again thank our store associates for their relentless focus on serving customers and driving productivities in our stores.", "With that, I will now turn it over to Brandon." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Joe. I'd like to begin by saying what an honor it is to serve as Lowe's CFO. Over the past several years, we've made tremendous progress transforming Lowe's into a leading omnichannel retailer with a world-class finance organization. I'm extremely excited to be joining the executive leadership team in my new capacity as we continue our momentum.", "Now, turning to Q1 results. We delivered diluted earnings per share of $3.51, an increase of 9% compared to prior year, driven by improved gross margin rate and disciplined expense management against lower sales. As expected, we lapped our most difficult sales comparison of the year given the approximately 300-basis-point benefit from government stimulus last year. Q1 sales were $23.7 billion with a comparable sales decrease of 4%.", "Comparable average ticket grew 9.1%, driven by higher Pro sales, increased levels of product inflation, and 150 basis points of commodity inflation. This was offset by comp transaction count declining 13.1% due to a later start to spring, as well as the impact of cycling over government stimulus and storm recovery in the prior year. Keep in mind that comp transactions increased 11.8% last year, which results in a two-year comp transaction count decrease of 2.9%. U.S.", "comp sales were down 3.8% in the quarter and up 19.7% on a two-year basis. Our Pro sales outpaced DIY with 20% sales growth in the quarter as we continue to build on our momentum with the Pro driven by our elevated product and service offering. And while demand for core DIY categories remain strong, lower sales in seasonal categories pressured sales by approximately $350 million in the quarter or approximately 150 basis points. On Lowes.com, sales increased 2% in the quarter and over 39% on a two-year basis.", "Our U.S. monthly comps were up 8.5% in February, down 7.8% in March, and down 6.9% in April. In March, we cycled over the third round of government stimulus and the storm recovery sales in Texas while April sales were negatively impacted by unfavorable weather. Looking at U.S.", "comp growth on a two-year basis from 2020 to 2022, February sales increased 34.5%, March increased 25.3% and April increased 6%. Gross margin was 34.03% of sales in the first quarter, up 74 basis points from last year. Product margin rate improved 50 basis points as we leveraged our disciplined pricing and product cost management strategies to effectively manage product cost inflation and lumber price volatility. Also, higher credit revenue drove 25 basis points of benefit to gross margin this quarter, while a favorable product mix drove 20 basis points of benefit.", "These benefits were partly offset by 10 basis points of pressure from live goods damaged by unseasonably cold weather, as well as 10 basis points of planned pressure from increased distribution costs. SG&A of 18.19% levered 21 basis points compared to SG&A in Q1 last year. As Joe mentioned, we drove improved store labor productivity which was offset by lower fixed cost leverage against lower sales and increased wage rate. Operating profit was $3.3 billion, in line with prior year.", "Operating margin rate of 13.96% of sales levered 67 basis points versus prior year. Our ability to leverage operating margin despite a decline in sales reflects our improved operating capabilities that enable us to rapidly adjust in a dynamic operating environment. The effective tax rate was 23.7%, in line with prior year. Inventory ended the quarter at $20.2 billion, up $2.6 billion from Q4 levels in line with seasonal trends.", "This reflects a $1.9 billion or 10% increase from Q1 2021. Our inventory balance reflects an approximately 13% increase from both product and commodity inflation, while balances were also higher than expected due to a late-breaking spring. Now, turning to our 2022 financial outlook. Our Q1 performance was in line with our expectations, excluding seasonal categories.", "However, as Bill mentioned, spring is truly a first-half event, and the timing is driven by when weather breaks across the country. Over the past two-plus weeks, we are seeing improved trends in our seasonal categories, which is reinforcing our confidence that we will deliver first-half results in line with our full-year guide. This morning, we reaffirmed our full year 2022 financial outlook. We continue to expect 2022 sales in a range of $97 billion to $99 billion for the year, representing comparable sales of down 1% to up 1%.", "We continue to expect Pro to outpace DIY for the year. As a reminder, our 2022 sales outlook includes a 53rd week, which equates to approximately $1 billion to $1.5 billion in sales. We continue to expect gross margin rate for the full year to be up slightly as compared to prior year. However, as lumber prices declined several weeks earlier than we expected, gross margin pressure will shift into Q2 as we continue to turn through our higher-cost inventory layers.", "As a result, we now expect to see our gross margin for the first half to be up slightly compared with our gross margin in the first half of 2021. We also continue to expect operating margin in the range of 12.8% to 13% for the full year, driven by a slightly higher gross margin rate and continued execution of our PPI initiatives. We are also confirming our outlook for diluted earnings per share in a range of $13.10 to $13.60. In 2022, we still expect capital expenditures of approximately $2 billion, and we remain committed to our disciplined capital allocation strategy with approximately $12 billion in share repurchases this year while also supporting our 35% target dividend payout ratio.", "Finally, we are affirming our outlook of return on invested capital above 36% for the year. Now, I'd like to close by reviewing one of our value creation drivers at Lowe's, our shareholder-focused capital allocation strategy. In Q1, the company generated $2.6 billion in free cash flow. And through a combination of both dividends and share repurchases, we returned $4.7 billion to our shareholders.", "During the quarter, we repurchased 19.2 million shares for $4.1 billion, and we paid $537 million in dividends at $0.80 per share. Capital expenditures totaled $343 million in the quarter, as we continue to invest in the business to drive growth and enhance returns. We ended the quarter with $3.4 billion of cash and cash equivalents, which includes proceeds from our $5 billion notes offering in March. This larger-than-planned bond issuance enabled us to slightly accelerate our share repurchase plans in the quarter.", "The balance sheet remains extremely healthy, and we continue to make progress toward our target of 2.75 times adjusted debt-to-EBITDAR, ending the quarter at 2.24 times. Driven by both strong operating performance and a disciplined capital allocation strategy, we delivered return on invested capital of 33.8% in the quarter, up 380 basis points versus last year. In closing, we are confident in our trajectory and excited for the substantial opportunity ahead of us as we continue to grow our market share, expand operating margin, and deliver meaningful shareholder value. And with that, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We are now ready for your questions. [Operator instructions] Our first question today is coming from Greg Melich from Evercore. Your line is now live." ] }, { "name": "Greg Melich", "speech": [ "OK. Thanks. I have two questions. One is just to understand the shift of spring and stimulus.", "Should we be looking at a three-year comp when we think about how that flows in, in the second quarter, sort of in the mid-30s? And then my second question is on inventory." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Hey, Greg, this is Brandon. Just as I mentioned in my prepared remarks, we came out of April, U.S. comps down 7% for the month.", "And I'll say early on, we feel really good about our trends in May, especially within our seasonal categories comping positive and above the company average as spring is breaking across the country. We have some of our biggest volume weeks ahead with Memorial Day, Father's Day, J4. We're pleased with the sequential sales improvement, confident in the full Q2 recovery of the $350 million. And then when we look at the balance of the year, I think with the weather trends, Q2, $350 million.", "We're going to continue to see the Pro strength 20% comp in Q1, 64% two-year. Inflation is going to continue to be a bit of a tailwind for us as well. But all that being said, our range is down one to plus one. We're confident in that go-forward for the full year.", "And that yields Q2 to Q4. That's a slight positive comp over the balance of the year for the one year." ] }, { "name": "Greg Melich", "speech": [ "Perfect. And then on inventory, you mentioned the 10% growth that inflation was -- and mix was about 13% of that. Am I -- does that imply that units are actually down 3% year on year?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Greg, spot on. Inventory balance was up 10%, and we have in the prepared remarks price and commodity inflation, along with carrying additional seasonal inventory in Q2 -- heading into Q2 is pressuring both dollars and terms. I will remind the group every year, we do manage our seasonal inventory to the first half, and we have a strong holiday lineup upcoming and a couple of other things. We continue to strategically invest in inventory to support the Pro, job locked quantities and we've had a couple of constrained categories where we've made in-stock improvements, in particular, in paint and appliances.", "But we're in our best in-stock position since the beginning of the pandemic, and I'll kick it over to Bill if there's anything more he wants to add there." ] }, { "name": "Bill Boltz", "speech": [ "No, I think, Brandon, I think you hit it. I think the key for us is making sure that we're focused on sell-through the seasonal buys that we've made. We shared with you during the fourth-quarter call that we brought in some of the seasonal inventory ahead of the season. And so, you know, we're focused on working through that through the first half of the year." ] }, { "name": "Greg Melich", "speech": [ "And you guys haven't seen any trade down, it sounds like?" ] }, { "name": "Marvin Ellison", "speech": [ "Greg, this is Marvin. The answer is no. As you can imagine, we spent quite a bit of time looking at this literally on a daily, weekly basis with the DIY and Pro customer across geographies, online, and we've seen no material trade down in our business." ] }, { "name": "Greg Melich", "speech": [ "That's great. Good luck, guys. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is coming from Brian Nagel from Oppenheimer. Your line is now live." ] }, { "name": "Brian Nagel", "speech": [ "Good morning. First off, Brandon, congratulations on your new role." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Brian." ] }, { "name": "Brian Nagel", "speech": [ "My question, and I get -- maybe I'll direct it to Marvin primarily, but thanks for all the detail on the call. And I guess what I'll say is there, as analysts following where the news of weather disruptions are now well documented. As you look at the business, what gives you the greatest confidence that these slower spring sales were, in fact, weather-related and not indicative of a now, say, be more cautious consumer pulling back on discretionary spending?" ] }, { "name": "Marvin Ellison", "speech": [ "Brian, that's a really good question. This is Marvin. So, I'll take the first part, and I'll let Bill just give more of a product-specific assessment. So, when you take a look at the quarter, the month of February was really strong, 8.5% of positive comp in the U.S.", "In the month of March, we were running to a stimulus overlap and so we were anticipating that negative comping March was, and we had really difficult weather on top of stimulus. And then April, as we mentioned, was the coldest in over 20 years. And when we start to look at the categories and their anticipated performance, it was obvious to us that this was a weather-driven event. The good news is, well, I mean, we operate in all states.", "So, we could easily look at the southern parts of the country where we were in something relatively close to seasonal weather and all of these categories were performing exceptionally well, live goods, outdoor power, grilled patio, etc. And then the moment we get a glimpse of weather in some of these northern markets, those categories would take off and perform well in the moment, the weather would shift. I mean, obviously, you'd see the decline. So, the way we analyze this literally on a daily, weekly basis is very obvious to us that the Q1 impact was driven by weather.", "And as Brandon and I both mentioned in our prepared comments, as we look at the month of May, I mean, we're pleased with the trends we're seeing. And that also reflects that the moment we are getting to what is more of a seasonal weather environment, those same categories that underperformed in April, are now overperforming the company in the month of May. So, I'll let Bill add any other details." ] }, { "name": "Bill Boltz", "speech": [ "No, I think the only thing to add, Marvin, is that we're also seeing strength out of new and innovative product. And so, you look at, you know, the strength of like the EGO brand and the battery-powered outdoor product just continuing to perform very well. The strength of John Deere, the strength of Aaron's in the riding mower segments doing very well. And as you touched on, as we saw green shoots of weather throughout the first quarter, we saw the strength in project -- outside project businesses like live nursery, like exterior Pro projects.", "So, you know, it just gives us good confidence that we can carry that through Q2." ] }, { "name": "Joe McFarland", "speech": [ "Yeah. Brian, I'll just add one additional comment there. If you look at our Pro growth that Marvin mentioned earlier at 20%, and then you look at the strength and the health of that Pro -- strong Pro market trends we're seeing, our revamped Lowe's Pro offering, the expanded Pro product that Bill mentioned earlier in his prepared remarks, the deeper inventory and then the launch of our new MVP program. And so, I think we've got good confidence in the underlying trends there." ] }, { "name": "Brian Nagel", "speech": [ "Yeah. That's all very helpful. I appreciate it. And I guess just one really quick follow-up.", "So, as we think about these seasonal sales and the weakness that happened in Q1, is it fair to assume that basically, all the sales should be made up here in Q2? In other words, there's really no lost demand?" ] }, { "name": "Brandon Sink", "speech": [ "Brian, that's correct. It's fair to assume that the $350 million would shift in fall of Q2." ] }, { "name": "Brian Nagel", "speech": [ "All right, guys. Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question is coming from Simeon Gutman from Morgan Stanley. Your line is now live." ] }, { "name": "Simeon Gutman", "speech": [ "Hey, everyone. Good morning. So, the first-quarter earnings, at least, beat the Street handily, and you're not making any change to the year. I think the second quarter, it sounds like you'll make up some sales.", "And so, the first half will be the same. The fact that first quarter was better, did it -- and by the way, no one is getting paid or rewarded for raising any outlook. So, I guess, implicitly, it means that something was taken out. I don't know if that's the right way to think of it or just there's conservatism.", "So, curious your thoughts around that? And anything that is changing in the second half, the way you're looking at the business since you have some head start here in the first quarter." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. So, Simeon, this is Brandon. A lot of this is timing-related and specifically around gross margin. So, as I said in my prepared results remarks for Q1, 74 basis points of improvement driven by product margin rate mix.", "We also benefited from proprietary credit. But keep in mind, the benefits on the product margin side are temporary in nature, especially -- can be temporary in nature, especially in periods of inflation. Cost layers are going to lag and that's true for both commodity and product-related inflation. So, as we cycle into Q2, we do expect some level of step back, specifically due to lumber deflation that began.", "We began seeing that late March. And then we have some other variables, such as shrink in credit. We expect that to largely be neutral over the back half. And then the supply chain, inclusive of market delivery build-out, higher transportation costs are going to be a slight drag, which is consistent with what we've guided and what we've messaged.", "So, it's mainly margin, it's mainly timing as the cost layers turn a bit of a step back. But for overall margin, modest improvement in margins for first half and up slightly for the full year. So, that's the reason we didn't flow the beat to the full year." ] }, { "name": "Marvin Ellison", "speech": [ "So, Simeon, this is Marvin. I think it's important for me to note that we're really pleased with the profit performance in the first half. For a retailer our size, it's really difficult to have declining sales on a year-over-year basis and have leverage from an operating margin and gross margin perspective. That took a lot of work and a lot of operational discipline from the supply chain, cost management, payroll, and expense management, etc.", "And to Brandon's point, we're in this unprecedented environment of lumber inflation and deflation. And so, we're just planning conservatively because as we say, the last couple of weeks, we start to see lumber starting to shift, and we're just anticipating that that's going to give us some headwind in Q2." ] }, { "name": "Simeon Gutman", "speech": [ "That's helpful. My follow-up, it's related on fuel prices. And Brandon, you just touched on transportation costs. Does this mean that you're adjusting your pricing as well real time? I know you mentioned you'll feel a little pressure, so maybe you don't fully offset it.", "And does the level of inflation help your business on the top line? Or you assume that there might be some unit degradation as pricing may continue to tick higher?" ] }, { "name": "Marvin Ellison", "speech": [ "So, let me take -- this is Marvin. I'll take the first part of that. We've spent a lot of time putting in improved systems from a pricing standpoint. So, we are scraping and we're doing pricing analysis real time, both in-store and online by geography.", "One thing that Bill put in place early on when he arrived is that every day competitive pricing strategy where we've gotten off this high-low promotional cadence that Lowe's was known for to more of an everyday competitive price. And the only way you can be competitive every day is you have to have a good line of sight to the competitive prices of your competition by category, by geographic location. And so, we've done a lot of that. And in some cases, with inflation -- product inflation, we have to carry that forward to the consumer.", "But in a lot of cases, we're just focused on being competitively priced. And I'll let Brandon provide some financial specifics of what that looks like." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Yes, Simeon, I would just add to your question on fuel costs, transportation, also add import container cost into that mix. The teams have done a great job just giving us visibility to where those costs are, when they're going to hit. And it is correct to say, as we manage the totality of the portfolio, that that's a consideration set along with direct costs from the vendor.", "So, we are managing that appropriately, managing in this retail environment. So, that would be the only additional thing I would add to the comment. On transportation, in particular, on fuel, it is a more minor cost of the overall portfolio. When we look at the totality of supply chain, and we feel like we're doing some other things like managing trailers, intermodal, and leaning into some of those other things to also help offset that." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, everyone. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question today is coming from Karen Short from Barclays. Your line is now live." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. So, I had a couple of questions. Just in terms of how you think about traffic versus ticket with respect to your guide, can you maybe talk about that a little bit more? And then within your margin structure, I mean, I do think there's definitional differences with you and your largest competitor on how you actually think about square footage.", "But can you maybe just give us an update on -- in terms of your 13% operating margin or and/or bridging the gap with your largest competitor? Thanks." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. Karen, let me start with the first question, and I'll pass it back to Marvin to get the second point. So, on the ticket transaction side, I'll point to Q1 ticket, specifically inflation, a little bit harder to pinpoint. But we do believe from an inflation standpoint, we ran high single digits during Q1, and that's inclusive of 150 basis points from lumber and commodity.", "And I'll say the finance and merchant teams are still in the thick of this. We're working with our suppliers day in, day out to figure this out. I will say, however, as we lap second half of '21, we do expect the inflation impact to start to moderate. We're expecting mid to high single-digits positive over the balance of the year.", "And then on the transaction side, as we mentioned in the opening comments, DIY was a primary driver of the decrease there for Q1. It was down double digits, partly planned due to the Texas storms and the stimulus, the weather miss from spring delayed accelerated that. We do believe Q1 will be our low watermark on transactions for 2022 and that that transaction decrease should moderate as we cycle through the balance of the year. So, net-net, mid to high single-digit positive ticket expected over the balance of the year, offset by down transactions is the formula that will get us to the flat comp, and we expect that dynamic to narrow ticket and transactions as we move through the balance of the year." ] }, { "name": "Marvin Ellison", "speech": [ "Karen, I'll take the other question. When you think about our operating margin and you think about kind of the more structural differences between us and our largest competitor, I think it really comes down to the penetration of DIY versus Pro. I think that's an obvious reflection in the first quarter. The good news for us is, we're not setting a Pro penetration target.", "We just have an expectation we're going to continue to improve that business. And if you think about my prepared comments, in the last three years, we've been increasing our Pro penetration by roughly 600 basis points. So, we feel like that we're headed in the right direction. But as you think about overall operating income, we're very pleased with our performance in the quarter, and we have a very good line of sight to getting us to that 13% and beyond just based on executing our Total Home strategy, focusing on Pro, online and all the work that Bill's team is doing on private brands and how we're continuing to grow that business.", "In the private brands specific initiative, it drives margin improvement. It gives the customer great innovation and style, and we can do it all at a really competitive price and it's a key point of differentiation in addition to all the investments we're making in infrastructure, whether that's supply chain or operations and infrastructure. Again, we feel like we have a clear line of sight, and we're going to continue to execute to that, and we have an expectation that we're going to be on track with delivering on that expectation." ] }, { "name": "Karen Short", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question today is coming from Christopher Horvers from J.P. Morgan. Your line is now live." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, and good morning. So, my first question is just following up on the May commentary. You talked about DIY now running ahead of the total company average comp. If you're still getting 20% growth in Pro backing into that math, that will sort of cleanly get you above the mid-single-digit comp.", "Is that math reasonable?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Chris, this is Brandon. I don't know that we said that DIY is going to be running ahead of Pro in Q2. I would say the majority of the $350 million that we expect to recover is going to be reflected in the DIY business. But the Pro DIY dynamic, certainly unique in Q1, just given the environment we've been in and what we've been cycling, but that breakout in that dynamic, Q2 to Q4 should start to normalize a bit.", "But Pro is absolutely going to be expected to outpace DIY, grow 2x that of market, which will translate to our guide of down 1% to up 1%. And I'll just remind you, the seasonal performance in the seasonal business through the first couple of weeks outperforming expectations in the balance of the business. So, that's how I would answer your question." ] }, { "name": "Christopher Horvers", "speech": [ "OK. Sorry, I thought you said outperforming the company average. It was outperforming expectations." ] }, { "name": "Brandon Sink", "speech": [ "Correct. Correct." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. All right. Sorry about that. And then in terms of -- Marvin, in the press release, it seems like you added just a line around sort of increased macro uncertainty.", "To an earlier question, you mentioned not seeing any trade-down effect in a very responsive business to the weather. So, can you expand on that? Is there something you are observing? Is it just simply given all the puts and takes on the consumer being, you know, less fulsome now versus maybe three months ago?" ] }, { "name": "Marvin Ellison", "speech": [ "It's really more of an acknowledgment of what we're all seeing in just a broader macroeconomy. And I think what's interesting for home improvement is that we're aware that we have inflation concerns. We're aware that there is rising interest rates. But as we look at the home improvement sector, we still remain very confident in the outlook and we're very confident in the sector.", "And so, I'll just repeat what I've said. We've seen no material trade down from our customers. We closely monitor Pro and DIY. We look at it intently as you can imagine.", "And when we think about the key economic drivers of our business, it remains home price appreciation. It remains the age of housing stock, you know, it remains, you know, those things that give the homeowner confidence and continuing to invest in the home. And as we talk to our Pro customers, they're booked up for the year. We talked to our DIY customers.", "They would just wait for the sun to come out. And so, we feel good about the home improvement sector. And my statement was just more of an acknowledgment of the broader macro environment that we're all seeing." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Thank you very much." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question today is coming from Liz Suzuki from Bank of America. Your line is now live." ] }, { "name": "Liz Suzuki", "speech": [ "Thank you. So, we've written recently about how 95% of the base of U.S. homeowners are not impacted by interest rates and that housing turnover isn't really as important as home price appreciation. But the pushback we've gotten is that those 5% of homes that do change hands presumably see a greater degree of renovation spending.", "So, my question is, have you seen any reliable stats on how much the average homeowner spends on renovation when they prepare a home for sale and when they purchase a home? Because we're just trying to get a sense of what that portion of the home improvement market is actually impacted by rising rates." ] }, { "name": "Marvin Ellison", "speech": [ "You know, Liz, it would be anecdotal at best. So, we don't have any firm data to represent that. But our view of it and our conversations with Pros and consumers, you tell us that your statement is correct. But again, we don't have any fact-based data to support that." ] }, { "name": "Liz Suzuki", "speech": [ "And then just a quick follow-up on how product innovation has contributed to average ticket. I mean, the growth in average ticket is obviously more than just inflation. So, what do you view as the categories where product innovation may be accelerating the normal replacement cycle and how much of a tailwind that could be when inflation does ultimately normalize?" ] }, { "name": "Bill Boltz", "speech": [ "Yeah, Liz, it's Bill. And so, what we're seeing with product innovation, we really see it across the store, across every category. But in areas like appliances, you see customers trading up to smart appliances to better quality appliances. As I mentioned in an earlier question in response, battery outdoor power equipment with the EGO brand specifically.", "You're also seeing it in the likes of gas-powered outdoor power with John Deere and Aaron's, you know, all innovative products there. You're seeing it in paint. So, just really across the categories, you see innovation. And, you know, we're also able to offer that in our private brands with, you know, the introductions of Stainmaster.", "So, you're seeing that now start to weave its way in. I talked about -- it's already been in carpet and now you're seeing in tile, vinyl, laminate flooring. So, you know, you got Origin 21, which is a new modern brand for us, again, offers great innovation and great value." ] }, { "name": "Marvin Ellison", "speech": [ "And, Liz, this is Marvin again. I just want to reinforce the point on the value of home price appreciation to consumer confidence. And it's one of the reasons why I think home improvement is a unique retail sector in kind of this macro environment where there are a lot of questions about the health of the consumer. What our data tells us, and it correlates historically, is when your home value is going up, you simply have more confidence to invest in that home because you see it as an investment and not an expense.", "And we have unprecedented home price appreciation, but we also have an unprecedented supply demand issue for the availability of homes. So, our data tells us, this is less of bubble and it's more of a supply demand issue where you have 1.5 million, 2 million homes of demand versus the availability. And so, if you think about what Bill said about trading up, our customers, they feel more comfortable investing in home because they think they're going to get a return on that investment. And I think that's the value of home price appreciation to our business." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thanks very much." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from Zach Fadem from Wells Fargo. Your line is now live." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. Can you help me reconcile the sequential step-down in SG&A dollars? How much would you quantify as seasonal versus what would you call structural or PPI-driven? And then how should we square the Q1 SG&A takeout versus the balance of the year?" ] }, { "name": "Marvin Ellison", "speech": [ "So, Zach, this is Marvin. I'll take the first part of that, and then I'm going to let Brandon and Joe provide some context. So, relative to payroll, we have an activity-based payroll model that allows us to flex hours up and down based on sales velocity by location of store, but also by department. That is a significant contrast to what we had in place when I arrived in summer of 2018 that we literally were riding complete the schedule from Mooresville, North Carolina, and sending that out to every store on a weekly basis, irrespective of volume trends.", "So, I'll let Joe talk about payroll, so you can get a view of why we were able to leverage as effectively as we did in Q1 and how we think that's a sustainable result that we'll see for the balance of the year." ] }, { "name": "Joe McFarland", "speech": [ "Yes. Thanks, Marvin, and good morning, Zach. Listen, from a payroll standpoint, I think it's important to think about the PPI initiatives as not just one-time initiatives, but ongoing initiatives. And so, as we look at, you know, our ability to leverage SG&A through different initiatives, centralized RTVs, and get down a whole list of the PPI initiatives.", "So, this is not a one-time, but it's going to continue. And I think we've done it very effectively because both Pro and the do-it-yourself customer are showing increased LTR and service scores. So, I think that just kind of points to some good productivity." ] }, { "name": "Brandon Sink", "speech": [ "Yes. And the only other thing I would add, Zach, so SG&A, you know, leveraged 21 basis points. That's consistent with the earnings algorithm we have for the full year in the range of what we would expect. I think the good news there being able to leverage against our quarter with the highest expected negative comp is going to be a great proof point for us and as we move through the year.", "And then in this inflationary environment, I think, to Joe's point, really being able to use those workforce optimization tools, understand truly within the business, both in the supply chain and in stores, what are volumes, what are units, what are transactions and being able to flex the model against that demand and understand the split between the drivers of the business has been really powerful for us. So, I'll just add to that." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And with the spread between your Pro and DIY comps widening to about 30 points in the quarter, I realize the weather and seasonal component will normalize. But as you think about the balance of the year, how do you square overall industry Pro industry growth versus DIY this year? And is it fair to assume your Pro business can track at a double-digit rate from here?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, you know, Zach, we talked about our expectation to grow, you know, 2x the market in Pro. We think that that is achievable based on the list of Pro-related products that Bill and his merchant teams have added to our assortment based on our new MVP Loyalty Program that's exceeding expectations on the number of enrollments. And one other really interesting data point, if we look at the Pro customers currently enrolled in our new MVP Loyalty Program and our credit program, they're spending 300% more than Pro customers not enrolled. So, it gives us a lot of confidence that our Pro growth is sustainable.", "And not to mention with some other initiatives that we are filing to include job site fulfillment that we think will give us an opportunity to start in the future to serve a larger Pro. So, based on all of those initiatives, we feel like that our Pro growth will continue. Look, it's challenging, none of us have a crystal ball, obviously, and there are a lot of dynamics in our Pro DIY mix. Having said that, we factored all those things into our guidance, and we think that the guidance, as Brandon reinforced is reflected on our view of how we think the DIY Pro mix will play out for the rest of the year." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Thanks for the time, guys." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Thank you." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you all for joining us today. We look forward to speaking with you on our second-quarter earnings call in August." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2022-11-16	[ { "description": "Vice President, Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "Brandon Sink", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Jonathan Matuszewski", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies third-quarter 2022 earnings conference call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, vice president of investor relations." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning. Here with me today are Marvin Ellison, chairman and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president of stores; and Brandon Sink, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2022.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties, and important factors, including those discussed in the risk factors, MD&A, and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website.", "Now, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate, and good morning, everyone. In the third quarter, our total company comparable sales increased 2.2%, while U.S. comps increased 3%. These better-than-expected sales were driven by improved DIY demand supported by fall nesting trends as travel slowed down and children returned to school.", "We also saw continued momentum in Pro reflecting the success of our Pro initiatives and the resilience of home improvement demand. In addition to strong sales growth, our persistent focus on productivity once again drove improved operating performance with substantial improvement in adjusted operating margin of 54 basis points and adjusted diluted earnings per share of $3.27, an increase of 20% as compared to last year. These outstanding results enable us to make critical investments in our most important asset, our associates. In this quarter, we announced an incremental $170 million investment and permanent wage increases for our frontline hourly associates.", "These increases are designed to ensure that our more tenured associates continue to receive market-competitive wages. And in further recognition of the hard work and dedication, we are awarding $200 million in bonuses to our frontline hourly associates ahead of the holiday season. At Lowe's, we make every effort to ensure that our associates share in our financial success, and I am very pleased that we are once again able to award a discretionary bonus because our performance is tracking ahead of our expectations. This is a true win-win outcome for the company, for our shareholders, and for our associates.", "All of these investments reflect our efforts and our commitment to become the employee of choice in retail, where we continually invest in our associates and help them support their families and grow their careers at Lowe's. Now, turning to Pro. We delivered growth of 16% and 36% on a two-year basis, the tenth consecutive quarter that we've driven double-digit Pro growth. We are building on our greatly improved Pro product and service offerings with our new MVPs Pro Rewards and Partnership Program and our enhanced Pro CRM, which Joe will discuss later on the call.", "We recently completed our annual Pro pulse survey, which provides real-time insights into what's on the minds of our Pros and how they view their future business opportunities. And we're encouraged to hear that Pros remain optimistic with over 70% saying that they expect even more work in 2023 than they had in 2022. This is just another proof point of the resilience of home improvement demand even in this uncertain macro environment. On lowes.com, sales grew 12% this quarter over four times our U.S.", "growth rate, representing a sales penetration of 10%. We continue to enhance the online user experience, as well as our fulfillment capabilities, as we focus on driving this critical growth initiative within our total home strategy. Turning to our supply chain transformation. We've made significant strides in our rollout of our market delivery model for big and bulky products this quarter, spanning the country from Southern California to Southern Illinois to Atlanta, Georgia.", "We've now reached an important milestone with eight geographic regions covering more than half our stores converted to the new model, and we're on track to complete the rollout by the end of next year. This is a centerpiece of our supply chain transformation as the market delivery model will enable us to further consolidate our industry leadership position in appliances and position us for profitable growth in other big and bulky products like grills, riding lawn mowers, stock cabinets, and vanities. This also improves the customer experience through expanded fulfillment options and a seamless omnichannel shopping experience powered by technology. We also just announced that we will be opening a new coastal holding facility in the port city of Suffolk, Virginia.", "Our expanded coastal holding facility network is opening up capacity for us to hold product upstream from our distribution centers, which creates the flexibility we need to flow the products quickly and where and when it's needed. This helps us to not only capture sales but also mitigates markdown risk because we avoid stranding product unnecessarily in our stores. And now, I'd like to discuss the macro environment and specifically address some misperceptions that I've heard about the home improvement market. You've heard me talk about this before, but demand drivers for home improvement are distinctly different from those that drive home building, so it's important not to confuse the two.", "And as a reminder, at Lowe's, the three highest correlating factors of home improvement demand are home price appreciation, age of housing stock, and disposable personal income. So, let's start with home price appreciation. Even if there is a broad-based decline in home prices, homeowners currently have a record amount of equity in their homes, nearly $330,000 on average, which remains supportive of home improvement investment. And even in the select U.S.", "markets where home prices have declined after a particularly steep run-up during the pandemic, we are not seeing any impact to sales. Second, the average age of homes in the U.S. is over 40 years old and roughly 3 million more homes built during the housing boom in the mid-2000s, will be entering prime remodeling years by 2025, which is a key inflection point for big-ticket repairs. This is one of the key reasons why two-thirds of home improvement spend is nondiscretionary on repair or maintenance projects that cannot be delayed.", "Third, consumer savings are near record highs, while disposable personal income remain strong. And more than 90% of homeowners either own or home or are locked into a low fixed mortgage insulating them from rising rates. On top of these three factors, there is a persistent $1.5 million to $2 million under supply of homes, and 250,000 first-time millennial homebuyers are expected per year through 2025. This unique combination of factors is causing homeowners to trade up in place, preferring to invest in repairs and renovations, to make their current homes meet their families evolving needs rather than buying a new home.", "And this is why we're so confident about the outlook for the home improvement industry even in a period of high inflation and rising interest rates because the key drivers of our business remain supportive. And with the investments that we've made to transform our business, we also have the operating agility needed to rapidly pivot if market conditions worsen. And we have a very experienced leadership team of home improvement veterans who have developed a proven playbook to respond to a slowdown. At the same time, we would not lose our focus on investing in long-term growth.", "Now, before I close, I'd like to take a moment to discuss our recent announcement regarding our intention to sell our Canadian retail business to Sycamore Partners. Lowe's first entered Canada in 2007 and later expanded with the acquisition of RONA in 2016. Over the last few years, we focus on the retail fundamentals of our Canadian operations, which brought the Canadian business to profitability and improved its operating cash flows. However, for this business to achieve the profitability in line with the U.S., significant incremental capital investments would be required to streamline the banners and improve operating margins.", "By contrast, we have tremendous opportunity for continued market share and profitable growth in our U.S. home improvement business. This transaction will simplify our business model, improve our operating margins and return on invested capital while enabling us to deliver sustainable value to our shareholders. Brandon will provide details regarding the financial impact of the transaction later on the call.", "I would like to thank our entire Canadian team for their hard work and dedication to our customers, and we look forward to collaborating with Sycamore Partners in executing a seamless transition. I'd like to also extend my appreciation to our team in the U.S. for their ongoing commitment to serving customers and the communities. And with that, I'd like to turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. In the third quarter, U.S. comparable sales increased 3%, reflecting solid core home improvement demand across both Pro and DIY customers. This quarter, we drove positive comps in our building products and home decor divisions, fueled by momentum with the Pro and improve DIY demand.", "In hardlines, comps were down slightly as we cycled over significant storm prep activities in Louisiana from Hurricane Ida in 2021 that did not repeat at the same scale when Floridians prepared for Hurricane Ian in 2022. Overall, growth was well balanced with eight of our 15 merchandising departments above company average. Beginning with our home decor division, the fall nesting trends that Marvin mentioned led to standout performance across core interior categories, including appliances, paint, kitchens and bath, and flooring. Appliance sales were bolstered by a strong Labor Day event and higher online sales as we continue to enhance our lowes.com user experience.", "As an example, this quarter, we began displaying delivery dates earlier in the purchase process to highlight our improved next-day delivery options. If the customer needed to quickly replace a refrigerator or washer that's just stopped working, this feature now helps them focus their attention to product that's immediately available. This is especially important for Lowe's as our appliance business is skewed toward replacement within existing homes versus new housing starts. As I mentioned last quarter, we also continue to see customers trading up for innovation, like with our new Maytag Pet Pro washer with technology that removes pet hair from clothes in the wash cycle, which is exclusive to Lowe's.", "This quarter, we also launched a new exclusive home center partnership with Mila, a global leader known for high-end premium appliances. This reflects our ongoing commitment to ensuring that we have new, high-quality offerings across all price points with leading products from all-star brands like Trex, DEWALT, Owens Corning, John Deere, EGO, Honda, KitchenAid, Samsung, LG, Kohler, Moen, Whirlpool, Husqvarna, and Ariens. Paint delivered strong positive comps this quarter across both Pro and DIY. Many of our Pros, especially those who focus on repair and remodel work, paint as part of their larger jobs.", "In other words, these are Pros who paint rather than professional painters. And these Pros are starting to see the value of our new MVPs Pro Paint Rewards program paired with our expanded job site delivery for paint. These enhanced benefits and capabilities are making it more convenient and cost-effective for Pros to purchase their paint directly from Lowe's, earning us more of their business. In our continued partnership with Sherwin-Williams, we are also upgrading our paint departments across the U.S., including a new color wall that converts all HGTV colors to Sherwin-Williams colors, which resonates with both DIY and Pro customers.", "With our new color wall, we are bringing all the colors together so that customers can easily match their favorite Sherwin-Williams paint color at our paint desk. We are also resetting some categories to pull relevant, higher-margin, and more frequently purchased products closer to the front of the department, making it easier for customers to get everything they need for their paint project in one trip. We plan to have half of our stores converted to this new color wall by the end of this year and roll it out everywhere by the end of next year. We are very pleased with the progress we've made in this core category in just a few short years.", "We are gaining traction with both Pro and DIY, and this recent update highlights just a few ways that we plan to continue to take market share in paint. We also had strong positive comps in kitchens and bath, largely driven by improved in-stocks for cabinets and customers opting to trade up for larger, higher quality in-stock cabinets versus waiting for custom orders. Within flooring, vinyl flooring once again led the way as busy homeowners returning to durable, low-maintenance flooring options available in popular brands like Pergo and STAINMASTER. And we're gaining momentum across our private brand portfolio, especially in STAINMASTER, Origin 21, Allen + Roth, and Kobalt, as this is just another indication of the traction that we are gaining with our total home strategy.", "Turning to our performance in building products division. We continue to see broad-based, balanced growth across Pro and DIY in millwork, rough plumbing, electrical, lumber, and building materials, driven by strong project-related demand. We are encouraged by the DIY strength that emerged in building products this quarter as lumber prices come down, DIY consumers are reengaging in home improvement projects they had previously put on hold, leading to double-digit lumber comps in the quarter. In our hardlines division, as lumber demand increased, so is demand for related attachment categories like fasteners, leading to our strong positive comps in hardware.", "We also continue to see a trend of customers investing in innovation. Our EGO battery now powers 75 different tools, everything from traditional outdoor power equipment like mowers, trimmers, and leaf blowers to lifestyle products like camping generators and misting fans. And with the accelerated growth in battery-powered products that we're seeing, it's not surprising that EGO continues to lead the pack in battery-powered outdoor power equipment. Given the concerns in the marketplace, some of you have asked if we're seeing a shift away from discretionary purchases, which is what we typically expect to see in a softer macro environment.", "And the straightforward answer is no. We had a strong sell-through in Halloween this year with an early sell-out of our 12-foot lighted animated mummy at a price point over $300. One could argue that this is one of the most discretionary items we sell. And with Halloween, in total, being a highly discretionary category, this continues to give us a positive indication of the strength of our consumer.", "We kicked off the holiday season with our trim a tree sets early in the quarter. We are seeing early sell-through on taller, higher-end artificial Christmas trees, which is another example of both discretionary purchasing and consumers trading up. Before I close, I'd like to thank our merchants, supply chain team, and our vendor partners for their hard work and the continued partnership as they continue to provide our customers with the products that they need as we support our stores and communities in the recovery efforts from Hurricane Ian. Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thank you, Bill, and good morning, everyone. Let me begin with a heartfelt thank you to our associates. Our strong performance this quarter is a direct reflection of their hard work and dedication to providing excellent customer service. That's why we are so focused on becoming the employer of choice in retail where associates choose to stay to build their careers.", "At its core, that means providing good, stable jobs, comprehensive benefits, competitive wages, and bonus opportunities. As Marvin mentioned, this quarter, we announced $170 million in permanent wage increases, and we are awarding $200 million in bonuses ahead of the holiday season for our frontline hourly associates. This translates to up to $1,000 for eligible full-time associates and up to $500 for eligible part-time associates. As someone who started my career as an hourly associate in home improvement, I understand how meaningful this type of financial recognition can be.", "Our executive leadership team is passionate about rewarding our associates and taking care of our customers, which is demonstrated in the investments we make in both our people and in the communities we serve. Another example of these investments in action is the transformation of our disaster response capabilities over the last few years, which dramatically improved our ability to support communities through devastating storms like Hurricane Ian. Year round, Lowe's now has a cross-functional command center dedicated to supporting our disaster response efforts. In fact, it was these enhanced capabilities that enabled us to respond so effectively to the pandemic.", "We also deploy our emergency response teams to the hardest hit areas. These associates volunteer to lead their home stores, giving their colleagues in the impacted areas a chance to focus on their families, and we go a step further to help impact the associates by deploying refueling stations and our mobile disaster relief trailers with showers, washers, dryers, and meals and offering financial assistance through our Lowe's Employee Relief Fund. In addition to demonstrating the importance of our improved disaster response capabilities, Hurricane Ian also spotlighted the value of our expanded omnichannel fulfillment options. Earlier in the quarter, Lowe's rolled out same-day delivery nationwide with more than 1,700 stores now supported by Instacart.", "This partnership allows us to deliver over 30,000 items stocked in our stores, that weigh up to 60 pounds, to our customers. In the days leading up to the storm, we received thousands of these same-day orders to help customers prepare and protect their homes. Customers were able to get critical items they needed like water, sand, buckets and batteries without having to leave their homes, and it continues to be a helpful option for many who need supplies in the wake of the storm. And we continue to optimize our parcel network in Q3, another important step in our journey to enhance our omnichannel fulfillment capabilities.", "We rebalanced our network to ensure our parcel stores are optimally located close to shipping hubs, and we have upgraded our technology and hardware to support faster fulfillment. Ahead of the holidays, we are on track to meet our goal of decreasing shipping times by 50%. And these are just a few of many examples of our tenacious focus on perpetual productivity improvements, or PPI, that are scaling across our stores over time. Shifting to Pro, I would like to thank our Pro team for delivering outstanding results once again this quarter, driving Pro comps over 16% for the quarter and 36% on a two-year basis.", "We are leveraging our new MVPs Pro Rewards and Partnership Program to capitalize on this continued demand by engaging Pros, incentivizing purchases, and building long-term loyalty. Our program is laser focused on helping Pros grow their business because we know that when Pros succeed, we succeed. This partnership-based approach is already paying off with higher-than-expected adoption rates and building overwhelmingly positive feedback from our Pros. We recently asked all of our regional vice presidents to find Pros who do not want to sign up for our loyalty program, so we can talk to them and understand why.", "But that proved to be a real challenge because once Pros here the benefits, they are eager to join. So, awareness and continued execution will be the key to our ongoing success. As I close, I would like to thank our associates once again for their commitment to Lowe's and our customers. Without them, the strong results that we delivered this quarter would not be possible.", "Now, I'll turn it over to Brandon." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Joe. I would like to begin this morning by providing additional details regarding our recent announcement of our intention to sell our Canadian business. As Marvin mentioned, despite making meaningful progress in improving our Canadian retail business over the past few years, it has continued to lag our U.S. operations and sales growth, operating profit, and return on invested capital. In fact, the Canadian business represents approximately 60 basis points of dilution on our full-year operating margin outlook.", "And during the quarter, we recorded a pre-tax noncash impairment charge of 2.1 billion related to this business. Looking ahead, this transaction makes us a U.S.-focused business and gives us a clear line of sight to meaningful, long-term improvement of our sales productivity, operating margin, and return on invested capital in particular. We are excited to share our updated financial targets at our upcoming analyst and investor conference in December. Turning to our Q3 results.", "We generated GAAP diluted earnings per share of $0.25 compared to $2.73 last year. Now, my comments from this point forward will include certain non-GAAP comparisons where applicable. Excluding the 2.1 billion asset impairment charge, we generated adjusted diluted earnings per share of $3.27, an increase of 20% compared to third quarter of 2021. This increase was driven by a combination of top-line growth, strong P&L management, and disciplined capital allocation.", "Q3 sales were 23.5 billion with comparable sales up 2.2%. Comparable average ticket increased 8%, driven by product inflation, 80 basis points of commodity inflation, and higher Pro sales. Of note, FX represented a 30-basis-point headwind to consolidated comps. Higher average ticket was partly offset by comp transactions declining 5.8%.", "Of note, comp transactions have improved significantly as we moved through the year with Q3 over 730 basis points higher than Q1 and 60 basis points higher than Q2. U.S. comp sales were up 3% in the quarter, while sales in Canada were down 10.2% in USD, with roughly half of the decline attributable to a stronger dollar. Pro sales were up 16% in the quarter, driven by broad-based strength across all categories.", "DIY sales trends improved from Q2 with strong performance across many core home improvement and categories as consumers spent more time at home following summer travel activity. DIY project-related demand also increased sequentially due to lower lumber prices. On lowes.com, sales increased 12% in the quarter, partly driven by strong appliance sales. Finally, we estimate that the net effect of storm-related sales year over year was relatively flat as we cycled over Hurricane Ida in the prior year.", "Our U.S. monthly comps were up 4% in August, 3.4% in September, and 1.4% in October. On a three-year basis, U.S. comps increased 33.5% in August, 37.8% in September, and 42.1% in October.", "Gross margin was 33.3% of sales in the third quarter, up 20 basis points from last year. Product margin rate was up 110 basis points versus the prior year as we cycled over a lumber margin pressure in the third quarter of 2021, which was triggered by a steep decline in prices that began last July. Higher product margin rate was partly offset by 30 basis points related to higher domestic and import transportation costs, as well as the expansion of our supply chain network, along with 35 basis points of pressure from shrink. Adjusted SG&A of 18.7% of sales levered 41 basis points, driven by higher sales and substantial improvement in productivity.", "Adjusted operating profit was 3 billion, up 7% versus the prior year. Operating margin rate of 12.71% of sales leverage 54 basis points, driven by both higher gross margin and SG&A leverage. The adjusted effective tax rate was 24.5% below the prior-year rate. Inventory ended the quarter at 19.8 billion, up 3.1 billion from the same quarter last year, largely driven by product inflation and higher freight costs with units roughly flat to prior year.", "This morning, we are increasing our full-year 2022 financial outlook based on stronger-than-expected flow-through year to date. Please note that our outlook for operating margin, diluted EPS, and return on invested capital are all adjusted to exclude asset impairment and expected transaction costs associated with the sale of our Canadian retail business. We now expect 2022 sales of approximately 97 billion to 98 billion, representing comparable sales of flat to a decline of 1% as compared to prior year. Please note that at the midpoint of the range, this implies that fourth-quarter comparable sales will be slightly positive.", "This reflects our expectations of continued strong Pro performance and steady DIY trends. As a reminder, our 2022 sales outlook includes a 53rd week, which equates to approximately 1 billion to 1.5 billion in sales. We continue to expect gross margin rate to be up slightly as compared to the prior year. As you look ahead to the fourth quarter, keep in mind that we are cycling over the second round of lumber inflation in 2021, which benefited product margins.", "We also expect continued shrink pressure next quarter. Given our disciplined focus on expense management, we now expect adjusted operating margin of approximately 13% for the full year. And we are raising our outlook for adjusted diluted earnings per share for the year from $13.10 to $13.60 to our updated range of $13.65 to $13.80. This reflects better-than-expected SG&A leverage, as well as higher-than-planned share repurchase activity.", "We expect capital expenditures of up to 2 billion this year. Additionally, given our larger-than-expected 4.75 billion notes offering in Q3, we expect to accelerate share repurchase activity that we had originally planned for 2023 into this year. We now expect 13 billion in share repurchases in 2022. And finally, we are raising our outlook of adjusted return on invested capital to above 37% for the year.", "Now, turning to our best-in-class capital allocation strategy. In Q3, the company generated 1.7 billion in free cash flow. And through a combination of both dividends and share repurchases, we returned 4.7 billion to our shareholders. During the quarter, we repurchased 20.5 million shares for 4 billion.", "We also paid 666 million in dividends at $1.05 per share. Capital expenditures totaled 403 million in the quarter as we continued to focus on high-return projects that support our growth objectives. We ended the quarter at 2.5 times adjusted debt to EBITDA, and we are well on track to reach our target leverage of 2.75 times in 2023 while also maintaining our triple-B-plus rating. Finally, we delivered return on invested capital of 27.6% inclusive of a 590-basis-point impact related to the asset impairment recorded in the third quarter.", "In closing, I'm confident that we will continue to deliver shareholder value through our leading capital allocation strategy while investing in our associates and our business to drive long-term sustainable growth. And with that, we'll open it up for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We're now ready for questions. [Operator instructions] And our first question today comes from the line of Simeon Gutman from Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Good morning, everyone. Hey, Marvin, I wanted to maybe play devil's advocate for a second on housing, this idea that it's just taking a long time for all these pressures to catch up to the consumer in the segment for all the reasons you cited, plus there's been some labor and product shortages. So, curious how much you debate that, and that there is a certain level of home price depreciation that's going to eventually weigh on this customer." ] }, { "name": "Marvin Ellison", "speech": [ "No, I appreciate the question. And here's what I would say. When we look at markets around the country where we saw an aggressive increase in home prices during the pandemic, now you can see some of those prices start to fall. Those markets are performing at the same rate of performance as other markets.", "So, we're already seeing due to the life cycle of home price appreciation and home price declines around the U.S., signals of kind of what the broader macro may look like in months, quarters, and years in the future. The great thing about operating stores in every state and virtually in every ZIP code is that you have a pretty good sample size of kind of what's currently happened but also what future trends may look like. And we're not trying to spin the data. I mean, trust me.", "We're looking at this every day like you are but from a different vantage point, trying to understand demand patterns. But the reality still remains that home prices have appreciated at record levels, as I said in my prepared comments, on average, $330,000 per home. The facts are that homes are older than they've been since World War II. And two-thirds of our business is nondiscretionary because when your house gets older, things break.", "That's just commonplace. The facts are that we have more personal disposable income today than we had before the pandemic, and that's primarily in the bank accounts of homeowners. And the facts are, we're still 1.5 million to 2 million homes under current demand because of the lack of home building coming out of the financial crisis in 2008, 2009. So, those are just facts.", "And when we look at and try to forecast our business, we have to ask one simple question. Historically, what data points correlate closely to demand patterns for Lowe's? And what I just outlined to you are the data points that correlate to demand patterns, and that's what we look at." ] }, { "name": "Simeon Gutman", "speech": [ "Yep. That's a fair point. I'll jump off of housing and maybe go back to the business. If you look at the things Lowe's can be doing better, and, obviously, you're executing against all the plans that you put in place since you've joined, does it involve higher capex, maybe reallocation of capex? Or is it mostly execution in process?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, I would say from a capex standpoint, we have no expectation to go above our current, you know, capital allocation dollar amount of roughly 2 billion per year. We'll have our investor conference next month, and I can just give you a little bit of a precursor. That's what the number is going to be for next year. So, as we look at things that we still have to catch up, and I'll be very transparent, we're not where we want to be.", "We still have a supply chain transformation process that's underway, but we can get all that accomplished and stay within that $2 billion capex dollar amount. We still have significant IT investments that we need to make. We made incredible improvement, but all those things also fall within that current allocation of capex. You know, Bill is working to continue to improve merchandising and pricing systems.", "Again, those things are all mapped out. They're costed out, and we have a good understanding of it. And we feel like at $2 billion of capex will allow us to achieve all of these things. And again, we'll speak to those in more specificity next month in New York.", "But what I will say to you is, yes, are we working on execution? We are. But I can tell you right now, I couldn't be more pleased with our ability to execute at a high level and arguably the most difficult retail environment of our lifetimes. Anytime you could be a $100 billion company and you can be so dependent on the global supply chain, and you can manage inventory with basically flat to negative units for the whole year as we have, that tells you that the degree of execution and collaboration is at a high level." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you. Good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. Your big competitor yesterday talked about seeing some early signs of deceleration in the business in areas like grills. Are you seeing any of those similar signs? And separately, what do you think drove the acceleration in October on a monthly -- three-year monthly stack basis?" ] }, { "name": "Marvin Ellison", "speech": [ "You know -- so, Michael, I'll take the first part of that. I'll let Bill Boltz come in and provide some perspective. But when we look across all of our merchandising departments, we don't have any really red blinking lights of concern relative to certain categories, certain items, certain SKUs. Obviously, when you start to get into different times of the year, we're going to have performance changing based on customer demand.", "So, we didn't have an anticipation that grills would be a top-selling category in the third quarter. It tends not to be. The same wood patio. And as we spoke to a lot of detail last quarter, we do believe there was some degree of pull forward in some of these more seasonal discretionary categories.", "But we are not seeing anything that feels or looks like a trade down or consumer pullback. I mean, to the contrary, the third quarter was our best performing DIY quarter of the year. And that customer segment tends to be kind of the indicator for us on the overall health of our business. Pro has been strong all year.", "And the good news is for the first time this year, we saw continued strength in Pro, and we saw sequential improvement in DIY. So, that is something that gives us confidence that things are headed in the right direction. I'll let Bill talk about what performed well in the third quarter relative to product categories that really gave us a really strong two to three years stack for that mark." ] }, { "name": "Bill Boltz", "speech": [ "Yep. Thanks, Marvin. And, Michael, I think just a couple of things. We see -- as we go into Q3, we see a shift away from a heavy reliance on seasonal like we do typically in Q2.", "Yet there was still some seasonal business to be had in Q3, and that helped us as the weather was favorable. We -- as I said in my prepared remarks, our building products business continued to perform well, and we continue to see strength really across all of our Pro-related categories. And then the shift to indoor, as you see, appliances, kitchen and bath, flooring, paint, those businesses, both on a DIY and the Pro side, you know, continue to do well. And then, holiday with Halloween, and then the early sets of our trim a tree categories were what we saw in Q3.", "And then our online business continued to perform well in Q3 as well." ] }, { "name": "Joe McFarland", "speech": [ "Hey, Michael, this is Joe. I'll add just one additional point. And that's our new MVP Pro Rewards Program that we have been discussing. And so, when I look at our adoption rates being way better than expected, the new Pro CRM platform and then just a combination of our strong credit offering along with Pro loyalty gives us a lot of confidence in that business as well." ] }, { "name": "Michael Lasser", "speech": [ "Awesome. My follow-up question is at the risk of pulling forward a little bit of your messaging from a couple of weeks now, your SG&A dollars have been very well contained over the last few quarters, leading to the idea that maybe Lowe's doesn't have as much cushion in its cost structure in the event that there could be a downturn in home improvement demand, either because of housing or just a weakening labor market. Why is that wrong?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, I would say it's wrong based on the performance in Q1, just use that as your data point. The season broke late, top line was not what we anticipated, yet we still leverage operating margin for the quarter. We see that as an example of the levers that we now have in place to be agile. As I said in my prepared comments, we've got a lot of experience sitting around this table.", "There's very few things that we have not seen. We have a really strong playbook developed. And we think that if the market turns more negative than we may anticipate, then we have the ability to pull those levers and perform really well. As a matter of fact, we're not giving you the details.", "Brandon is going to spend a bit of time next month at the investor conference outlining some of those levers and the agility we built so that we can be really, really swift to react to any market conditions." ] }, { "name": "Michael Lasser", "speech": [ "That sounds great. Have a nice Thanksgiving, and thank you very much." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you. Same to you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning. Congrats on the nice quarter again. My first question, you know, I don't want to have the risk of sounding nitpicky, but I mean, given the strength in the business, and as Michael just pointed out in his question, the -- basically, these accelerating trends through Q3, and then you talked about the initial strength in seasonal with the mummy sales, why not lift -- why not lift sales guidance for the year, especially in -- when you're lifting earnings guidance?" ] }, { "name": "Marvin Ellison", "speech": [ "So, I'll give you the philosophical perspective, and I'll let Brandon give you the financial perspective. As you know, Brian, there's a lot of unknown out there. And so, we're not going to be overly bullish for no reason. You had a midterm election that still candidly hadn't been quite determined.", "You have aggressive action from the Fed. You have global geopolitical events happening. And so, we're just being, what I'll describe as appropriately conservative. Do we have confidence in our business? Absolutely.", "Do we have confidence in what we're going to deliver for the holiday season, you bet we do. And we think we have a great plan for the balance of this quarter and going into next year. But in an environment where there's so much concern in the macro. We just felt it was appropriate to just be conservative.", "So, our decision not to lift guidance has nothing to do with our lack of confidence. It's just more about being prudent and not being overly aggressive in an environment where there's a lot of on-asset macro questions. So, I'll let Brandon add some additional detail." ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Brian, this is Brandon. As I indicated in my prepared remarks, we looked at three-year comps did see sequential improvement as we moved across the quarter. The Q3 exit rates were strong. Bill mentioned the improvement specifically in the interior DIY-related categories.", "The midpoint of our full-year guide is flat to down one, which implies a slightly positive comp for Q4. And if you recall back in August, we were guiding actually to the bottom end of that range of flat to down 1%. I will cite that the commodity volatility and the impact Q3 to Q4. With lumber where it is, we've actually seen a benefit of 80 basis points to comps in Q3.", "If the pricing runs out into Q4, we're expecting that to actually flip to a 90-basis point drag. So, that's about 170-basis-point swing. Again, that's taken where we are from a benchmark perspective of below about $500 and running that out and comparing that to where lumber prices inflated round 2 of last year. So, all in, excluding lumber, and the differences I just cited, the Pro comp momentum is expected to continue, and the DIY trends that Bill mentioned are expected to continue through Q4." ] }, { "name": "Brian Nagel", "speech": [ "That's very helpful. I appreciate the color there. Then my follow-up question in a separate topic, it is with regard to supply chain. So, Marvin, you keep talk -- you highlighted that there's a lot of success that you've had in improving the low supply chain internally.", "By most measures, now the external environment for supply chain is getting better with shipping costs and such. So, I guess the question, are you seeing that? And then recognizing you haven't given guidance yet for 2023 but to the extent these external supply chain issues continue to correct, could that be a tailwind of some sort as we hit over the next several quarters?" ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Look, it's a great question, Brian. And without getting in front of what we're going to discuss next month, I would say that the short answer is, yes. There are elements of the supply chain that definitely will give us some cost advantages next year.", "Brandon is going to be very transparent and very detailed on kind of what we see going into next year. And, obviously, supply chain is going to be a big component of that. In addition to just the overall cost environment for supply chain, we're going to talk about strategic initiatives as well that we're excited about because as far as much work as we've done in supply chain, as I mentioned earlier, we still see it as one of our key opportunities to improve. There's not a great retailer in the world that doesn't have a great supply chain, and we're committed to having a great supply chain." ] }, { "name": "Brian Nagel", "speech": [ "Appreciate it. Congrats." ] }, { "name": "Marvin Ellison", "speech": [ "OK. Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Thanks, Brian." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Liz Suzuki with Bank of America. Please proceed with your question." ] }, { "name": "Liz Suzuki", "speech": [ "Great, thank you. Just as you think about the makeup of comp going forward between transactions and average ticket, you mentioned that in some categories where you saw inflation moderate, you saw a subsequent increase in transactions. Does that give you confidence going forward that as inflation does start to moderate, it will be -- you know, that average ticket decline or lower growth rate would be offset by a pickup in transactions?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Liz, this is Brandon. I think on the inflation front, we do continue to see high single-digit inflation this quarter, inclusive of about 80 basis points that I mentioned earlier of commodity inflation. Our consumer does continue to be resilient. We haven't seen any significant trade down.", "In fact, we've actually seen trade up in place across a number of categories. And our Q4 forecast, which we're focused on at this point, we're expecting that to continue at the high single-digit mark. We are going to get some relief related to lumber pricing that I mentioned earlier, so that net 170-basis-point swing. But for Q4, that's the forecast is that the inflation is going to continue to lift our ticket, which is going to be the primary driver of our comp, and it's going to be offset by transactions being down in Q4." ] }, { "name": "Liz Suzuki", "speech": [ "And then just looking out beyond Q4, as you think about the potential outlook for comps going forward and how that ticket versus transactions could play out, I mean, one of the pushbacks that we get is that if ticket remains -- if ticket starts to come down but transactions remain negative, that would be a severe headwind to comp. I'm just, you know, curious how you're thinking about that outlook going forward." ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Liz. We're going to hold until December to really give you a deep view there. We'll have an updated view of the macro, the comp scenarios within that, and specifically the makeup of our comp. And we'll plan to go into details there on December 7." ] }, { "name": "Liz Suzuki", "speech": [ "All right, great. I'll see you then." ] }, { "name": "Brandon Sink", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "HI. good morning. So, following up on the SG&A dollar question, as you've been able to take out a couple of hundred million of SG&A in both Q1 and Q2, and while Q3 was basically flat, it looks like your Q4 SG&A embeds a pretty notable step-up in trend, even excluding the extra week. So, can you just help me understand the puts and takes on the SG&A line in a little bit more detail and perhaps talk through the impact of the efficiency initiatives and then also to what extent you're able to flex up and down labor with the lower volumes today?" ] }, { "name": "Marvin Ellison", "speech": [ "So, Zach, I'll take the first part of that, and then I'll let Brandon and, maybe, Joe provide some additional detail. So, for us, I think the key thing to understand is we have what we call PPI, perpetual productivity improvement initiatives. And we're going to go into some level of detail on how this has become more of cultural process across the whole company at the investor conference next week. But specific to your question, we still believe that we have technology investments that we can make in the store environment specifically to where we can continue to drive SG&A leverage while improving customer service.", "But it's easier to drive SG&A leverage if you're just pulling payroll out indiscriminately. But what Joe and his team has done, we've actually improved leverage in the store from an expense and payroll standpoint and concurrently drove up customer service. And that's the key, and that's really all about technology investments. So, we think that there's still additional initiatives on our project road map that will continue to give us those benefits.", "I'll let Brandon take the more financial part of your question, and then if Joe can add something else about payroll and how we can adjust it rather quickly relative to the demands that we're seeing from the consumers in our stores." ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Zach, this is Brandon. The only thing I would add, implied, our SG&A is expected to lever in Q4. And just as a reminder, we are cycling an incentive payout from 2021 in Q4. But I would just add to what Marvin said, continuing to drive substantial PPI initiatives -- store tech modernization, front-end transformation, managing back-office spend.", "So, we're really proud of the progress that we've made, as we mentioned earlier, expecting to significantly outperform from an EBIT standpoint even in declining sales for the full year. And we'll tell you more about what we have in store 2023 in December." ] }, { "name": "Marvin Ellison", "speech": [ "And, Zach, I'm going to let Joe talk about the activity-based model that drives our payroll system in the stores, so you can get a sense that we just don't have a blanket approach. We generate payroll based on a number of transactions and footsteps, and we think that's the best way to look at it. So, Joe, you can expound on that." ] }, { "name": "Joe McFarland", "speech": [ "Yes. And so, thanks, Marvin. What I'd tell you is with our labor system that we have implemented in the last few years, this is really detailed. It's down to by store, by department, by day, by time of day.", "In addition, as you think back in the last several years, our 60-40 initiatives to align the associates with customers and then the tasking activities, you know, we've gone through a series of steps that continued pay go-forward dividends for us. And so, we have a lot of confidence in our ability to navigate to continue with the large investments we've been making. I think, you know, 2023 will be a transformative year for us from an IT system standpoint and the ease of what we're doing." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Appreciate all the color there. And then, Marvin, you've mentioned in the past about two-thirds of your business is tied to repair and maintenance activity. And then the remaining third of your business, to what extent would you say those sales are tied to, housing turnover or home price appreciation? And then considering the slowing in these housing metrics, how do you characterize the current demand environment for repair and maintenance activity, which is more stable and recurring versus sales that are perhaps more discretionary or bigger ticket in nature?" ] }, { "name": "Marvin Ellison", "speech": [ "No. Zach, it's a fair question. What I will tell you is that we're seeing strength in both areas. So, obviously, when you see 19% growth in Pro, 10 consecutive quarters of double-digit Pro growth, then that tells you that there's big-ticket projects going on that are remodel in nature but are also what I would call upgrade in nature.", "We talked about trading up in place, and that is a phenomenon that we're seeing because the 1.5 million to 2 million shortages of homes and the high-interest rate environment is just incentivizing homeowners to keep their low fixed rate and modify their existing home. And so, because of that, you're seeing a combination of older homes getting the maintenance and repair that falls in that two-thirds. But then you see the other one-third that simply upgrading and improving the environment, a new kitchen, finishing the basement, a new bathroom, etc. And so, we're seeing a combination of all of those things.", "And as Bill walked through the different merchandising department of performance, you can see it embedded in all of those different results." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Thanks for the time." ] }, { "name": "Marvin Ellison", "speech": [ "No. Thank you." ] }, { "name": "Operator", "speech": [ "The next question comes from the line of Jonathan Matuszewski with Jefferies. Please proceed with your questions." ] }, { "name": "Jonathan Matuszewski", "speech": [ "Great. Thanks for squeezing me in. And great results. My first question is on inventory.", "It looks like the inventory sales spread widened a bit sequentially in 3Q. From our store check, it looks like your in-stock positions are the best they've been in years. So, is it safe to say that the majority of that inventory increase year over year is tied to average unit cost? And on that topic, how should we think about inventory levels tracking at the end of 4Q? That's my first question. Thanks." ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Jonathan, this is Brandon. So, I would say inventory overall, we feel, is in a really solid position. Balance is up 19%, driven exclusively by product cost inflation and freight units are flat. As you mentioned, our in-stock rates continue to improve across all of our categories.", "We're continuing to make investments in Pro, specifically in those high-demand SKUs. We feel like we got the right levels to support the expected demand that we see for Q4 and into '23. And in reference to Q4, we do expect the inventory to build over Q4 with early ordering, I think, for springs consistent -- compared to pre-pandemic levels. We are still seeing a bit of unpredictability in the supply chain due to the zero-COVID policy in China.", "But just also as a reminder, when we look at our seasonal businesses, specifically, we do start setting south and deep south in Q4, and then we're also maneuvering around Chinese New Year, which is the latter part of January. So, it's going to be critical that we're in stock for spring, and we're making those decisions based on lead times and supplier health across each of our categories." ] }, { "name": "Jonathan Matuszewski", "speech": [ "That's really helpful. And then a quick big-picture question on Pro for you, Marvin. Lowe's continues to have great traction there. It looks like the multiyear comp held up this quarter at 36%.", "So, when you think about the recent share gains with the Pro, curious if the drivers have evolved at all. If you could talk through how much new Pro customer acquisition has been driving Pro sales versus greater wallet share from existing Pros, you know, that would be great, and whether you're seeing any change in those 2 drivers. Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you for the question. We don't give a lot of external information on number of new customers down to that level of specificity. But what I will tell you is that our new loyalty program is absolutely driving new Pro customers, and it's driving more return visits of existing customers, which is exactly what we wanted. And a key data point is this.", "When a Pro customer is enrolled in our Pro Rewards platform and credit, they shop three times more. So, that is the key data point. And so, in Joe's scripted comments, he talked about the adoption rate and how it really comes down to our ability to engage the Pro. And when we engage them and educate them, they tend to adopt the program.", "So, I'll let Joe provide a little bit more context on Pro. But we're really pleased with the progress and equally pleased that we saw the DIY customer come back strong in third quarter than we've seen them all year." ] }, { "name": "Joe McFarland", "speech": [ "Jonathan, just a couple of things to add. First off, our Pro team here at Lowe's is just full of deep experience inside sales, outside sales, and they've done a really nice job. And so, we're still in the early stages of the MVPs Pro Program but very, very pleased with the adoption that we're seeing. So, we've spoken a little bit in the past about our Pro CRM platform, so we have the ability to better anticipate Pro's needs and drive sales.", "And then, you know, this really does a nice job of what we call leveling the playing field so that every Pro is important and has the ability to earn points no matter what the size -- and so, things like purchase-based offers, then completing different actions to deepen their relationship with Lowe's. And so, we'll continue pressing forward here but very pleased with the Pro progress." ] }, { "name": "Jonathan Matuszewski", "speech": [ "Nice to hear. Best of luck." ] }, { "name": "Kate Pearlman", "speech": [ "Thanks. Thank you all for joining us today. We look forward to speaking with you at our analyst and investor conference on December 7." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2018-11-20	[ { "description": "President and Chief Executive Officer", "name": "Marvin R. Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "William P. Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joseph M. McFarland III", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "David Denton", "position": "Executive" }, { "description": " -- UBS Securities -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": " -- J.P. Morgan Securities -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": " -- Morgan Stanley & Co. -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": " -- Guggenheim Securities -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": " -- Wells Fargo Securities -- Analyst", "name": "Zachary Fadem", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies third quarter 2018 earnings conference call. This call is being recorded. Please note, if you pressed 1 to enter the question queue prior to the start of today's call, your signal did not register. You will need to press 1 again to enter the queue.", "Also, supplemental reference slides are available on Lowe's investor relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call. During this call, management will be using certain non-GAAP financial measures.", "The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks, and the company can give no assurance that they will prove to be correct. Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission.", "Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. Dave Denton, Chief Financial Officer. I will now turn the call over to Mr. Ellison for opening remarks. Please go ahead, sir." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you, Regina. Good morning, everyone. As reflected in our earnings release earlier today, the strategic reassessment of our business continued in the third quarter. Our top priority this quarter was taking the necessary steps to build a sustainable foundation to position Lowe's for long-term success by exiting underperforming stores of non-core businesses. This will allow us to intensify our focus on our core retail business.", "As far as the strategic reassessment, we made the decision to close 20 U.S. stores and 27 stores in Canada, as well as four other Canadian locations. We also intend to exit our retail operations in Mexico and our Alacrity Renovation Services and Iris Smart Home businesses. These were difficult decisions to make, and we believe we can deliver the greatest return to our shareholders by focusing our attention on running outstanding retail businesses in the U.S. and Canada. These actions send a clear message that we'll no longer pursue ventures that dilute our return on capital. Instead, we're committed to a more effective capital allocation process that will deliver better returns to our shareholders.", "I'm pleased to announce that we have substantially completed our strategic reassessment of the business, and now we can shift our attention to improving execution in our retail stores and online. Of course, we'll continue to evaluate all elements of our portfolio annually.", "Now let me comment on our performance in the third quarter. We delivered comparable sales growth of 1.5%, driven by a 2.3% increase in average ticket, partially offset by a 1% decline in transactions. Our U.S. home improvement comp grew at 2%, with positive comp in 11 of 14 geographic regions. As expected, the Tampa and Houston markets had the weakest comparable sales in the quarter due to touch prior-year comparisons from Hurricanes Harvey and Irma. We also posted 12% comp growth on Lowes.com.", "Diluted earnings per share were $0.78 for the quarter and adjusted diluted earnings per share were $1.04, a decrease of 1% for the same period a year ago. Our third quarter results reflect many of the things we discussed on our second quarter call. First, while we drove strong traffic to our stores and website, out-of-stocks continued to pressure sales. Second, our inefficient reset process continued to create disruption in our stores and contributed to out-of-stocks. In fact, all of our categories with negative comps -- millwork, paint, fashion fixtures, and flooring -- were pressured by poorly executed resets.", "Third, our store processes are too complex; our labor and management system is primitive; and our associates are burdened with too many tasks. These distractions are preventing our associates from spending adequate time with the customer to provide assistance. Four, our project specialist and install sales business is too complicated, which prevents us from delivering an outstanding customer experience and it pressures our sales.", "The good news is I'm pleased with strategic initiatives the leadership team designed in Q3 to address these chronic issues. You'll hear more about these plans later in the call. As I said earlier, our priority in the third quarter was building the sustainable foundation for long-term success. Part of the foundation for long-term success was identifying a world-class Chief Information Officer.", "Earlier this month, we were pleased to name Seemantini Godbole as our new Chief Information Officer. Seemantini is an accomplished retail executive with more than 25 years of global technology expertise and a proven track record for transforming IT and digital platforms. This is the final addition to our executive leadership team, and I'm confident in her ability to help us modernize our IT and omnichannel systems. Also, during the third quarter, our new leadership team assessed our functional areas, upgraded talent, conducted deeper dives in their business areas.", "The team was committed to identifying the root causes of our sales-per-square-foot challenges, merchandising reset issues, our chronic out-of-stocks, and our low job-lot quantity issues. But rather than implementing quick fixes to address these chronic and long-standing issues in the third quarter, we developed plans to drive sustainable improvement, and this is reflective of our commitment of building a foundation of sustainable, long-term success.", "In a moment, Bill Boltz, our Executive Vice President of Merchandising and Joe McFarland, our Executive Vice President of Stores will walk you through a detailed review of the third quarter results, and outline improvements they're making in merchandising and store operations, as well as our plans for the fourth quarter. I'm also please to welcome Dave Denton to the call. As we previously announced in August, Dave has been appointed our Chief Financial Officer. While today is his first official day with the company, he's spent the past several weeks meeting with our executive leadership team, and will share his views on the business as well.", "Now turning to the macroeconomic environment, although interest rates have ticked up and housing turnover has been pressured, the home improvement backdrop remains strong, driven by robust, real residential investment, home price appreciation which continues to encourage homeowners to engage in discretionary projects. The average age of the home in the U.S. is 40 years, which creates an attractive opportunity for our project categories that support maintenance and repair. Consumer confidence continues to hover at high levels, as consumers remain upbeat about their employment and income prospects, suggesting that we will continue to see solid gains in consumer spending, supported by stronger, real disposable personal income growth.", "Looking ahead, our future is bright. We operate in a fragmented $900 billion marketplace, and we have a unique opportunity to fix the long-standing product issues that will improve our performance and increase our market share. As we look at our Q3 results specifically, our top line underperformance both in stores and online, we see the issue as poor execution, not a macro concern. As I mentioned earlier, we're not chasing short-term fixes, but we have every expectation that our actions and initiatives will begin to drive improvements in our business as we enter 2019.", "I look forward to sharing more details on our long-term strategic plans at our analyst and investor conference on December 12th. Now before I close, I'd like to thank our associates for their hard work and dedication to serving customers. Our systems and our processes don't make it easy for our associates. Nevertheless, I'm incredibly proud of the way they support customers, each other, and the communities in which they live and work. This is evident in their response to Hurricanes Florence and Michael this quarter. We've already hosted 27 hurricane-relief events, and served 15,000 hot meals. We delivered 18,000 disaster relief buckets for impacted communities. And this afternoon, our associates will serve 50,000 people Thanksgiving meals in hurricane-impacted areas in North Carolina and Florida.", "I would also like to send our thoughts and prayers to all the individuals in the communities being impacted by the California wildfires. We're using one of our closed Orchard Supply Hardware locations for emergency relief and the warehouse donated supplies from the community. This is the most devastating wildfire in California history, and we will do all we can to support our associates and the communities impacted by this horrific event. Now with that, I'll turn the call over to Bill Boltz." ] }, { "name": "William P. Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. Today marks my 99th day with Lowe's, and I'm pleased to be here to discuss the performance of the merchandising team. As Marvin shared with you, we posted comparable sales growth of 2% in U.S. home improvement this quarter. The favorable macro environment combined with great values and events drove traffic to our stores and website, but the continued challenge is with out-of-stocks, poor reset execution, and assortment issues in certain categories put pressure on our ability to turn those visits into transactions.", "Let me take a moment to discuss some of the positives from the third quarter. Seven out of 11 merchandising departments had positive comps in the quarter. Seasonal and outdoor living, appliances, lawn and garden, kitchens, and rough plumbing and electrical all delivered comps above the company average. Seasonal and outdoor living led the way with high single-digit comps driven by double-digit comps in grills and lawnmowers. Along with the increased demand driven by the inventory rationalization activity, in addition we also delivered on a response for hurricane-related products such as generators, air conditioners, and dehumidifiers.", "Our lawn and garden comps were the result of the capitalizing on the extended growing season, along with our fall preparation activity and our grass seed, fall fertilizer, live goods, and watering programs. For the ninth quarter in a row, we drove above-average comps in applications, as we continued to leverage our omnichannel offering through our leading brands, our breadth of assortment, and strong Labor Day and Columbus Day events. Our kitchen department also posted above-average comps, with strength in organization and shelving, as well as cabinet and countertops.", "We also had solid performance in our core pro product groups within rough plumbing and electrical. We continue to be excited about the effectiveness of our new destination brands attracting pro customers, as was evidenced by the double-digit comps in SharkBite plumbing fittings and our strong growth in water heaters, driven by the professional brand of A.O. Smith.", "Also during the quarter, we completed the rollout of two key programs into our stores, with Zoeller pumps and MAPEI tile setting material. We also launched new exclusive pro cordless power tools from both Bosch and Metabo HPT, that brings the power of a corded tool to the jobsite through the ease and convenience of cordless.", "We continue to see robust consumer demand bolstered by a strong home improvement sector. As Marvin noted, during the third quarter, we took steps to begin to strengthen our merchandising focus on our retail basis. We've added industry experts to the team as part of building our a world-class merchandising organization. In addition, as many of you know, in the third quarter we also undertook an aggressive inventory clearance process that was focused on eliminating slow-moving or underperforming SKUs, and ultimately reducing the clutter in our stores. With that process complete, we've now begun reinvesting those dollars into improving in-stock on our best-selling SKUs and focusing on job-lot quantities for the pro customer.", "Although the inventory clearance activity and the subsequent reinvestment will allow for significance benefits in the future, the discounted sales cannibalized other merchandising categories during the quarter. Within merchandising, we are streamlining our decision making processes. We are investing in faster moving SKUs, and we are shifting the mindset from managing to an inventory dollar amount to managing to an inventory turnover goal; which, for example, will allow us to have sufficient inventory on hand before the season breaks and have the stores set and ready for our customers.", "Now let me discuss some of the opportunities from the third quarter. Our underperforming categories were largely impacted by out-of-stocks stemming from poor reset execution, all of which had recovery dates that were pushed back and therefore the planned improvements were not realized in the quarter. Millwork was pressured by supply and reset challenges in categories such as window blinds, resulting from a difficult product transition. Out-of-stocks and limited job-lot inventory in core product categories, including both interior and entry doors, also exerted pressure on the comp. We expect to see improvements in these areas in the early part of 2019.", "Our paint business was impacted by brand transitions along with supply disruption as we transitioned into our exclusive partnership with Sherwin-Williams. Going forward, we're working with our supplier to improve our inventory position and we expect to see improvement in this area by year end. Our fashion fixtures department was negatively impacted by reset challenges in lightbulbs and commercial lighting, where supply availability and a shortage of third-party labor to perform the resets led to out-of-stocks and reset delays. We expect to make continued progress in our reset completion and in-stock improvements throughout the fourth quarter.", "Finally, the underperformance in our flooring business continued, and was driven by reset disruption in hard surface and an assortment that is still overly focused on soft flooring, as we continue to see consumers shift to the ease and innovations that are available in vinyl plank flooring. Going forward, our new assortments will better reflect this trend, with the expansion of our exclusive, SmartCore vinyl plank products. Our updates to these areas, which are in the early stages, will introduce new lower price points in laminate that will provide great values to both the pro and DIY customer.", "These updates will also expand the off-shelf space, and will introduce new looks and trends for tile, laminate, and vinyl planks that will be assorted to the local market. Given the complexity of these activities, we expect to have solutions implemented in the latter half of 2019. Although we were not pleased with our execution or results in the third quarter, as Marvin mentioned, we have identified the root causes of the issues that negatively impacted our sales. We are focused on changing or results by enhancing our processes to address these issues, and we anticipate that we will see improved execution in 2019.", "Now let me transition to the fourth quarter. We are excited about our continued rollout of Craftsman, including individual mechanics' tools, hand tools, and power tools. Throughout the fourth quarter, we will showcase Craftsman on multiple end caps, highlighting exclusive products and offers, including three great values that are featured at $99. We are proud to be the exclusive destination in the home center channel for this iconic brand, offering some of the best hand tools, storage, and outdoor power equipment products in the industry.", "We are also excited about our plans for an in-graded, omnichannel holiday experience that will be driven by strong Black Friday, Cyber Monday, and other key holiday events. We will continue to highlight our best-in-class appliances offering and showcase strong values focused around tools, holiday lighting, trees, and décor, along with other great gift ideas from across the store.", "In conclusion, as part of our refocus on merchandising basics, we have five key priorities: (1) we are simplifying our merchandising organization, and we are continuing to recruit talented, experienced leaders to enable faster decision making, and to ensure that we are optimizing our assortments across all channels; (2) we are implementing a localized assortment strategy with the development rollout and support of a field-based merchandising team; (3) we are taking steps to rebuild our reset process by reducing our reliance on third-party labor; with that, we are redesigning our internal reset process wit the implementation and rollout of our new merchandising service team or what we refer to as MST; (4) we are changing our end caps and off-shelf strategy to showcase great values and innovation that drive traffic and that ultimately improve the overall sales productivity of this valuable real estate in our stores; and (5) we will continue to strengthen our merchandising presentations by adding key brands to our assortments and by investing in both job lot and presentation quantities within our best-selling SKUs.", "All of this is designed to drastically improve the experience for our pro customers. All five of these initiatives were launched at the end of the third quarter and we will be laser focused on the rollout plans and execution as we move into 2019. I look forward to discussing these five priorities in more detail at our December 12th analyst and investor conference.", "We are excited about the opportunity ahead of us and we are working very hard to position Lowe's for the future and to capitalize on the strong demand in a healthy sector. Our changes will take time, but we have a detailed plan in place to allow us to make steady progress with near and long-term wins. Thank you, and now I'll turn the call over to Joe." ] }, { "name": "Joseph M. McFarland III", "speech": [ "Thanks, Bill, and good morning, everyone. Like Bill, I too am celebrating my 99th day with Lowe's, and I'm very excited to share with you the steps we are taking to improve store operations. When I joined the company, it struck me that some of the basic and foundational elements of operations were not in place. As an examination, there were no engineered standards for in-store processes like unloading a truck, flowing product from receiving to the sales floor, or stocking the shelves to drive in-stocks. And labor scheduling systems were antiquated and ineffective, leading to payroll inefficiency and detracting from customer service.", "Other than cost of goods sold, payroll is the largest expense for the company, and we had limited, ineffective tools to track, allocate, or monitor coverage. In addition to payroll inefficiency, stores were inundated to communications and reports with no prioritization. This lack of payroll efficiency combined with non-existent communication standards led to process breakdowns like excessive out-of-stocks and a poor customer experience.", "Although these process challenges hindered our execution in the third quarter, I have encountered these types of issues before, and have put solutions in place to solve them. Therefore, in the third quarter, we established an operations team with home improvement experts to take initial steps to simplify our focus and develop processes and procedures to address all identified issues. As part of simplifying operations, we're focusing the teams on key priorities and metrics while removing distractions and non-value-added tasks.", "To improve customer service, we have recently eliminated sales floor tasking activities during the busiest hours of the day so that our associates could focus solely on selling and providing excellent service. This process eliminates competing demands and provides a clear, concise, and consistent approach to deliver a repeatable and reliable customer experience across all stores.", "Easier this month, we also significantly reduced the volume of communications and reports going to our stores. Previously, corporate and field associates communicated directly with the stores, bypassing a formal gatekeeping process, and leading to information overload, conflicting messages, and inconsistent execution. To focus our teams on the most essential initiatives and allow them to spend more time with customers, we funneled all store communications through a single portal, established clear weekly priorities, and held the stores accountable for executing against these priorities. To drive efficiency, we've also streamlined the reams of reports and metrics sent to our stores, and instead focused the teams on analyzing and improving their customer service scores.", "To address the overly complex project specialist and installed sales business that Marvin mentioned, we recruited an experienced industry leader to the team in the third quarter. Through his leadership, we are taking steps to simplify and redesign how we engage customers and grow sales in this very important business. I look forward to sharing more details with you at our December 12th analyst and investor meeting.", "In addition to simplifying our focus in stores, we developed a comprehensive in-stock process, including standardized procedures for efficiently moving product from receiving to the sales floor, and rolled it out to U.S. stores in November. We expect that we will begin to see measurable improvement in our in-stocks as we head into 2019.", "As we work to improve our customer engagement, we continue to [inaudible] program. During the World Series and over Veterans Day weekend, we ran a television spot featuring our veterans, thanking all veterans for their service while building awareness of our 10% off discount for active-duty and retired military. As a Marine veteran who served in both the Gulf War and Desert Storm, I am proud of the fact that through our military discount, we will provide over $1 billion in savings for our veterans this year. This is unprecedented in retail, and I'm proud to work for a company that stands with our veterans.", "To recap, as part of our store operations focus on retail fundamentals, we have five key priorities: (1) we have developed and are rolling our engineered standards for all in-store operational activities; (2) we are taking steps to simplify communications and reporting sent to our stores; (3) we are rolling our a consistent and comprehensive strategy to improve our inventory in-stock execution; (4) we are developing a new payroll allocation system to deliver a better customer experience while driving payroll efficiencies. Finally, we are establishing clear priorities to ensure that customer service is top of mind for our associates in the stores. This includes giving our district managers and store managers the autonomy to adjust assortments in their stores to meet the local demands of their customers. We are a big believer in the power of entrepreneurial spirit in the home improvement retail.", "We know there is still more work ahead to fully capitalize on the healthy demands in our sector, and we believe we have the plans and expertise in place to win in today's retail environment. The good news is I've not encountered any issues or business problems in my last 99 days at Lowe's that I have not experienced before. Therefore, I am confident in our ability to develop a world-class operational focus. Thank you, and I will now turn the call over to Dave Denton." ] }, { "name": "David Denton", "speech": [ "Thank you, Joe. Good morning, everyone. I'm excited to be with you today, and while I know many of you from my past, I look forward to working with all of you as we position Lowe's for long-term financial success. While today is technically my first official day as CFO, over the past several weeks, I spent a great deal of time immersing myself in the business. I've engaged with both the executive leadership team, as well as the finance team here at the company. I've had the opportunity to both review and participate in the ongoing strategic planning efforts, and I strongly believe the company is taking the necessary actions to be well positioned for success in both the near and long term.", "I've grown to appreciate the strong fundamentals of the home improvement market driven by robust real residential investment and home price appreciation. And yet I've seen the existing challenges facing the Lowe's business. I've come away from the past few weeks with tremendous excitement about the future and believe we can create significant long-term value for all stakeholders, including both shareholders, customers, and associates. This morning, I'll spend a few minutes reviewing the company's financial performance in the third quarter, and provide an overview of our expectations for the balance of this year.", "As a reminder, in the first quarter of this year, we adopted the new revenue recognition accounting standard, and as a result, we reclassified certain items within operating income, the most significant of which was the reclassification of the profit-sharing income associated with our proprietary credit program from SG&A to sales. The adoption of the standard had no meaningful impact on operating income and no impact on comparable sales. Also, it was adopted on a modified, retrospective basis so the prior year has not been adjusted.", "Also, before I review the underlying operating performance of the business, let me briefly discuss the pre-tax charges taken during the quarter. As described in the press release this morning, our strategic reassessment has resulted in $280 million of pre-tax charges. These charges were incurred to reposition Lowe's with the objective of improving the company's financial returns and to allow the organization to focus on the key drivers of long-term value creation. Specifically, these charges include $123 million associated with our decision to close all Orchard Supply Hardware locations; $121 million related to our decision to close certain underperforming stores in the U.S. and Canada, along with a few other Canadian locations; $22 million related to our decision to exit retail operations in Mexico; and $14 million related to our decision to exit Alacrity Renovation Services and the Iris Smart Home business.", "The $280 million in pre-tax charges can be classified into a few major expense categories. These include approximately $130 million of long-lived asset impairments; $15 million in lease obligations; $103 million in accelerated depreciation and amortization; and $32 million in severance obligations. Given the nature of these expenses, we estimated that the net future cash outflows will be approximately $50 million.", "I'll now turn to a review of our operating performance for the quarter, starting with our capital allocation program. In the first 9 months of 2018, we generated nearly $6 billion in free cash, and through a combination of both dividends and share repurchases, we've returned approximately 60% of this cash to shareholders. In the third quarter alone, we paid $390 million in dividends, and our dividend payout ratio currently stands at 35% over the trailing four quarters.", "In August of this year, we entered into a $310 million accelerated share repurchase agreement, which settled in the quarter, retiring approximately 2.8 million shares. We also repurchased approximately 2.9 million shares for $310 million in the open market. In total, we repurchased $620 million of our stock in the quarter. This brings our year-to-date share repurchases to $2.5 billion through the end of Q3, with a plan to repurchase $3 billion for the year. We have approximately $4.5 billion remaining in our share repurchase authorization.", "Importantly, we continue to invest in our core business, with capital expenditures of approximately $300 million in the third quarter and nearly $850 million year-to-date. We are very deliberately managing our capital expenditures, focusing on investing in areas that both stabilize our business and generate healthy, long-term returns.", "Looking at the income statement, we generated GAAP diluted earnings per share of $0.78, compared to $1.05 of the third quarter of LY. On a comparable basis, excluding the $280 million in pre-tax charges associated with our strategic reassessment, adjusted diluted earnings per share was $1.04 a share, a 1% decrease over last year's earnings per share. Despite softer sales in the quarter than anticipated, the $1.04 of adjusted earnings per share beat our expectations. The better-than-planned performance was the result of a lower effective tax rate and better margin performance from our inventory rationalization activities.", "Sales for the third quarter increased 3.8% to $17.4 billion, supported by an average ticket growth of 4.5%to $75.89, partially offset by a roughly 1% decline in total transaction. Adoption of the new revenue recognition standard provided 143 basis point benefit to sales growth. Comp sales were 1.5%, driven by an average ticket increase of 2.3%, partially offset by a transaction decline of about 1%. As the team has shared, we continue to see strong traffic growth in the third quarter; however, challenges with inventory out-of-stocks, poor reset execution, and assortment concerns in certain categories pressured our ability to turn those visits into transaction.", "During the quarter, the net effect of cycling the hurricane season was approximately a 100 basis point drag on comp sales. Headwinds from Hurricanes Harvey and Irma were partially offset by demands from Florence and Michael. Our inventory rationalization efforts in the quarter provided an approximately 15 basis point benefit to comp sales.", "Looking at monthly trends, comps were 4% in August, 0.7% in Supply, and essentially flat in October. Excluding the estimated net negative impact of hurricanes and adjusted for the estimated pull-forward impact of our inventory rationalization efforts, our monthly comps were 3.7% in August, 1.9% in September, and 1.7% in October. Gross margin for the third quarter was 32.5% of sales, a decrease of 157 basis points from Q3 of LY. Again, adoption of the new revenue recognition standard provided 107 basis point benefit to gross margins.", "Our efforts to aggressively rationalize inventory and to eliminate slow-moving or underperforming SKUs negatively impacted gross margin by 180 basis points. This effort was an important step in better positioning the company's inventory to foster long-term sales growth in ROIC improvement. We also experienced 35 basis points of additional pressure from reset-related clearance activity and 25 basis points from clearance activities from the wind-down of our Orchard Supply Hardware operation.", "Finally, product mix shift had a 10 basis point negative impact on gross margin in the quarter. SG&A for the quarter was 24.5% of sales, which de-levered 180 basis points. Again, adoption of the new revenue recognition standard resulted in 118 basis point of SG&A de-leverage. Additionally, pre-tax charges in the quarter related to our strategic reassessment drove 105 basis points of de-leverage as well. These items were partially offset by 20 basis points of leverage due to incentive compensation, and 15 basis points of leverage from a favorable employee insurance adjustment.", "Depreciation and amortization for the quarter was $433 million, which de-levered 36 basis points, again, primarily as a result of the accelerated depreciation related to the exit of Orchard Supply Hardware. Operating income decreased 373 basis points to 5.5% of sales. Our effective tax rate was 21.8%, compared to 37.1% LY. This significant improvement is largely the result of tax reform, as well as a few other discrete items that were recorded in the quarter.", "Quickly, let me highlight a few items related to the balance sheet. Inventory at $12.4 billion decreased $28 million or 0.2% versus the third quarter of last year, again, primarily the result of our inventory rationalization activity. Inventory turnover was 3.84x, a decrease of 10 basis points versus Q3 of LY. At the end of the third quarter, lease adjusted debt to EBITDAR was 2.29x. Our return on invested capital was 19%.", "Looking ahead, I'd like to address several updates that we've made to the Lowe's business outlook. As Marvin shared, the home improvement backdrop remains strong, driven again by robust real residential investment in home price appreciation, which continues to encourage homeowners to engage in discretionary projects. But as you well know, 2018 continues to be somewhat of a rebalancing year for Lowe's, as we are refocusing the organization to both enhance returns and drive shareholder value.", "As a result of our strategic reassessment of the business, and the ongoing execution challenges, we have updated our expectations for the balance of this year. We now expect a total sales increase of approximately 4% for the year, driven by comp sales increase of approximately 2.5%. We anticipate opening 8 stores. On a GAAP basis, we expect an operating margin decline of 240 to 255 basis points. This includes charges of 135 to 150 basis points associated with our strategic reassessment of the business.", "As a reminder, we incurred $230 million of pre-tax charges in the second quarter, $280 million in the third quarter, and expect an additional $460 to $580 million in the fourth quarter. Keep in mind that the amounts, the nature, and the timing of any additional charges associated with the exit of our retail operations in Mexico will depend on the plan executed, and therefore have not been reflected in our business outlook.", "The effective tax rate is expected to be approximately 24%, and for the year on a GAAP basis, we now expect diluted earnings per share of $4.08 to $4.24 per share. Excluding the impact of the charges associated with our strategic reassessment, adjusted diluted earnings per share is now expected to be $5.08 to $5.13 a share. We are now forecasting cash flows from operations will be approximately $6.7 billion, and capital expenditures of approximately $1.2 billion. This is expected to result in free cash flow of approximately $5.5 billion for 2018.", "Our guidance assumes approximately $3 billion in share repurchases for the year. Again, we remain excited about the future of our business, and we are focused on taking the necessary actions to drive returns and shareholder value. With that, we'll now open it up for questions." ] } ]	[ { "name": "Operator", "speech": [ "We are now ready for questions. To ask a question, press *1 on your telephone keypad. To withdraw your question, press the # key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one follow-up. Our first question comes from the line of Michael Lasser with UBS. Please go ahead." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. If we look at your performance relative to your large competitor or relative to the category, you clearly took a step back in the quarter. Now, I don't think anyone thought it was going to be easy, but Marvin, when can we expect to see some progress from Lowe's by narrowing these stats to your competition?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Okay, Michael, I think for us, and I stated this in the prepared comments, we are really focused on creating a sustainable foundation in the third quarter. We made a conscious effort not to chase short-term fixes or short-term results. In any quarter, retailers can make decisions on promotional cadence and special buys and those types of tactical things. We stayed away from all of those types of decisions because I wanted to give the team the appropriate time to really get to the root cause.", "That's why I think it's appropriate to know that both Bill Boltz and Joe McFarland are celebrating their 99th day with the company today. Although we made great strides in our reassessment of the business, we have a lot of really new executives. Having said that, we have an expectation that we're going to see the business improve going into 2019, but we're also expecting some sort-term improvements in the business, just based on all of the actions that the team has taken and some of the initiatives put in place in the third quarter.", "Some very fundamental things that we are looking at that we think will deliver some short-term results will be just the simple improvement in customer service. Joe talked about how we're moving tasks and designating service versus task time. Those things are important. Bill talked about bringing some level of productivity to our end caps. Our end caps in the past have been used for billboards, not real sales productivity. So we think just that simple transition will add some value. The improvements we made in the supply chain and how we now have better coordination between supply chain and the stores will improve our in-stocks, and we'll see incremental improvement.", "To answer your question specifically, we were not chasing short-term results in the quarter. If there's an expectation that some of these chronic, long-standing issues can be fixed in a couple months, that's really unrealistic. Rather than trying to chase quick fixes, we wanted to fix it at the root, and we think we're doing that. That's why we believe that going into '19, you'll see this company start to have sustainable improvement month over month and quarter over quarter." ] }, { "name": "Michael Lasser", "speech": [ "Marvin, as you head into 2019, what's the chance that any sort of gains that you make with the self-help and addressing some of the execution issues are simply just offset by what will probably be a tougher industry environment next year, and how are you preparing for that?" ] }, { "name": "Marvin R. Ellison", "speech": [ "I think for us, the great thing about our business is that we're in a $900 billion, fragmented, home improvement marketplace. If you combine us and our chief competitor, that's less than $200 billion in revenue. So there is a lot of market share up for grabs. We have been very transparent on the issues that we are dealing with as a company. Most companies are not going to be as transparent. The reason why that's important is because when we fix these very long-standing, chronic issues -- poor reset execution, out-of-stocks, assortments not being localized, poor customer service, no real focus on the pro customer -- irrespective of what could happen with our competitor or competitors plural, we have market share opportunity just because we've been underperforming as an individual company in a massive marketplace where we have about 10% share.", "And so we're not as concerned with what's happening in other places, not even in the macro, because we feel really good about the macro environment for home improvement. This is really more about us understanding the steps we need to take to improve our execution, and the team will lay out some very specific short- and long-term initiatives at our December 12th analyst and investor conference." ] }, { "name": "Michael Lasser", "speech": [ "Great. Thank you so much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Christopher Horvers with J.P. Morgan. Please go ahead." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning. Can you talk a little bit about the 180 basis point headwind for the inventory clearance and reconcile that to the 15 basis point lift to sales from clearance? Is there any assumption in there on ticket cannibalization, sort of stealing a more full-price sale and thereby [inaudible] from that clearance activity?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Chris, the one reason why a retailer never desires to have a massive inventory liquidation process is because it really wreaks havoc on your numbers. But as Dave stated in his prepared comments, we believe that we saw some comp benefit early in the quarter from the inventory liquidation because it was being sold at a higher average ticket. As we got into the month of October, when we started to see the liquidation at its most aggressive cadence, we believe that not only did it hurt our average ticket, we think it cannibalized sales.", "I remember as an antidote being in the store and seeing a heater being clearanced in the month of October. I thought that was very odd, so after we followed up, I realized that was a heater from two seasons ago that had been trapped in the overhead because it had never been properly clearanced out. If you think about that for a second, October is a time where we're really selling heating at a very high rate, but if you can trade down and get a unit that's roughly 60% to 70% off, it's going to cannibalize regular-ticket items.", "And so we think it may have benefited us at the beginning of the quarter from a comp standpoint, but as the quarter progressed specifically October, we think it was a negative impact." ] }, { "name": "David Denton", "speech": [ "Chris, it's Dave. The good news is while no company likes to liquidate inventory, we had about $500 million to liquidate. That's now largely behind us, so we're now positioned going into the back half of the quarter and into '19 clean from that perspective. I think we're well positioned to put the right inventory in the right locations to begin to improve performance." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. Just as a Devil's advocate question, you've talked about conversion issues at Lowe's. My question is, how do you necessarily know that sale would've been made if it weren't for that aggressive discount on the product?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Well, Chris, our conversion issues were less about the liquidation of inventory and more about just being out of stock. This is a very simple retail analysis. When customers walk into a brick-and-mortar location, they have an intention to either buy or to get some level of consultation on an item they're considering buying. We're in the project business, so that happens quite often. But when we talk to our customers and ask the question, what drove a decision not to buy when you physically showed up at a store, it is overwhelmingly that you were not in stock.", "So our conversion issues had nothing to do with the inventory liquidation. It had everything to do with the fact that we had four very problematic [inaudible] under way, and we still have a significant number of out-of-stocks on our shelves. You can just simply walk our stores and see it with the naked eye. So as Joe McFarland mentioned, we put some operational processes in place that's going to help us to improve this, but out-of-stocks is also something you can't flip a switch on, unless you're going to make some aggressive short-term decisions like air freighting in product or making some bad, short-term decisions. We chose not to do that.", "We're actually fixing the reset process with an internal team that's going to own resets. We're having better coordination between supply chain and store operations, and we have a consistent in-stock process in the stores. And so conversion for us was driven almost exclusively by out-of-stocks. So we're going to continue to just execute and improve in-stock and we think our conversion will improve accordingly." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. Then just one quick one for the model. How should we think about depreciation going forward? Thank you." ] }, { "name": "David Denton", "speech": [ "I think if you look at Q3, if you back up the charges I indicated from my prepared remarks, it should be fairly consistent going forward. It will depend a little bit about what we do with Mexico and the ultimate disposition of that business." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Thanks." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Simeon Gutman with Morgan Stanley. Please go ahead." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning. Maybe I missed it, but did you quantify how much you think all the reset activity and the out-of-stocks hurt your comps in the quarter?" ] }, { "name": "Marvin R. Ellison", "speech": [ "We did not." ] }, { "name": "Simeon Gutman", "speech": [ "Do you have a guess or is it too difficult to gauge?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Simeon, I've learned that guessing is probably not a good thing to do on an earnings call, but what I'll tell you is it is a little too difficult to gauge. We spent most of the time quite candidly trying to get to the root cause of why these issues exist. Bill Boltz and his team spent a lot of time understanding supply issues, supply coordination issues, third-party reset issues, just in-store planning, and so we feel really good about the fact that we've identified the root cause.", "And so we're really focusing our time and attention now on trying to put those plans in place to solve those issues. We'll have a much more detailed and specific overview of this at our December 12th analyst meeting because we felt it was important to make sure that we communicate externally how we're solving this because we spent time on the last two calls talking about it being a chronic issue. Now we want to spend time about the steps we're taking to correct it." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. I guess within that question, I think paint, this category has been affected for I think two quarters in a row. I figure maybe you have some estimate around on that business. And then maybe a way to think about is can you tell us what the comps were in the categories that weren't affected? For the answer, I would exclude probably outdoor and seasonal, just given that there was probably some hurricane stuff, noise in there. So we if we look at traditional categories, you did mention some above average, some at company average. But maybe you can give a little more color on the categories that didn't have some type of reset activity?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Well, Simeon, I think for me, the best way to answer your question is that we had four negative comping categories for the quarter. All four had reset interruption issues. And so that's probably the most effective way to answer the question. Where we did not have reset issues, we had positive comps. Where we had reset issues, we had negative comps. And so I think to me, that's the best explanation of the impact of poor reset execution on the business. I think anything beyond that would just be data that may not be useful." ] }, { "name": "Simeon Gutman", "speech": [ "Fair enough. My real follow-up is you mentioned to us, I think it was in September, that there were a couple of pro brands that Lowe's didn't have. I forget -- you didn't name the brands. I don't know if you could share with us what it is. But what's the visibility on that? Does that -- trying to get new brands -- does that take a backseat now to you fixing some of the core operations of the business?" ] }, { "name": "Marvin R. Ellison", "speech": [ "I'll do two things. First, we're always going to talk about the brands that we have and the brands that we're very proud to have. I'll let Bill talk about some of those pro brands. I'll just say for the record, the brands that we don't have that we desire to have, we're actively working to try to get them in our stores. But we will just take the practice of only talking about the brands we have because those are the companies we want to highlight. Bill, just talk a little bit about some of the pro brands that we feel really good about that performed well in the third quarter." ] }, { "name": "William P. Boltz", "speech": [ "We're excited about what happened with water heaters and A.O. Smith. We're very excited about what happened with SharkBite, as I mentioned in my prepared remarks, SharkBite plumbing fittings. We finished the rollout of Zoeller pumps. We finished the rollout of our tile setting material under MAPAI. We introduced new pro cordless products under Bosch and Metabo HPT. As good merchants, we'll continue to evaluate assortments and look at where those opportunities are going forward and try to make sure that we're doing our best to offer the products and brands that the customers want." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Steve Forbes with Guggenheim. Please go ahead." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. I wanted to start with the five key priorities you mentioned within the merchandising and store operational functions. Not to take too much from the analyst day, but can you briefly address the anticipated timing of the completion of these initiatives? Is it a first half, second half '19? Just some general idea on the timing of the initiatives would be helpful." ] }, { "name": "Marvin R. Ellison", "speech": [ "Steve, I'll hand it over to Bill and let him go first, and I'll ask him to keep it high level, because as you can imagine, we're still working on some of the really specific details of these. Although these initiatives were launched at the end of the third quarter, there's still some specific details we're working on. I'll ask Joe to appropriately stay a little high level on operations as well. So Bill can talk about those priorities for merchandising." ] }, { "name": "William P. Boltz", "speech": [ "We're continuing to evaluate talent and to bring in experienced leaders, and so that will continue as we go into the early part of next year. We want to have that done, obviously, as quickly as possible. As we work through some of the merchandising opportunities, some of those categories I called out in my prepared remarks that will take us longer. Some of those we'll take into the back half of '19 because of the complexity. The ones that we can get sooner, we'll obviously implement as early as we can in the early part of 2019. So we'll take them as they come and continue to work through them on an issue-by-issue basis." ] }, { "name": "Marvin R. Ellison", "speech": [ "Joe, you want to talk about ops real quick?" ] }, { "name": "Joseph M. McFarland III", "speech": [ "For store operations, what I would say is we have identified all of the challenges that we have. Certain things like simple process or receiving trucks, customer service, we have already begun implementing those. As we think about the new payroll allocation system, we've already taken initial steps; however, that will flow into 2019. And so I'd say we're well under way; that we have identified all the root causes; and we're excited to share more as we get together in December." ] }, { "name": "Steven Forbes", "speech": [ "Thank you. Then just a quick follow-up for Dave. You called out a bunch of the margin dynamics during the quarter for gross margin. What about transportation costs and supply chain costs? Can you quantify that drag this quarter?" ] }, { "name": "David Denton", "speech": [ "We've been watching that closely. Like all industry participants in this sector, transportation cost is a worry. I'd say as that as we look at our forecast for the balance of the year, we've included that in our guidance. I would say it's not a significant headwind at this point in time, but it's something that we're watching closely as we cycle through the balance of this year and into next year." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Zach Fadem with Wells Fargo. Please go ahead." ] }, { "name": "Zachary Fadem", "speech": [ "Good morning. With your strategic review coming to a head, Marvin, could you talk about how your findings compared to your expectations going in? I'm sure you had some ideas around what needed to change, so I'm curious if you could speak to areas within your business that are maybe functioning better than you expected. Then for those areas underperforming, how does the magnitude of change needed compare to what you initially thought?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Zach, what I've been most pleased with is really the people side of the business. As I said in my prepared comments, we don't make it easy on our associates. We spent a lot of capital as a company over the last seven years, but we haven't necessarily spent a lot of capital on making the stores more efficient, making our supply chains modern, and just creating an easier working environment for our associates. So our associates have been resilient. I've visited all of our geographic markets, including Canada and our MSH operations for pro. In every case, I walk away being encouraged by our associates.", "I mentioned the engagement with the community and we were serving 50,000 meals to day for Thanksgiving for communities affected by the hurricanes. This is the kind of thing that I had no real impact on. It was just happening when I got here. So that's part of the associates loving the business and the culture.", "I would say the decisions we've made rather quickly were around leadership structure and organization. I felt that we needed to bring in some core retail experts. What I've learned in my successes and failures in retail is that when you're solving problems, it is best to go out and find leaders who've kind of best there and done it before. That's why when I look around the table at Don Frieson in Supply Chain, and Bill Boltz in Merchandising, and Joe McFarland in Stores, and Dave Denton as our CFO, and Seemantini as our new Chief Information Officer, etc., etc., we've gone out and recruited world-class leaders who've kind of been there and done it before. That's required.", "And so mostly I was disappointed in what I found, but I felt like the need to bring in experienced leaders so that we could solve these problems quickly, and also I just wanted to make sure that we had a more disciplined capital allocation process. As I mentioned earlier, a lot of the strategic reassessment and closing underperforming stores, exiting non-core businesses, getting out of environments where we can't really be competitive because we can't get to scale, like Mexico, is all a part of making sure we reallocate capital and invest in creating a great home improvement retail environment.", "That's where we are, and we'll continue to make the necessary changes, but we feel great about the future of this company. We can identify obvious shortcomings in what we're doing on a daily and weekly basis. We can look at where we're underperforming from a sales perspective, and we can point exactly to what's causing it. To me, that's very encouraging because we know how to fix it. So [inaudible]." ] }, { "name": "Zachary Fadem", "speech": [ "Got it, Marvin. Thanks. That's helpful. I think a quick one for Dave. First of all, welcome aboard. Then on the store closings and the additional initiatives announced today, I'm curious if you could speak to your approach to some of the cost savings coming out next year? How do you think about just the process of redeploying and reinvesting those savings? Are there any of those savings that you would expect to drop to the bottom line next year?" ] }, { "name": "David Denton", "speech": [ "Well, obviously, we're making these investments and these decisions to position the company for long-term financial success. There's no doubt about that. I think the team is really focused against that very intensely. I do think that the savings that are going to be generated from these activities are partly going to be invested a little bit if we think about repositioning the company and some of the efforts your heard from both Joe and Bill today. But importantly, as we think about the future and the future growth and the returns on the business that we have today, this will largely fall to the bottom line and really enhance those returns over the next future period." ] }, { "name": "Zachary Fadem", "speech": [ "Got it. Thanks so much, guys. I appreciate the time." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "David Denton", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Greg Melich with MoffettNathanson. Please go ahead." ] }, { "name": "Greg Melich", "speech": [ "Great. I had a couple questions. I just want to make sure I piece together the guidance and the inventory adjustments right. If I got it right, there's $320 million of inventory hit in the third quarter, and I think, Dave, you mentioned around $500 million over the course of the year. If we think about those numbers, it's sort of 60 to 90 bps of margin hit this year. Should we be thinking about that if there was, what was it, 35 to 150 bps of charges, right? Mostly non-cash, that really this year EBIT margins are down 90 to 100 bps but that inventory is 60 to 90 of it and that's sort of a clean like-for-like slate into next year? Am I piecing it together right?" ] }, { "name": "David Denton", "speech": [ "Well, a little bit. Let me just step back a minute. We had roughly $500 million of inventory to clear. We roughly cleared that at a 40% discount. I think that's largely behind us. As we cycle into Q4, we're essentially clean from the inventory rationalization perspective. So don't think about a hangover into Q4. Think about that being complete in Q3." ] }, { "name": "Greg Melich", "speech": [ "Got it. So if we took just the third quarter, that's now behind us, and that what we saw in the gross margin, that 320 to 330 is when we get to next year, now we're clean when we think about it as sort of a run rate of margin. Great. And then second and sort of bigger picture on just traffic and conversion, I think Marvin you mentioned that traffic was still positive, but we basically have transaction counts down. How do you measure what traffic really was versus that conversion? Was it the store traffic was up 1% but we were down transaction counts down a percent and that's the difference in terms of close rate?" ] }, { "name": "Marvin R. Ellison", "speech": [ "I think a couple ways. Measuring traffic online is just pure data driven, so that's something we have 100% visibility to like any other e-commerce or brick-and-mortar company with an e-commerce platform. So that's pretty straightforward. When we look at traffic in the stores, we have monitoring devices to measure traffic. Our environment is more difficult to measure conversion because we're a project business. We're going to shift our discussion from conversion to transactions. I think that is a better way to understand a year-over-year comparison of our business.", "Having said that, we still feel very good about traffic, both online and in store based on how we measure it, but we understand that we have challenges in driving transactions and/or conversion based on the traffic. When you look online, we know we have some issues with functionality that we're addressing. We also know that we have issues with search and navigation and ease of checkout. If you look at our mobile app, you can see an app that desires to be much more robust. We're in the process of delivering on that.", "As we look in the store, I'll go back to my previous comments. We don't want to make this overly complicated. When a retailer is not delivering on the traffic that's walking into your store, there are really a couple of basic reasons why. Either you are priced incorrectly from what you advertised, or you're out of stock. We feel good about the consistency of our pricing, and all of our data tells us that we're out of stock. That's why we put such a huge emphasis on addressing this issue. And so we understand the root cause. We understand how we got here, and now we're working to create a sustainable solution to fix it." ] }, { "name": "Greg Melich", "speech": [ "That's great. Thanks. Good luck, guys. See you in a week." ] }, { "name": "David Denton", "speech": [ "Thank you. We're going to take one more question." ] }, { "name": "Operator", "speech": [ "Our final question will come from the line of Scot Ciccarelli with RBC. Please go ahead." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. Thanks for fitting me in here. I guess this is a bigger picture view for a second as well. When you look at your performance against Home Depot, the bulk of the sales gap on a per-store basis, Marvin, as we've talked about, is really on the pro side. If you were to get the stores right where you want them, the in-stocks where you want them, I know this is an opinion, but over what kind of timeframe do you think you would start to take market share back on the pro side, and related to that, why would a pro change who their incumbent product supplier is? Thank you." ] }, { "name": "Marvin R. Ellison", "speech": [ "Scot, it's a fair question. I'll speak specifically on the pro customer. The pro customer is a very important customer, but they are a very, very simple customer. This customer is looking for a couple of fundamental things. First, they're looking for a great price. They're looking for service that saves them time because time is money. And they're looking for the brands that they identify it. That's really it. They're pretty much agnostic on anything else.", "So Lowe's has proven that you can have a dominant market share in pro and lose it, because at one point Lowe's had dominant market share in pro and they didn't maintain it because primarily those three things I outlined were no longer competitive advantages. And so for us, we're going to make sur that we are competitively priced. That's something that Bill and his team have taken the lead on. We're going to make sure that we have great service because, again, time is money. Service for the pro is not giving them product knowledge. It's about having job lot quantities. It's about giving them the ability to buy and stage product. It's the ability to load. It's the ability to speak their language and to engage them at he pro desk or engage them online.", "Now the third level is to go out and get the brands. As Bill and I both mentioned, we're actively engaged in trying to fill our assortment with brands that we currently don't have. When you do those things, the pro is totally agnostic to the channel in which they shop, because it's all about those three things for them." ] }, { "name": "Scot Ciccarelli", "speech": [ "And do you think that if you match apples-to-apples, the pro would come to Lowe's instead of Home Depot?" ] }, { "name": "Marvin R. Ellison", "speech": [ "I think the key is we spend very little time looking across the street. We are a customer-centric company. What we believe is if we take care of the customer, everything else will take care of itself. I'll just remind you that we operate in a $900 billion marketplace. So we don't care a whole lot about what's happening across the street because between Lowe's and our largest competitor, that's less than $200 billion in market share, which means there's more than $700 billion up for grabs in this really fragmented environment. For us, it's less about what's happening with a competitor. It's more about how we serve customers and how we go out and take share in this fragmented market that we're in." ] }, { "name": "Scot Ciccarelli", "speech": [ "Understood. Thanks a lot, helpful." ] }, { "name": "Marvin R. Ellison", "speech": [ "Okay, thank you very much. We appreciate your time and attention on the call, and we look forward to speaking to you again on our fourth quarter call, which will be Wednesday, February 27th. Thanks and have a very blessed Thanksgiving." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, this concludes today's conference. Thank you call for joining, and you may now disconnect." ] }, { "name": "Scot Ciccarelli", "speech": [ "More LOW analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
LOW	2018-05-23	[ { "description": "Chairman, President, and Chief Executive Officer", "name": "Robert A. Niblock", "position": "Executive" }, { "description": "Chief Customer Officer", "name": "Michael McDermott", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Marshall Croom", "position": "Executive" }, { "description": "Chief Operating Officer", "name": "Richard Maltsbarger", "position": "Executive" }, { "description": " -- Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": " -- Wedbush Securities -- Analyst", "name": "Seth Basham", "position": "Analyst" }, { "description": " -- Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": " -- RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": " -- Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": " -- UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": " -- MoffettNathanson -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": " -- Bank of America Merrill Lynch -- Analyst", "name": "Elizabeth Suzuki", "position": "Analyst" }, { "description": " -- Gordon Haskett -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": " -- Jefferies -- Managing Director", "name": "Daniel Binder", "position": "Executive" }, { "description": " -- Goldman Sachs -- Analyst", "name": "Matt Fassler", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone and welcome to Lowe's Companies first quarter 2018 earnings conference call. This call is being recorded. Please note if you press 1 to enter the question queue prior to the start of today's call, your signal did not register. You will need to press 1 again to enter the queue.", "Also, supplemental reference slides are available on Lowe's investor relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call. During this call, management will be using certain non-GAAP financial measures. The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures.", "Statements made during this call will include forward-looking statements as declined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risk and the company can give no assurance that they will prove to be correct. Those risks are described in the company's earnings release and its filings with the Securities and Exchange Commission.", "Hosting today's conference will be Mr. Robert Niblock, Chairman, President, and Chief Executive Officer, Mr. Mike McDermott, Chief Customer Officer, and Mr. Marshall Croom, Chief Financial Officer. Joining during the Q&A session will be Mr. Richard Maltsbarger, Chief Operating Officer. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir." ] }, { "name": "Robert A. Niblock", "speech": [ "Good morning and thanks for your interest in Lowe's. Before we discuss our first quarter results, I want to take a moment to talk about the leadership announcement we made yesterday. As you know, in late March, I announced my plans to retired from Lowe's. Since that time, the board has been engaged in a thorough and comprehensive search to identify the right leader to take the reins. I'm pleased the board has found that leader in Marvin Ellison.", "Effective July 2nd, Marvin will become President and CEO. Marvin is an experienced retail CEO and a 30-year industry veteran with expertise in complex omnichannel environments. He has a deep appreciation for Lowe's culture, people, and customers which makes him the ideal person to serve as this great company's next leader. I'm confident that this will be a smooth transition.", "As this is my last earnings call, I want to reiterate that it has been an honor to serve as Lowe's Chairman, President, and CEO. We're fortunate to have a strong leadership team who is passionate about helping people love where they live and creating enhanced value for shareholders. I'm confident in the company's prospects for growth and value creation under Marvin's leadership and I look forward to following Lowe's process for many years to come.", "With that, I will now turn to our results. In the first quarter, we experienced a delayed spring selling season due to prolonged unfavorable weather across geographies that impacted outdoor categories. As a result, we delivered fourth quarter comparable sales growth of 0.6%, driven by a 4.3% increase in comp average tickets. However, spring has finally arrived and comps in May are double-digit positive.", "Our US home improvement comp in the first quarter was 0.5% with positive comps in 6 of 14 regions, while two regions were essentially flat. We posted positive comps in 5 of 11 product categories while one category was essentially flat. As you know, Lowe's has built a very strong seasonal business over the years, with approximately 35% of Q1 and 40% of Q2 sales historically driven by outdoor categories.", "With more rain and snow in the first quarter than we've seen in 12 years and the coldest April since 2007, outdoor products were certainly impacted. However, comps for indoor products were positive.", "Appliances led product category growth with another strong quarter of double-digit comps supported by our integrated omnichannel experience. And we continued to strengthen our relationships with pro customers, driving out performance in rough plumbing and electrical, lumber building materials, tools and hardware, and millwork.", "We're pleased with our sales growth with pro customers as we leveraged the strong foundation we built to drive comps above the company average. We continue to make investments to deepen our relationships and make it simpler for pros to do business with us, including the expansion of our pro services team.", "We continue to see strong customer response to investments we've made to enhance our online shopping experience which is reflected in our 20% online comp growth this quarter. Internationally, we delivered double-digit comps in Mexico, while comps in Canada were positive, both in local currency. We continue to make progress integrating RONA. We believe the business is poised for continued growth from the rollout of appliances, a strong digital offering and online store conversions and remodeling.", "However, comps in Canada were pressured by challenging weather conditions similar to those we experienced in the US. For the quarter, we delivered diluted earnings per share of $1.19, a 15.5% increase over last years adjusted diluted earnings per share. Delivering our commitment to return excess cash to shareholders, in the quarter, we paid $340 million in dividends and repurchased $750 million of stock under our share repurchase program.", "As I mentioned, spring has finally arrived. We are encouraged by the strong sales momentum we're experiencing in the month of May. Spring is a first half event and I'm confident the Lowe's team is prepared to capitalize on increased demand with compelling offers in seasonal staffing and inventory in place to serve customers.", "Our entire leadership team and board of directors are actively working together to analyze our performance and business expectation and drive improvements in key areas such as tracking conversion, inventory management, and gross margin stabilization. Mike will speak to those efforts in a moment.", "Looking ahead to the rest of the year, we expect that solid macroeconomic fundamentals, such as strong employment and income gains, will sustain home improvement market expansion and that the home improvement industry is poised to grow its share of overall consumer spending. Housing is expected to remain a positive driver as demand in excess of supply drives home price appreciation and we continue to see household formation improvement over the past year, which should persist amid steady job gains.", "We'll continue to focus on and invest our resources in what is most relevant to engaging customers in the moments that matter and improving the capabilities our employees need to better serve customers. In doing so, we will strengthen our competitiveness, positioning us to continue capitalizing on home improvement demand.", "I would like to thank our more than 310,000 outstanding employees for their commitment to serving customers, serving their communities and fulfilling our purpose-driven mission to help people love where they live.", "Thanks again for your interest. With that, let me turn the call over to Mike." ] }, { "name": "Michael McDermott", "speech": [ "Thanks, Robert and good morning, everyone. We entered the season well positioned to capitalize on spring demand with compelling messaging, more personalized, targeted content, strong assortments as well as inventory in-plays and seasonal staffing ready to help customers complete their project. But a late spring due to unfavorable weather across geographies exerted approximately 300 basis points of pressure on comp sales.", "Weather had a disproportionate impact on seasonal categories, such as lawn and garden and seasonal and outdoor living. However, we drove positive comp growth for indoor products. We achieved double digit comps in appliances, as we leveraged our investments in customer experience, both in store and online as well as our best in class selection of leading brands and our service advantages like next day delivery, haul away, and facilitation of repairs and maintenance.", "We also saw continued strength from the pro customer with comps above the company average. Pro demand drove solid comps in rough plumbing and electrical and we continue to be excited of the effectiveness of destination brands in attracting pro customers. Pro strength also drove above average comps in lumber and building materials, tools and hardware and millwork.", "In order to continue growing our pro sales, we're investing to improve the pro experience. We're building on our strength in the MRO space by leveraging our maintenance supply headquarters business, having launched a streamlined product category this month with branch expansion to follow later this year. We're investing in outside selling capabilities as well as improving jobsite delivery options.", "We continue to execute on our strategic priorities, including enhancing our digital presence. We drove comp growth on lowes.com in the quarter, which now represents approximately 5% of sales. We'll continue to upgrade our online shopping experience with enhanced assortment informed by digital line reviews and optimized search capabilities to meet customers' evolving expectations.", "And as the do it for me opportunity continues to grow, we're providing differentiated services, delivering complete home improvement project solutions to our in-home sales platform. We're connecting our omnichannel access, making it even easier for customers to engage with our in-home project specialists and request services in lowes.com, driving an increase in projects this quarter.", "As noted on our February call, we're focused on strengthening our day to day executions. We're working diligently to improve traffic conversion by accelerating associate readiness and knowledge through our training programs and providing even more prescriptive scheduling to better align staffing to customer traffic, not only by department but also around QE marketing and promotional campaigns. We're also reengineering key processes, project quoting, our paint service model, and our pick up in store experience all improve our utilization of associate hours and provide a better customer experience.", "This quarter, we completed the first phase of our process to centralize project quotes, starting with flooring, allows our sales associates to guide customers through their projects, focusing on education, project planning, and product selection, rather than spending their time on the administrative task of compiling a project quote. We also added functionality on lowes.com to allow customers to request a consultation online, which has the dual benefit of making the process easier for the customer while removing another administrative task from our selling associates.", "We recently rolled out our improved paint service model, separating tasking and selling activities. We cross-trained 17,000 associates to assist with mixing paint during peak selling periods, allowing our skilled paint associates to focus on providing project advice and color selection expertise.", "We've advanced our pick up in store customer experience with convenient reserved parking spaces, dedicated space in stores with clear signage to direct customers to the pick-up location, and optimized processes to ensure that product is staged and ready for pickup within two hours of an order being placed.", "We expect the new processes will drive greater efficiency to drive fulfillment and improve our ability to meet the expectations of case studies, allowing them to pick up product within five minutes of arrival. Central quoting, our paint service model, and our pick up in store experiences are examples of actions we've taken within the quarter to improve our processes in stores and a snapshot of the more extensive process reengineering effort under way to improve store execution as we continue through 2018.", "We've identified additional opportunities as well. For example, in high-touch categories such as flooring, millwork, and kitchens, we will improve installer responsive and lead times, and integrate our systems to provide better visibility into order status and improved communication to the customer. These opportunities in high-touch categories are additional ways to improve the experience and drive better conversion over time.", "As we work to better capitalize on traffic growth, our supply chain transformation efforts are also key to better serving customer expectations and improving conversion in the short and long-term. We're focused on optimizing the flow of product through our supply chain to better connect customer needs with the products and services we offer and improving inventory management to ensure that we have the right product in a sellable position for the customer.", "For example, we're currently testing ways to improve the flow of product from our regional distribution centers to our stores, including more frequent highly organized shipments of product to allow for greater efficiency in unloading trucks and stocking product on shelves. And given increased demand for in home delivery, we're piloting a segmenting delivery network for appliances and other bulky product through a network of bulk distribution centers and cross-dock facilities.", "This segmented network will manage inventory at the market level, improving our working capital efficiency while also reducing damage as bulky product is handled less and will manage deliveries more efficiently at the market level rather than at the store level.", "In the first quarter, we make progress in stabilizing gross margin. Throughout the year, we plan to expand our application of new pricing and promotion analytics tools to ensure that we're competitive on highly elastic traffic-driving products while increasing profitability across less elastic items. Through our value improvement efforts, we will continue to work closely with our vendors to reduce first costs.", "Looking forward to Q2, we're encouraged by the strong sales momentum we've seen as weather has improved. Given that spring is an event that spans the first half of the year, we're focused on capturing the increased demand that the season is now creating. We believe we're well-prepared with seasonal staffing and inventory to serve incremental traffic. We look forward to our Memorial Day, Father's Day, and July 4th events with exciting messages, compelling values, strategic brands, and differentiated experiences all designed to capitalize on the excitement of the season.", "We're proud to welcome Craftsman into our outstanding portfolio of brands with mechanics toolsets, tool storage, garage organization, flashlights, and pressure washers, available just in time for Father's Day. Then later this year, we'll expand our Craftsman offering to include individual mechanics and hand tools, power tools, and select outdoor power equipment.", "We're honored to be the exclusive destination in the home center channel for this iconic brand, offering some of the best tools, storage, and outdoor power equipment in the industry. Together, we're making it easier for customers to access the high-quality, durable tools, and expert guidance they need to confidently tackle any home improvement project.", "We're also excited about our expanded partnership with Sherwin Williams as we work together to deliver a simplified line design that makes it easier for customers to select the right product for their painting needs. Sherwin Williams is now the exclusive national supplier to Lowe's US retail outlets for interior and exterior paints, including the Valspar, and HGTV Home brands. Under this expanded strategic partnership, Lowe's will become the national home center to offer top-selling brands Krylon, Minwax, Cabot, and Thompson's WaterSeal, as well as the top paintbrush brand, Purdy.", "In summary, we'll continue to improve our execution while accelerating the investments that will improve our ability to serve rapidly evolving customer expectations, strengthen our competitiveness and position Lowe's to capitalize on solid project demand now and into the future.", "Thank you for your interest and I'll now turn the call over to Marshall." ] }, { "name": "Marshall Croom", "speech": [ "Thanks, Mike. Good morning, everyone. During the quarter, we adopted the new revenue recognition accounting standard, ASU2014-09. As a result, we reclassified certain items within operating income, the most significant of which was the reclassification of the profit sharing income associated with our proprietary credit program from SG&A to sales.", "The adoption of this standard had no impact on operating income and no impact on comparable sales. It was adopted on a modified retrospective basis so the prior year has not been adjusted. Sales for the first quarter increased 3% to $17.4 billion, supported by total average ticket growth of 5.7% to $74.98. Total transaction count decreased 2.8%.", "Adoption of the new revenue recognition standard provided a 76 basis points benefit to sales growth. Comp sales were 0.6% driven by an average ticket increase of 4.3%, offset by transaction decline of 3.7%. Looking at monthly trends, comps were 0.6% in February, 1.1% in March, and 0.1% in April.", "As Mike indicated, prolonged unfavorable weather across geographies delayed the spring selling season and negatively impacted comp sales in the quarter by approximately 300 basis points. Gross margin for the quarter was 34.63% to sales, an increase of 23 basis points from the first quarter of last year.", "Adoption of the new revenue recognition standard provided a 58 basis points benefit to gross margin. As we've grown our share in appliances, gross margin has been impacted from both the mix and rate perspective. We were also lacking competitive actions taken a year ago, which were partially offset by benefits from buying improvement as well as positive results from our pricing optimization efforts. Lastly, our transportation costs, shrink, and inflation negatively impacted gross margin in the quarter.", "SG&A for the quarter was 24.12% to sales, which deleveraged 113 basis points. Adoption of the new revenue recognition standard resulted in 66 basis points of the deleverage. While our spring seasonal hiring was a success, lower than planned sales drove 32 basis points of payroll deleverage. An increasing demand from continued growth in appliances drove 18 basis points of deleverage in customer delivery costs.", "Depreciation and amortization for the quarter was $360 million, which was 2.07% of sales and leveraged 9 basis points. Operating income declined 81 basis points to 8.44% of sales. Interest expense for the quarter was $160 million, which leveraged 4 basis points. The effective tax rate for the quarter was 24.3% compared to 35.5% last year as a result of tax reform. Diluted earnings per share was $1.19 for the first quarter, a 15.5% increase over last year's adjusted diluted earnings per share of $1.03.", "Now to a few items on the balance sheet, starting with assets. Cash and cash equivalence at the end of the quarter was $1.6 billion. Inventory at $13.2 billion increased $950 million or 7.8% versus the first quarter of last year, which was primarily driven by investments in key categories such as appliances from appliances, flooring, and tools, as well as investments across pro categories. Inventory turnover was 3.8 times, a decrease of 20 basis points versus the first quarter last year.", "Moving on to the liabilities section of the balance sheet, accounts payable of $10.1 billion represented $199 million or 2% increase over the first quarter last year. At the end of the first quarter, lease adjusted debt to EBITDA was 2.23 times. Return on adjusted capital was 19.4%.", "Now looking at the statement of cashflows, operating cashflow was $3.4 billion and capital expenditures were $224 million, resulting in free cash flow of $3.2 billion. In the first quarter, we paid $340 million in dividends and we repurchased approximately 8.7 million shares of stock for $750 million. We have approximately $6.2 billion remaining our share repurchase authorization.", "Looking ahead, I'd like to address several of the items detailed in our Lowe's business outlook. As Robert and Mike indicated, spring is a first half event. We expect to recover the majority of our first quarter sales miss over the next two quarters and believe we are prepared with the seasonal staffing and inventory to serve increased traffic.", "As a result, the only adjustment to our guidance stems from the adoption of the new revenue recognition accounting standard. So, from 2018, we expect this change to positively impact sales by approximately 1% and negatively impact operating margin by approximately 10 basis points. It does not affect operating income or comp sales.", "We now expect the total sales increase of approximately 5%, driven primarily by comp sales increase of 3.5%. We anticipate opening approximately 10 stores. As a result of the new accounting standard, we now expect gross margin expansion of approximately 60 basis points for the year. And on a GAAP basis, we now expect an operating margin to decline approximately 40 basis points. Effective tax rate is expected to be 25.5%. For the year on a GAAP basis, we reaffirm our diluted earnings per share guidance of approximately $5.40 to $5.50 for the year.", "We are forecasting cashflows from operations of approximately $6.5 billion in capital expenditures of approximately $1.7 billion. This is expected to result in estimated free cash flow of approximately $4.8 billion for 2018. Our guidance assumes approximately $2.5 billion in share repurchases for 2018.", "Regina, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "To ask a question, press *1 on your telephone keypad. To withdraw your question, press the # key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one follow-up. Our first question will come from the line of Seth Sigman with Credit Suisse. Please go ahead." ] }, { "name": "Seth Sigman", "speech": [ "Thanks. Good morning, guys. And Robert, best of luck to you. There's been a lot of talk in recent quarters about the opportunity to improve conversion in the store. Mike, you discussed a number of initiatives to improve that today. As you sort of benchmark yourself versus others in the industry and other retailers, is there a way to frame the opportunity? I guess I'm more curious over time, is that something that's declined within the Lowe's store? We're just trying to understand the opportunity. I guess related to that at the core, what do you think the core issue is here? Is it in stock? Is it service? Is it assortment? Any perspective on that I think would be helpful." ] }, { "name": "Richard Maltsbarger", "speech": [ "Absolutely, Seth. This is Richard. I'll actually take the question. To your question specifically, we have experienced a declining close rate over the past year. We have began to highlight that last year as a part of our communications and we certainly still have work to do. We've had early progress in the quarter. I'd like to talk through some of the elements that we've put in place and some of the actions that Mike and I and the rest of the leadership team have in place for the rest of the year.", "So, first, in our call last quarter, we talked about a primary focus on associate readiness and development. I'm happy to say we came into this spring season the most ready for the season that we've been in recent memory with both the associate staffed and the readiness of their development under our program we call Red Vest Ready.", "The reality is with the delayed spring, we didn't achieve all the benefit we expected from that early season hiring, but thankfully, as the season has begun to spike over the past couple weeks, we believe we've had the staff in place to take advantage and it's helping to support the strong comps that we've experienced.", "The second area we're focusing on is reengineering key processes and activities, with a primary focus on being able to reallocate investments we make in non-selling labor to increase the percentage of that labor that can be on the floor serving the customer.", "A great example is what Mike covered with you in his earlier remarks, where during the quarter we cross-trained approximately 17,000 associates, most of whom are non-selling associates to be able to bring them to the floor during peak periods, such as intraday periods as well as key holidays like this weekend for memorial day to serve those customers by splitting the tasking behavior of mixing paint from a selling behavior of being in the aisle providing color expertise and project planning expertise to our customers with our dedicated paint associates.", "Other activities that we've had under way include what Mike talked about in terms of tests of more prescriptive scheduling, where during the quarter, we executed several tests in select markets. Some of those benefits of those tests are now being rolled across the country as we set our staffing plans for Q2 and as we move through these holiday periods.", "However, as I've gotten into the first 100 days of the role, been in the field, gotten the feedback from our store associates, been able to talk to many of our best customers, there are two additional areas in which Mike and I and the rest of the leadership team are taking action. The first is supply chain product flow, where we believe we've made the inventory investments necessary to have the depth and breadth in key categories like appliances, and flooring, and tools and hardware to serve both the pro customer and our DIY customer.", "Our focus has now shifted to how would we optimize that flow to improve our service levels and to improve our in stock percentages. As Mike noted, a key focus there is the movement of that good from our regional distribution center to our stores.", "The last area, as Mike noted, is he and I have led a deep dive into our high-touch selling categories during the quarter with specific emphasis on flooring, millwork, and kitchen, and identified ways in which we actually allow our selling associates to have more time in front of the customer. Central quoting is a great example of that. As Mike noted, the administrative burden passing to a central quoting team to allow our in-store project specialists to spend more time educating the customer, providing their project plan, helping them select their products, and then turning the finalization of the quote over to a team that specializes in doing this non-selling tasking activity.", "Ultimately, over time, Seth, it's going to take a combination of each of these different kinds of actions for us to improve conversion. We're confident from the early signs we've seen. We saw a great uptick in our customer satisfaction levels for in store experience during Q1 and believe that we're on to the right set of work that we need to undertake to improve conversion over time." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Richard, thank you very much for that color. Appreciate it." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Seth Basham with Wedbush Securities. Please go ahead." ] }, { "name": "Seth Basham", "speech": [ "Thanks a lot and good morning. My question is around the comp trends by ticket, your ticket under $50.00, comp down 4.1%. Is it possible to break that out excluding the seasonal categories so we get a better sense of what the underlying trend is?" ] }, { "name": "Michael McDermott", "speech": [ "The most significant impact, the tickets under $50.00 could be lied to our lawn and garden and seasonal business. Certainly weather had an impact on that performance. That's a significant transaction driver for us, with our concentration, about 35% of our business in the first quarter. That was the primary driver there." ] }, { "name": "Seth Basham", "speech": [ "Got it." ] }, { "name": "Marshall Croom", "speech": [ "Seth, one other point if I could, just to add on to that -- we talked about the 300 basis points of pressure in the spring, a lot of it is impacting the transactions as well for the seasonal items, which are spread across the lower buckets as well." ] }, { "name": "Seth Basham", "speech": [ "When you think about your conversion challenges, you're focusing, it seems primarily on converting within big ticket categories. What do you feel about the smaller ticket categories? Do you feel like you're well-positioned there or are there challenges in smaller ticket categories as well?" ] }, { "name": "Michael McDermott", "speech": [ "I believe we're well-positioned in smaller ticket categories across a broad array of product categories in the business. Obviously, from a conversion perspective, we are focused on high-touch categories as we try and improve the customer experience from both inspiration all the way through to enjoyment. When I take a look at our overall value perception, our competitiveness, our product assortment, I feel very good about the decision we've got across the take with categories." ] }, { "name": "Seth Basham", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question will come from the line of Eric Bosshard with Cleveland Research. Please go ahead." ] }, { "name": "Eric Bosshard", "speech": [ "Good morning. One of the initiatives you spoke to was gross margin stabilization. I'm wondering if you can expand a little bit on what you're seeing there and what you're trying to accomplish." ] }, { "name": "Michael McDermott", "speech": [ "Yeah, as Marshall highlighted, gross margin increased by 23 basis points, revenue recognition provided 58 basis points of that benefit. Obviously, we're lapping the competitive actions we took in 2017, partially offset by continued value improvement activity as we work closely with our vendor partners to deliver value in the marketplace and reduce first cost. But I'm really excited about the positive momentum I'm seeing, particularly around the installation of improved competitive analytics and pricing optimization tools.", "As we widen our visibility to the market, it gives us the ability to effectively manage the trade-offs required to remain competitive and stabilize gross margins. We saw meaningful sequential improvement in gross margin from fourth quarter to first quarter and we'll continue that work to deliver against our commitment." ] }, { "name": "Eric Bosshard", "speech": [ "And then follow-up if I could -- Robert, I'm just curious your thoughts as you pass the baton to Marvin what might be different or what might be the same if you have any perspective or thoughts you could provide us on that." ] }, { "name": "Robert A. Niblock", "speech": [ "Certainly, Eric, we're excited to have Marvin join the team. He's an experienced retail CEO, significant experience in the home improvement industry. So, I think that's very exciting for us to have him join. I called Marvin this week and spoke to him and congratulated him on the role and welcomed him back to the home improvement industry and told him I'd be available for anything I can do to assist in a smooth orderly transition.", "I think Marvin will be wanting to come in and review our strategy, what plans we have in place, initiatives that we're working on in areas as you've seen on the call today where we've outlined opportunities for improvement and he'll want to dive in and add his thoughts to what the team is already working on to see how we can continue to make progress and do a better job of taking care of customers' needs." ] }, { "name": "Eric Bosshard", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question will come from the line of Scott Ciccarelli with RBC. Please go ahead." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. I know you've talked about the decline you've seen in close rates and obviously, that's been a driver to your decline in transactions. But do you also have a feel for what's happened to your stores from a pure traffic perspective?" ] }, { "name": "Michael McDermott", "speech": [ "The traffic continues to be positive for both our stores and lowes.com. We continue to see positive yield from the Start with Lowe's campaign. We're driving better awareness, great values perception, engagement, and ultimately traffic. I think we're striking the right balance, the right allocation of digital and mass media. We're optimizing our spend and delivering targeted and personalized messages. I think we're really connecting with the customer in a very positive macro environment. We continue to engage customers with trusted brands, great values and promotions and a strong assortment. I think a lot of things are working for us on the traffic front right now." ] }, { "name": "Scot Ciccarelli", "speech": [ "Okay. Then hopefully just a quickie for Marshall -- on the monthly cadence you guys provided us, are there any calendar shifts we need to be aware of?" ] }, { "name": "Marshall Croom", "speech": [ "For us, no. We're four, five, for basis for us. So, there wasn't any meaningful shifts in the calendar for the first quarter." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Simeon Gutman with Morgan Stanley. Please go ahead." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning. I want to talk about the guidance and the decision to hold it for the full year. I picked up from the prepared remarks. It sounds like you expect to make up the sales in the second quarter and it sounds like a little bit of the third. Is that the same in terms of profit flow through and is there any less investment you're making in the year or is making the full year all predicated on recuperating some of the loss flow through that occurred in the first quarter." ] }, { "name": "Marshall Croom", "speech": [ "Simeon, we are anticipating recovering the majority of the sales miss in the first quarter. That's what we're expecting to flow through in Q2 and Q3. So, that's what we would have factored in to maintain our guidance. Again, the only other change that we made would have been for the revenue recognition accounting standard, but we believe we've got, again, the staffing, the inventory, the efforts to really -- how we're improving our customer experience, the shopability of the stores, the shoppable inventory, a lot of the associate investments that we're making to make them connected and confident within the stores.", "So, we do anticipate leaning into the investments that we laid out on the call in February for 2018 as we're looking to really ramp up our strategic investments to better improve customer engagement. So, think about some of the spend that we have across services, supply chain transformation efforts are just examples of what we're continuing to invest in." ] }, { "name": "Robert A. Niblock", "speech": [ "Simeon, this is Robert. Also recognize as we get to through the balance of the year, we'll start to lapse into the marketing additional surge that we had from last year as well as you're already seeing some of the early signs of the gross margin stabilization work that Mike and his team are doing and that will continue to make progress throughout the year. So, you'll see a layering effect of those items on top of the recovery of the sales that were delayed from the first quarter." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. So, just to clarify -- so, no less rate of investment than what you planned? I'm speaking to the investments that were made in light of some of the tax savings. Then as far as the improvement goes, it's cycling some things from last year as opposed to internal improvements beyond what you initially planned or that you're running better than expected." ] }, { "name": "Marshall Croom", "speech": [ "I think one, we're continuing to lean in to the investments as planned for the year. To Robert's point, there are certain things, competitive actions, the amp up in advertising, certain things we amped up beginning last year that will allow. With certain efforts under way, I would say we're encouraged but more to come as we get traction on some of the tests and pilots that we've got under way so that we're comfortable with our guidance as is." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. Maybe my follow-up -- any product categories that are less weather-sensitive where you outperformed or underperformed that are worth calling out?" ] }, { "name": "Michael McDermott", "speech": [ "I would tell you that Simeon, we continue to feel good about our appliance business, continue double-digit growth in that category. We're running something like 3x in the industry and continuing to take share. I think we've got the best in class assortment and experience for our customers there. I also see some great progress in some pro-related categories -- rough plumbing and electrical, for example, we continue to grow share. The water heater program with the new A.O. Smith brand continuing to gain momentum.", "We saw double-digit comp in electrical cable, thinking about a commodity that pros would leverage as they do their work for customers and expanded penetration with the plumbing and electrical pro. Lumber and building materials, continued pro-growth there, storm-related recovery demand and inflation is supporting some favorability in that space and then positive improvement above the average in tools in hardware, the pro being the biggest driver of that.", "You start to hear the theme that the actions and investments that we're taking in our associate engagement with a pro is paying off. Key brands like DeWalt, Marshalltown, Norton Abrasives, the recent launch of Estwing striking tools, and we really feel good that double-digit comps in subcategories like tool storage and mechanics' tools will continue to complement the launch of Craftsman. So, there are the categories I'm feeling pretty good about and continuing to see progress with our pro customer base." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, Mike and best of luck to you, Robert." ] }, { "name": "Robert A. Niblock", "speech": [ "Appreciate it, Siemon." ] }, { "name": "Operator", "speech": [ "Our next question will come from the line of Michael Lasser with UBS. Please go ahead." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks for taking my question and best of luck, Robert. So, if we allocate the 300 basis points of comp drag that you called out due to the weather all to your traffic, put your traffic down call it 0.7%, you have a pretty easy comparison this quarter. The two-year traffic trend was noticeably degraded even on that basis, down 2.2% or so. Why would the traffic have gotten that much worse, even adjusting for the weather? Was there more disruption this quarter? You would think that a lot of focus you put on traffic and conversion it would have gotten a little bit better." ] }, { "name": "Marshall Croom", "speech": [ "Yes. When you think of the 300 basis points impact from weather impacting lawn and garden, our seasonal categories, that's really what we were seeing is reduced transaction in those categories. So, again, positive comps in our indoor categories. That's how we think about the 300 basis point impact. I think as Richard highlighted, it's not just all weather, just continued focus on opportunities within conversion. Again, highlighting the number of factors, the five points that Richard laid out, associate readiness, etc. with the opportunities we have with execution within the stores." ] }, { "name": "Michael Lasser", "speech": [ "Outside of the weather, did conversion get worse this quarter from where it hasn't?" ] }, { "name": "Marshall Croom", "speech": [ "No, Michael. Outside of the weather, the pattern that we saw in the conversion challenges of last year has stabilized in a Q1 period and now the intensity of focus is on working our way back." ] }, { "name": "Michael Lasser", "speech": [ "And then my follow up question --" ] }, { "name": "Robert A. Niblock", "speech": [ "Michael, this is Robert. Keep in mind, when we look at the 300 basis points drag, I also think about the strong seasonal business we built, 35% first quarter of our sales, 40% of the second quarter. So, it does have a disproportionate effect given how tough the weather was this quarter." ] }, { "name": "Michael Lasser", "speech": [ "And then thinking about the double-digit comps that you've seen thus far in May. Is that are all traffic-related? Are you seeing conversion already improve? Then you talked about it extending through the third quarter. So, what makes you to believe it's going to be all the way through the third quarter given that you've seen double-digit comp trends quarter to date?" ] }, { "name": "Marshall Croom", "speech": [ "Michael, what we're seeing is balanced transactions and ticket through the first couple weeks of May. We take a look at our promotional alignment, product assortment, momentum in our business, we feel good that we'll recover a majority of that seasonal business loss as well as expanding growth in indoor categories throughout the second, third, and fourth quarter. So, a lot of optimism for us with the way the business is in May." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much. Good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Greg Melich with MoffettNathanson. Please go ahead." ] }, { "name": "Greg Melich", "speech": [ "Hi, thanks. Just to maybe dig a little deeper on pro and make sure I've got the guidance right, it sounds like given the categories and what you described, Mike, the pro is probably up to 35% of sales in the quarter. Is that right? If you think of what's working there, what do you think you're going to lean into to drive that the rest of the year? Then Marshall, I had a question on the guidance to follow-up." ] }, { "name": "Robert A. Niblock", "speech": [ "I would say they're great. We have had strong performance with the pro, but not ready to go beyond our 30% penetration number." ] }, { "name": "Greg Melich", "speech": [ "Okay. We'll stick with that. And then to make sure I've got the math right on this -- Robert, thanks for the help over the years and also please enjoy retirement -- the guidance now, given the shift in accounting, if EBIT dollars were down 6% in the first quarter but will still be up a little bit if I take the midpoint of your guidance for the year, it is fair to assume that EBIT dollars will be positive the last three quarters of the year or do you think it's really more of a back half given the way the cadence is flowing through, Marshall? Thanks." ] }, { "name": "Marshall Croom", "speech": [ "Thanks, Greg. Again, we're looking to recover the majority of the sales. So, that obviously will have a flow through impact. That's going to play out over Qs 2 and 3 that we have that as a recovery opportunity in the year. That's how we were thinking about we would recover sales and EBIT." ] }, { "name": "Greg Melich", "speech": [ "So, the EBIT dollars, just to focus on that given the accounting change, that will flow through, it sounds like, whenever the sales come, and if the second quarter, it's the second quarter, but if it ends up being more the third, it will be then?" ] }, { "name": "Marshall Croom", "speech": [ "Correct." ] }, { "name": "Greg Melich", "speech": [ "Got it. Thanks a lot. Good luck." ] }, { "name": "Marshall Croom", "speech": [ "Again, accounting change does not impact sales or operating income." ] }, { "name": "Operator", "speech": [ "Our next question will come from the line of Elizabeth Suzuki with Bank of America Merrill Lynch. Please go ahead." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Good morning, guys. You mentioned storm-related activity helped lumper. Can you call out any particular hurricane-related benefit and quantify that in any way?" ] }, { "name": "Marshall Croom", "speech": [ "Yes, Elizabeth. It was about 100 basis point-benefit in the quarter from hurricane-related activity from what we experienced last year. Again, it was a step change from Q4 to Q1, I think the benefit that we realized and we expect that to step down again in Q2 and dissipate over the back half of the year." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Okay. That's really helpful. Can you just talk a little bit more about the categories that didn't have positive comps outside of sales and outdoor living and lawn and garden? Presumably kitchen and flooring were probably comping negative. Can you just talk about what's going on in those categories?" ] }, { "name": "Michael McDermott", "speech": [ "Sure, Elizabeth. Paint, I think, had a significant weather impact. If you think about exterior stains and exterior paint in the first quarter, weather certainly hurt us there. When you think about flooring and kitchens, as Richard highlighted, we've got a lot of work under way to improve our conversion rate on those categories, not just through the selling experience, but also managing our installer base and reducing time in phase from the moment a customer makes a selection until the moment they receive an install.", "So, they're the areas of most significant focus and kitchen and flooring certainly have been impacted as high-touch categories." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please go ahead." ] }, { "name": "Chuck Grom", "speech": [ "Thanks, good morning. Just to clarify on your guidance that the change in the gross margin view for the year. I think you set aside 60 basis points -- that's entirely due to the rev rec change?" ] }, { "name": "Marshall Croom", "speech": [ "Correct, in first quarter, it was 58 basis points we were guiding to flat gross margin before the adoption of the revenue recognition standard. So, yes." ] }, { "name": "Chuck Grom", "speech": [ "Okay. Just as a follow up to that, when you provided the guidance earlier in the year, you said you expected the front half to be lower and the second half to be better, is that still the case?" ] }, { "name": "Marshall Croom", "speech": [ "Yes, that's primarily the case, lapping some of the actions that we took in Q2 and Q3 last year in addition to improving and stabilizing gross margin. So, again, more pressure on gross margin, ex-revenue recognition standard, more pressure on the first half than back half." ] }, { "name": "Chuck Grom", "speech": [ "Okay. And you guys are not going to restate last year?" ] }, { "name": "Marshall Croom", "speech": [ "We adopted the modified retrospective method. So, that does not require you to restate that, highlighting the impact in basis points on sales gross margin in SG&A." ] }, { "name": "Chuck Grom", "speech": [ "Okay. Thanks. I think you touched on this earlier, but can you update us on the progress you've made on your product portfolio analysis?" ] }, { "name": "Michael McDermott", "speech": [ "So, we continue to see positive improvement as it relates to moving more revenue under management of our new pricing optimization tools. As I mentioned on prior calls, it does take time to code models to that strategic approach and as we move more and more of that revenue under management, we are optimistic about the results we're seeing and the benefits it's having to our gross margin." ] }, { "name": "Chuck Grom", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Daniel Binder with Jefferies. Please go ahead." ] }, { "name": "Daniel Binder", "speech": [ "Thanks. I was wondering if you could just talk a little bit about the growth on lowes.com. It looks like it was a little bit slower than where we were last year. Just to get your thoughts on that and what you think the key drivers are to accelerate it." ] }, { "name": "Michael McDermott", "speech": [ "This is Mike again. We had another strong quarter with our digital properties, delivering a 20% comp. We continue to build our capabilities to support our overall omnichannel experience. Remember, lowes.com is not just about the business we do online, but integrating those interactions for our customers throughout their home improvement journey. We saw traffic, conversion, and comps all continue to improve. As we elevated our targeted marketing efforts to continue to drive traffic, optimizing our assortment to do digital line reviews, certainly remain competitive from a pricing perspective, improving conversions.", "So, as we get better visibility, faster site speed, intuitive navigation with investments in new search capabilities, improved checkout that we've got planned for this year, expanded assortment. I think our dotcom business will continue to grow and our visual capabilities will enhance the omnichannel experience. So, we're in a good place." ] }, { "name": "Marshall Croom", "speech": [ "Dan, this is Marshall, I'll add to that. When we had the question about continued investment in digital platform capabilities is something that we continue to lean into and invest. We've got a new Chief Digital Officer on board who's been here about four months, Vikram Singh. So, he's digging into our platform. We're looking forward to leaning into expanding our capabilities on that front. We comped 27% on online last year. So, our 20% is on top of that and our sales penetration is now about 5% of sales from an online standpoint. So, certainly it's part of a key element to our omnichannel strategy." ] }, { "name": "Daniel Binder", "speech": [ "Then as a follow-up, adjusting for any weather impact there may have been on the pro-sales growth, would you generally describe that growth rate as stable, accelerating, decelerating? I know it's above average, but try and understand trend, if it's getting better or similar to where we've been?" ] }, { "name": "Michael McDermott", "speech": [ "Daniel, it's a relatively similar pattern continued strong. We do believe all the tracking that we have in the marketplace, we continue to take share in that space." ] }, { "name": "Daniel Binder", "speech": [ "Thanks." ] }, { "name": "Robert A. Niblock", "speech": [ "Regina, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Our final question will come from the line of Matt Fassler with Goldman Sachs. Please go ahead." ] }, { "name": "Matt Fassler", "speech": [ "Thanks so much. Robert, all the best to you after all these many years. I want to start by talking briefly about February. February did not seem to be a weather callout in terms of impact the way March and April were. The February monthly number on a one-year basis, two-year basis still represented a bit of a step down from where we've been. So, was it really the last two months of the quarter that were light or was the first month difficult as well?" ] }, { "name": "Michael McDermott", "speech": [ "I would just say the bigger crunch we had were March and April from a transaction impact." ] }, { "name": "Robert A. Niblock", "speech": [ "Yeah. If you look at certainly the volume, as you know, Matt, in the business, it grows dramatically between second quarter and by the time we get to the end of the quarter. So, the impact on those higher volume weeks is much more significant than it would be in a month like February." ] }, { "name": "Matt Fassler", "speech": [ "Gotcha. The second question relates to expenses -- you actually came in a bit below the number from a dollar perspective adjusted for the accounting changes and all that, a little bit before our forecast there. I know you held on to the seasonal labor investment. Were there any other expenses that were deferred or shifted into later in the year? I know you gave new operating margin guidance for the remainder of the year, but as we think about whether that SG&A cadence needs to be taken up a bit as the year progresses." ] }, { "name": "Marshall Croom", "speech": [ "No, we actually were pretty pleased with our results in the first quarter. We had some productivity efforts that helped provide an offset even with the investment in labor. So, we'll continue to keep that as a focus as we lean into the year, where else do we have productivity efforts on that front. So, while we have that as a focus, we're also keenly focused on sales productivity opportunities as we move forward." ] }, { "name": "Matt Fassler", "speech": [ "Then finally, a bit more strategically, you talked about pricing analytics and your desire to roll them out as the year goes on and the impact you hope that has for gross margin. What's your best sense today from your consumer surveys as to your price impression and how responsive consumers are when you've been promotional and the elasticity that has emerged from those efforts?" ] }, { "name": "Michael McDermott", "speech": [ "Matt, we look at value perception pretty regularly and our value perception metrics continued to be consistent with where they've been since they took the competitive action in the second quarter of 2017. We remain competitive. We see a rational environment right now as it relates to the competitive pricing point. We've got a wider view into more competitors with these new tools. I really feel good about our position on the competitive front. So, priority one is to be competitive and to deliver great value to our customers and by doing that, we've got to make the right trade-offs to maintain gross margin. That's our focus and what we've seen so far are positive results." ] }, { "name": "Matt Fassler", "speech": [ "Gotcha. Thank you so much, guys." ] }, { "name": "Robert A. Niblock", "speech": [ "Thanks. As always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we record our second quarter 2018 results on Wednesday, August 22nd. Have a great day." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect." ] }, { "name": "Matt Fassler", "speech": [ "More LOW analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
LOW	2021-02-24	[ { "description": "Vice President, Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "David Denton", "position": "Executive" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone. Welcome to Lowe's Companies' fourth-quarter 2020 earnings conference call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded.", "I will now turn the call over to Kate Pearlman, vice president of investor relations." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning, everyone. Here with me today are Marvin Ellison, our president and chief executive officer; Bill Boltz, our executive vice president, Merchandising; Joe McFarland, our executive vice president, Stores; and Dave Denton, our executive vice president and chief financial officer. I would like to remind you that a notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2021.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release and on our investor relations website.", "With that, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Good morning, everyone. I'd like to begin by thanking our frontline associates for their efforts to serve our customers and communities during the ongoing pandemic. In recognition of the efforts and the unique challenges posed by the pandemic, we invested over $100 million in incremental financial assistance for our frontline hourly associates in the quarter, which brought our total COVID-related support for hourly associates to over $900 million for the year. We remain laser-focused on our highest priority, which has always been protecting the health and safety of our associates and communities.", "And in the quarter, we invested $65 million in support of store safety protocols and our communities. For the year, we invested nearly $1.3 billion in COVID-related support for our associates, store safety and our communities. Now turning to our results. For the quarter, we delivered total company comparable sales growth of 28% over the prior year and 41% growth in adjusted diluted earnings per share to $1.33.", "Those results cap off a fiscal 2020 where comp sales increased 26% and adjusted earnings per share grew 54% to $8.86. Looking at the fourth-quarter results from a geographic perspective in the U.S., growth was broad-based, with comparable sales growth exceeding 19% across all 15 geographic regions and exceeding 25% for all U.S. divisions. On lowes.com, sales grew 121% as customers shifted more of their shopping online, especially over the holiday season.", "We continue to enhance our omnichannel retailing capabilities in store operations, on Lowes.com and across our supply chain, with our goal to meet customer demand to shop however, whenever and wherever they choose. Once again, DIY comps outpaced Pro comps in the quarter, driven by consumer mindset that remains focused on the home. During the pandemic, the home has come to serve four primary purposes: a residence, a home school, a home office and the primary location for recreation and entertainment. In addition to the strength in the DIY customer, our continued focus on the Pro is a very important component of our total home market share acceleration strategy.", "And Pro continues to show strong momentum, evidenced by the mid-20s comp in the quarter and nearly a 20% comp for the year. Part of our Q4 success in Pro was driven by our steps to tailor our service offering for these busy customers, even redesigning the footprint of our stores to facilitate a fast, intuitive shopping experience for our small and medium-sized Pro. Pros are rewarding our efforts with their repeat business, returning to shop our stores over and over again. Looking forward, we're focused on further enhancing our service levels, both in-store and online, to meet the needs of our new and existing Pro customers.", "Joe will discuss our efforts to grow market share in Pro later on the call. Now turning to Canada. We delivered comp growth in the mid-teens despite several COVID-related operating restrictions that went into effect during the quarter. The new Canadian leadership team made tremendous progress in 2020 and remains focused on improving operational efficiency by executing a retail fundamentals playbook to drive greater labor productivity and improve gross margins.", "And as I mentioned earlier, we're gaining traction with our new Total Home strategy, which is our commitment at Lowe's to provide everything a customer needs for their home. As an example, during the quarter, we quickly pivoted from a successful holiday Season of Savings event to launch two events to support our Total Home strategy in January, a home organization event and a bath event. During the home organization event, we provided our customers with storage solutions for their home and garages, freeing up valuable space for other activities. The bath event helped our customers find everything they need from paint to fixtures to toilets and tubs and even towels to upgrade their bathrooms.", "And for the customers who didn't want to do-it-yourself, we provided installation services. Truly a total home solution for a dream bathroom. Both events helped us to close out the fourth quarter with very strong sales in January. Looking forward, I am confident we're making the right investments to leverage our Total Home strategy, while we shift our focus from retail fundamentals to accelerating our efforts to gain market share.", "As a reminder, our Total Home strategy will drive market share acceleration by enhancing our investments in Pro, online, installation services, localization and elevating our product assortment. We are confident that these initiatives will allow us to drive sustainable market share growth as we deliver a total home solution for our Pro and DIY customers. Before I close, I'd like to once again extend my heartfelt appreciation to our associates for their dedication to serving our communities in this time of need. Doing the most challenging personal and professional year in many of our lives, our associates made enormous sacrifices for our customers and communities.", "And I'm very pleased that the marketplace is taking notice as reflected by Fortune magazine recently recognizing Lowe's as the No. 1 Most Admired Specialty Retailer, bestowing that honor on Lowe's for the first time in 17 years. We're humbled by the recognition, but we also know that 2021 will be a very unpredictable year. Even with the vaccine rollout under way in the U.S.", "and Canada, we continue to grapple with numerous challenges presented by COVID-19. And although the business environment remains uncertain, we're confident that we will continue to drive market share gains and operating efficiency. Also, our newly developed operational agility allows us to quickly respond to a wide range of potential macro outcomes in 2021. And we will not lose focus on our No.", "1 priority, which is supporting the health and safety of our associates and our customers. And with that, I turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. We delivered U.S. home improvement comparable sales growth of 28.6% in the fourth quarter. And consistent with the trends we've seen since the second quarter, growth was broad-based across both DIY and Pro customers, in-store and online and across all merchandising departments.", "In fact, all 15 merchandising departments generated positive comps of over 16%. Great execution, combined with our compelling product offering of well-known national brands, balanced with high-value private brands, ensured that we were well positioned to meet the continued elevated demand for home-related projects during the quarter. Lumber was once again the top performer, driven by strong unit demand across Pro and DIY customers, as well as commodity inflation. Our merchants and our supply chain teams did an exceptional job in working with our vendor partners to keep up with demand and to ensure that our stores were stocked with job lot quantities.", "Several other categories posted comps above 30%, including building materials, which was driven by strong demand for roofing and gutters. An improved level of in-stock and an exceptional customer service have allowed us to continue to grow our Pro business in these Pro-focused building product categories. Our seasonal and outdoor living, lawn and garden and paint categories also delivered comps above 30% in the quarter, reflecting the consumers' continued focus on the home. Our seasonal and outdoor living team delivered a successful holiday season with a holiday trim a tree program that exceeded the customers' expectations.", "The team also leveraged our selection in key brands to drive strong sales in grills, patio heaters and fire pits, as these categories were strong throughout the quarter as consumers continue to enjoy their outdoor spaces. Outdoor power equipment was driven by sales of chore-related product, such as snowblowers, generators and pressure washers, as customers navigated the weather and worked to maintain their outdoor areas. Continuing the theme of enhancing the outdoors, we saw strength in lawn and garden, with notable outperformance in holiday-related live nursery, along with growth in hardscapes, outdoor planters and cleaning products. And finally, our paint category also continued its strong performance with both interior and exterior stains delivering strong comps as the weather early in the quarter remained favorable.", "Now turning to our online results. As Marvin mentioned, we delivered sales growth of 121% on lowes.com, our third consecutive quarter with over 100% comps online. And during the quarter, we continued to enhance the user experience as we simplified the search and checkout features to speed up the process for customers shopping online. And we are also now working on replatforming LowesForPros to the cloud to be completed in the first half of this year, which will significantly enhance the features that we offer to these time-pressed customers and then further build out our loyalty with the Pro.", "As we discussed last quarter, we have been resetting the layout of our U.S. stores with approximately 95% of our resets now complete. We expect to drive greater sales productivity per square foot by achieving three key objectives with this investment. First, driving Pro sales through a more intuitive and faster shopping experience as we've now placed relevant products adjacent to each other and added a Pro flex area for grab-and-go products at the front of the store.", "Second, increasing our localized product assortment by eliminating unproductive bays without planograms or what we call junk bays, which now opens up space for new products, better tailored to the local market. And then finally, third, driving more transactions by moving the basket-building category of cleaning products to the main power aisle of the store. We're confident that our stores are now easier to shop for both Pro and DIY customers, which positions us well to accelerate our market share gains. I'd like to offer my sincere appreciation to all the teams across the company who work so diligently to execute on this strategic initiative in such a short period of time.", "We also continue to elevate our brand and product offerings. We are continuing to build on our position as the leading appliance retailer in the U.S. with the addition of Midea and Hisense appliances to our stores. And Lowe's will soon become the exclusive home improvement provider of Mansfield plumbing products.", "This addition will make Lowe's the only home improvement retailer to offer customers the top three toilet brands in the U.S.: Kohler, American Standard and Mansfield. As we transition to spring, we're in a great position to safely serve customers, and our teams have already been preparing by completing our new spring sets as we anticipate the arrival of the season around the country. Leveraging our leading position in outdoor power equipment, we have a wide selection from EGO, the top-selling brand in battery-powered OPE, to John Deere, CRAFTSMAN, Husqvarna, Honda and Aaron's. In addition, we will have a terrific selection of patio furniture, including our refreshed allen + roth patio program, complemented by a wide array of grills as we continue to leverage the two leading brands in outdoor grilling, Weber and Char-Broil.", "We're confident that our products will inspire customers that are looking to upgrade their outdoor space, which we think will continue to remain a retreat for many this spring season. We're continuing to make changes to improve traffic flow within our outdoor garden centers to ensure social distancing while shopping, as well as showcasing inspirational vignettes and utilizing enhanced vendor support, all of which will drive a great spring season in lawn and garden. And finally, we are excited to deliver new innovation in flooring with the launch of Pergo WetProtect technology available in laminate, engineered wood and rigid luxury vinyl, and offering guaranteed protection for both the flooring and subflooring. This new level of total moisture protection is a great Lowe's exclusive product that will provide peace of mind for consumers and further differentiate our flooring offering.", "This spring, we will demonstrate to consumers that we provide everything they need to make their homes and backyards functional and safe, a reflection of our Total Home strategy. I'm looking forward to sharing more with you about our reimagined approach to spring on our next call. And before I close, I'd like to express my thanks for the resilience and dedication showed by our merchants and vendor partners during what was truly an extraordinary year as these teams work tirelessly to meet the high levels of demand for our products and services. Thank you.", "And I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Bill, and good morning, everyone. This past year presented challenges that few of us could have imagined. Lowe's has always been at the forefront in responding to crisis in our communities, and our associates rose to the challenge once again in 2020. In recognition of the outstanding efforts of our associates, in January, we announced a bonus of $300 for each full-time associate and $150 for each part-time associate.", "This $80 million bonus brought the total COVID-related assistance to our associates to over $900 million in 2020. And I could not be more pleased to announce today that for the fourth quarter in a row, 100% of our stores are under \"Winning Together\" profit-sharing bonus totaling $90 million. And because of their efforts, once again exceeded expectations, this represents an incremental $30 million over the target payment level. And we're supporting our communities again through hiring as we bring on more than 50,000 seasonal and full-time retail associates this spring to ensure that our customers get the exceptional service they expect from Lowe's.", "This builds on the more than 90,000 associates hired into permanent roles over the past year. 2020 changed the way the customers shop with Lowe's. Nowhere is this more evident than the 111% sales growth on Lowes.com for the year. And with roughly 60% of these online orders fulfilled in our stores, we needed to dramatically expand our fulfillment capabilities to support this increased demand.", "We began by rapidly rolling out curbside pickup in the first quarter, and then we began to launch touchless BOPIS lockers in our stores a few months later. We now have BOPIS lockers in over 1,200 stores with the goal of rolling out lockers to all U.S. stores by April. Providing multiple contactless pickup options for our customers, we are meeting consumer demands to shop Lowe's in whatever way they choose.", "And we've continued to enhance the mobile app to improve the customer pickup experience. This quarter, we began rolling out geofencing technology that alerts our stores when customers are on their way to pick up their orders, enabling quicker fulfillment when they arrive at the store. Last quarter, we announced that we were standing up dedicated fulfillment teams to handle all in-store fulfillment orders. All of these enhancements from the easy-to-use BOPIS lockers and the new geofencing technology, to the focus on the fulfillment teams, have already driven improvements in customer satisfaction and speed of service.", "Importantly, the fulfillment teams are also improving productivity as they leverage enhancements that we've made to the picking app. This is evidenced by a dramatic reduction in the number of hours needed to fulfill orders for pickup. In fact, we can now fulfill orders six times faster on average than one year ago. Now let's turn to our performance with the Pro.", "As Marvin mentioned, we delivered mid-20s comps in the fourth quarter. We continue to enhance our Pro loyalty offering by providing Pros with the tools they need to get the job done. This time of the year, our Pros are focused on not only their project pipeline, but they also need to close their books just like any other business. As a true partner to the Pro, we are now providing our Pro loyalty members with a $100 discount on TurboTax.", "Our Pro loyalty members can also export up to 24 months of transaction history, expediting their year-end close process. It's value-added offers like these that truly differentiate our Pro loyalty offering. Throughout 2020, we continue to raise the bar on our offering for the Pro, with better service levels, the right brands and products and the job lot quantities they need. Every day, we are demonstrating that Lowe's is executing our commitment to be the new home for Pros, which is reflected in the strong repeat rates that we're earning from new and existing customers.", "I'd like to offer a special thanks to the entire Pro team for a fantastic year. Job well done. And I'm looking forward to building on this momentum as we continue to grow our Pro penetration. And one way that will drive greater Pro penetration is through our newly launched Pro customer relationship management, or CRM tool.", "Rolled out to all stores in late January, this new technology provides our Pro desk with the tools to manage, grow and retain Pro accounts through consistent and data-driven selling actions. We will also be able to associate any transaction regardless of tender type to a specific Pro account, allowing us for better record-keeping for their business. Store associate training is currently under way, and we expect that the targeted outreach enabled by this tool will facilitate stronger and more personal relationships with our Pro customers. Over the past few years, the store operations team has made considerable strides in improving productivity in our stores, with technology enhancements that free up our associates to spend more time in the aisles serving customers.", "As we move into 2021, we are kicking off a new productivity initiative in-store operations that we are calling our perpetual productivity improvement, or PPI. This key productivity initiative will play a critical role in our continued multiyear improvement in operating profit. Through PPI, we will leverage new processes and technology to deliver continuous productivity enhancements. Some of the most significant technology initiatives under PPI are modernized checkout infrastructure, industry-leading in-store workforce management tools, new touchscreen POS, expanded rollout of digital signs, incremental functionality deployed to the handheld devices and enhanced store inventory management systems, to name a few.", "These perpetual productivity improvements will help us to move toward our multiyear goal of achieving $2.5 billion to $2.7 billion in store opex productivity that we set at the December investor update. I look forward to updating you on the progress we are making toward these important productivity initiatives on future calls. With that, I'll turn it over to Dave." ] }, { "name": "David Denton", "speech": [ "Thank you, Joe. I'll begin this morning with a few comments regarding the company's robust capital allocation strategy. In fiscal 2020, we generated $9.3 billion in free cash flow driven by outstanding operating performance, and we returned $6.7 billion to our shareholders through both a combination of share repurchases and dividends. During the fourth quarter alone, we paid $452 million in dividends at $0.60 per share.", "We also repurchased 21.1 million shares for $3.4 billion at an average price of approximately $160 a share. This brings the total to $5 billion in share repurchases for the year. We have approximately $20 billion remaining on our share repurchases authorization and plan to utilize our strong cash flow to drive significant long-term shareholder value. Capital expenditures totaled $619 million in the quarter and $1.8 billion for the full year as we invest in the business to support our strategic growth initiatives.", "We ended 2020 with $4.7 billion of cash and cash equivalents on the balance sheet. And along with $3 billion in undrawn capacity on our revolving credit facility, we have immediate access to $7.7 billion in funds. We remain confident that we have ample liquidity to navigate any unforeseen circumstances. At the end of the fiscal year, our adjusted debt-to-EBITDA ratio stands at 2.2 times.", "Now I'd like to turn to the income statement. In Q4, we generated GAAP diluted earnings per share of $1.32 compared to $0.66 last year, an increase of 100%. In the quarter, there was a very modest impact on operating income related to the previously announced Canadian restructuring. Now my comments from this point forward will include certain non-GAAP comparisons where applicable.", "In Q4, we delivered adjusted diluted earnings per share of $1.33, an increase of 41% compared to the prior year. These results were driven by higher-than-expected sales volume reflecting a continued consumer focus on the home, a modest benefit from the next round of government stimulus checks as well as strong execution across our operations. Operating margin improved in the quarter as our strong focus on cost control and productivity continued to pay dividends. Q4 sales were $20.3 billion, driven by a comparable sales increase of 28.1%.", "This was due to comparable store average ticket growth of 14.2% and transaction growth of 13.9%, with strong repeat rates from both new and existing customers. Commodity inflation drove a benefit of approximately 300 basis points to comps in the quarter as lumber continues to experience rising prices. U.S. comp sales were up 28.6% in the quarter.", "And consistent with our results for the past few quarters, growth was well balanced across both DIY and Pro customers, selling channels, merchandise departments and geographies. Our U.S. monthly comps accelerated through the quarter, were 23.8% in November, 28% in December and 35.7% in January. As Marvin mentioned, the company pivoted quickly from a strong holiday selling season in late December to launch bath and home organization events in early January.", "January sales also benefited modestly from the second round of government stimulus. Adjusted gross margin was 31.8%, down eight basis points from last year. Despite cycling over significant improvements last year in our process to more effectively manage product margin, product gross margin rate improved 125 basis points driven by continued execution on our pricing, cost management and promotional strategies. We took a less promotional stance across all categories, including our focus on EDLP and appliances, which benefited margin in the quarter.", "In addition, strong demand from holiday products led to good sell-through and minimal seasonal write-offs in Q4. These benefits to adjusted gross margin were offset by 40 basis points of pressure from inventory shrink, 40 basis points of pressure from supply chain cost, 35 basis points of pressure from lumber installation and 20 basis points of pressure from lower credit revenue. Adjusted SG&A of 22.3% levered 42 basis points to 2019. As we anticipated, we incurred approximately $165 million of COVID-related expenses.", "These investments included approximately $100 million in financial assistance for our frontline associates and approximately $60 million related to cleaning and other safety-related programs, as well as approximately $5 million in charitable contributions. These $165 million of COVID-related expenses negatively impacted SG&A leverage by approximately 80 basis points. As expected, we incurred approximately $150 million in the U.S. stores reset project, which negatively impacted SG&A leverage by approximately 75 basis points.", "As Bill mentioned, the resets have been completed in approximately 95% of our stores. These incremental costs were offset by payroll leverage of approximately 105 basis points related to higher sales volume and improved store operating efficiencies, occupancy leverage of approximately 30 basis points and advertising leverage of approximately 25 basis points. Adjusted operating income margin of 7.6% of sales for the quarter was up 41 basis points to the prior year as operational productivity improvements were offset somewhat by significant investments in our stores and supply chain to drive long-term growth. In addition, increasing investments in short-lived technology and store fixture assets is resulting in higher levels of depreciation versus our historical run rate.", "The adjusted effective tax was 25.8%. The tax rate was slightly lower than expected due to better-than-anticipated performance of our Canadian business in Q4. We continue to build up our inventory levels throughout the quarter to meet the sustained high levels of customer demand. At year end, inventory was $16.2 billion, and lumber inflation increased inventory values by approximately $240 million.", "Now before I close, let me talk about our current trends and how we're planning our business in '21. Although February is the easiest comp this year, we are encouraged that the strong broad-based sales trends that we saw in the fourth quarter have continued this month, apart from the impact of the recent winter storms. Looking at the balance of the year, our approach to 2021 remains consistent with how we outlined our planning at our December investor update. Like many companies, we have limited visibility into future business trends.", "It remains unclear when there will be a widespread availability of the COVID vaccine and whether there will be additional COVID-related restrictions like we're experiencing in the Canadian business today. Given the near-term uncertainty, at our December investor update, we outlined three different market-based scenarios on how the mix-adjusted home improvement market might perform, be it weak, moderate or robust performance levels. Keep in mind that our business is more heavily weighted in DIY and less penetrated in online than the broader market, both of which create modest downward pressure on the Lowe's home improvement market outlook. These three market scenarios would result in total sales expectations ranging from $82 billion to $86 billion for the year.", "While each scenario represents a top line decline from 2020 as we cycle this unprecedented industry growth, we continue to expect that our sales result will outperform the market as our initiatives are focused on delivering market share gains. Additionally, in each scenario, we expect our adjusted operating margin to increase year over year, ranging from 11.2% to 12%, depending upon the demand environment. And consistent with my comments at the investor update in December, embedded in each of these scenarios are the incremental investments in frontline associate wages and equity programs that totaled $1.4 billion through 2019 and 2020. At the same time, we have implemented a slate of perpetual productivity initiatives that Joe mentioned earlier.", "And we are investing to drive operational efficiencies in our business. We will also lap significant nonrecurring spend from 2020. While it's still very early in the year, we are seeing market trends essentially in line with the robust market scenario. This scenario assumes the relevant home improvement market will experience a modest contraction this year, and our sales would approach $86 billion.", "We will remain agile to react rapidly to any changes in the market, and we are able to quickly flex store labor, advertising and incentive comp expenses. And consistent with what we outlined at Investor Day, we are expecting $9 billion in share repurchases this year. Our repurchases activity should be roughly ratable by quarter but a little more concentrated in the first half of the year, given the robust cash flow generation driven by our spring selling season. And we are planning for approximately $2 billion in capital expenditures in '21.", "So in closing, we remain extremely excited about the future of our business and its ability to continue to deliver sustainable shareholder value. With that, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our first question comes from the line of Seth Sigman with Credit Suisse." ] }, { "name": "Seth Sigman", "speech": [ "Guys, good morning. Thanks for taking the question. Congrats on all the progress. Dave, I wanted to follow-up on the guidance point here.", "Obviously, not full guidance, but the scenarios you discussed in December. If I recall, it included gross margin relatively flat. Given the pressure as you saw in the fourth quarter, I'm just curious, should we be thinking about gross margin in '21 down slightly, but maybe more benefits from SG&A to still get to the same EBIT margin outlook? How should we be thinking about that?" ] }, { "name": "David Denton", "speech": [ "Yes. Seth, Happy New Year. Good question. Just I think, most importantly, is we're really focused on operating income and margin expansion as we cycle into this year.", "Clearly, we're focused on improving our gross margin performance, as you've seen us do that consistently through 2020. We continue to make really nice progress from a product cost perspective. I think what you're also seeing us do is we're investing from a supply chain perspective to make sure that we're building out in the future to meet the needs and demands of consumers in the future. So I think we're excited about that.", "I do expect that gross margin over the longer term, think about it flattish. We are experiencing some headwinds as we think about inflation from lumber, but nothing has materially changed from what we discussed in December, Seth." ] }, { "name": "Seth Sigman", "speech": [ "OK. Thank you for that. That's helpful. And then just a follow-up question about demand.", "Obviously, the strength you've seen has been pretty broad-based. Beyond some of the seasonal variations that you've been seeing, I'm just curious how you see the consumer or the customer evolving their focus in the category? How are the types of projects changing? And part of the question is whether you're seeing an acceleration in some of the bigger projects that may have been constrained during parts of this year. Because it does feel like the mid-20s Pro comp that you pointed to, does seem like that's an acceleration. So I just wanted to get a little bit more context on that.", "Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "So Seth, this is Marvin. I'll take part of that, and I'll let Joe comment a bit on Pro. As we've said, 2021, to state the obvious, is a very difficult environment to forecast. And I think all your questions are relevant.", "And what we can say is when you look at the comp cadence for the month during the quarter, you saw us accelerate throughout. You look at the month of January, which is a significant sales performer, and both Dave and I discussed the importance of our Total Home strategy leaning into those two events, the bath event and the home organization event, that gives you an indication that the customer is still in the project mindset as they continue to find ways to make their home more livable and more comfortable for all the various activities that COVID has forced upon us. So the short answer to your question is we feel great about the mood of the customer. We feel great about the trends relative to big ticket, small ticket, Pro and installations.", "And all the work that we put in place the last two years in our retail fundamental strategy just gave us a good position and platform to service the customer effectively across all those different categories. I'm going to let Joe talk a little bit about Pro because, again, we're very proud of the performance. As we mentioned in the prepared comments, we delivered mid-20% comps in the quarter for the year. We're hovering around 20% comps.", "And this was in an environment early in the year where the Pro business became very soft just because of the normal occurrences of customers not being comfortable allowing strangers in their homes. I'll let Joe discuss a little bit more on our excitement around Pro." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Marvin. And Seth, thank you for the question. You're correct, from Q3 to Q4, we did see a nice comp acceleration. We're excited about the underlying demand in the Pro space.", "As we look at the kind of robust pipeline that's out there in the Pro space, thinking about the expanded product offerings that we've had throughout the year. In addition, I mentioned in my prepared comments, the benefit from TurboTax and the progress that we're making to help these Pros expedite their year-end close. And then in addition, we've been focused on all the fundamentals. And as we continue to move forward, confident that things like our U.S.", "stores reset and the area that we created for Pros and the ease of Pros to shop. In addition, very excited about the growth of our new Pro loyalty platform, along with the integrated CRM that rolls out. And very excited about what's happening inside the Pro business." ] }, { "name": "Seth Sigman", "speech": [ "Thank you, all." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, everyone, and good morning. My first question is on the outlook or the perspective, if you will. Dave, you mentioned that the business is tracking toward a robust case. And I know robust, I don't know if it was couched as a base case for you or not, but I think we're interpreting it as one.", "Do you have any more confidence in that? Or are you expecting some twist and turns as the year goes? Or the fact that we're tracking there gives you confidence that -- more confidence in that scenario?" ] }, { "name": "David Denton", "speech": [ "Listen, I think we're only a few weeks into the year, but I think we feel encouraged by the trends that we're seeing at the moment. So I think we -- as Joe and Marvin just articulated, I think the health of the Pro business is sustainable and it's actually accelerating a bit. So I think we feel really good about that. At the same time, the consumer remains healthy and continues to invest in the home to support both their living needs but also their educational needs for the kids, in many cases, and continue to invest to make sure that, that is an asset that is sustainable for them going forward.", "So we're encouraged at this point, but pretty early still." ] }, { "name": "Marvin Ellison", "speech": [ "Simeon, this is Marvin. And what I'll add to that is, we'll go back to the same theme that you'll probably hear us say all morning. Obviously, we can't predict with any high degree of precision what 2021 macro will look like. But we're confident in two things: number one, that we're going to take market share; and number two, we're going to improve operating income.", "And I think for us, we're just planting our flag on those two things. We believe that 2020 was not an anomaly. We believe it's a reflection of a lot of hard work and retail fundamental implementations we put in place across Lowes.com, Pro, merchandising, store operations, IT infrastructure. And we believe that those initiatives and our Total Home market acceleration strategy is going to allow us to continue to take market share and, at the same time, improving operating income." ] }, { "name": "Simeon Gutman", "speech": [ "OK. And my follow-up is in the robust case of 120 basis points, I think, for margin expansion. I don't know if we said, but how much can you look at that amount and divide it among top line dependent versus internal execution or transformation dependent. I don't know if we looked at it that way or if we could bridge it versus the other scenarios." ] }, { "name": "David Denton", "speech": [ "Yes. I would just encourage you maybe to go back and look at our Analyst Day presentation. I had a building block slide in that presentation that walked us from kind of where we -- where our guidance was for the end of 2020 to a 12% margin rate perspective. And I think it does show a little bit of -- kind of how gross margin might perform as well as how SG&A is going to perform.", "And again, this is largely about, in aggregate, gross margin rates being relatively flat and us improving our SG&A performance across the business." ] }, { "name": "Simeon Gutman", "speech": [ "OK. Thanks, guys. Good luck." ] }, { "name": "Operator", "speech": [ "Our next question is coming from the line of Kate McShane with Goldman Sachs. Please proceed with your question." ] }, { "name": "Kate McShane", "speech": [ "Thanks. Good morning. Thanks for taking my question. I wondered if there was any way you could update us on what Pro is as a percentage of your sales today? I feel like there is some ceiling with your stock price or valuation because the thinking is, is you just don't have as big of exposure to the Pro as your main competitor.", "But with the comps that you've put up in 2020 and all the initiatives, I wondered if there was any further insight into what that percentage of sales is today." ] }, { "name": "Marvin Ellison", "speech": [ "Kate, this is Marvin. The best way that I'll answer that is we're going to pretty much stick to our 20% to 25% penetration. We're going to reevaluate that, obviously, coming out of 2020. The key is that, as you know, DIY significantly outpenetrated the Pro during the year.", "So we know that the 2020 data may not be a good, consistent data set to look at relative to Pro and DIY penetration. So we probably need to cycle through the first half of 2021 to get that data really balanced out. What I can say is, in Joe's prepared comments and also in mine, we laid out some of the specific initiatives related to the Pro. One of the key things that we focused on arriving at Lowe's a little over two years ago, is one of the main reasons why we had a gap relative to sales per square foot productivity and operating income by store was because the Pro penetration was significantly less than what it should have been.", "Pros drive productivity in multiple product categories throughout the entire store. And so part of our focus on the Pro is because we know it's going to be critical for us to improve overall productivity from a space perspective as well as driving operating income throughout the store. So we'll get back to you later in the year on an answer. But the key is we're going to be focused on it, and we think we're making great improvements." ] }, { "name": "David Denton", "speech": [ "And Kate, I'll just add that we look at it a little bit the opposite. We are underpenetrated, but that is the big opportunity we have. And all the investments we're making is going to allow us to really accelerate in that business segment pretty significantly over the next several years." ] }, { "name": "Kate McShane", "speech": [ "OK. Thank you. And then my follow-up question is just on wages and how we should think about that in 2021 relative to what was paid in 2020, especially considering the number of bonuses that were given to associates during that time." ] }, { "name": "Marvin Ellison", "speech": [ "So Kate, this is Marvin. I'll take it. And if Dave wants to provide any additional financial analysis, he can. But I think at the highest level, what we've laid out for operating income targets for 2021, what we laid out at the investor update in December and what Dave mentioned in his prepared comments, reflect any investments we intend to make in our associates.", "The good news for us, and Dave mentioned this earlier in the morning, that from the year 2019 and 2020 made a $1.4 billion investment in incremental wages, equity programs and other associate-related benefits, and that was pre-COVID. So other retailers candidly are catching up to the work investment that we already made going into COVID, so we don't have an enormous bogey, so to speak, that we need to make from an investment standpoint to catch up. We've been on a pathway to get our wages up. That's why we're very proud to say that we are one of the highest wage retailers from an hourly associate perspective in the U.S.", "So we don't see 2021 as anything that will be materially different than that. Obviously, we'll look at how the business is tracking, we'll look at the needs of our associates. But any investments we plan to make has already been factored into any financial guidance or at least the range of guidance that Dave has discussed in December and this morning." ] }, { "name": "Joe McFarland", "speech": [ "So Kate, it's Joe, and thanks for the question. I'll just add a few things to what Marvin said. And over the last two years, we've been taking steps from a store operation standpoint to simplify the store structure, if you think about some of the updates we've given, our four levels of sales associate on the sales floor and all the work we've done. And so in addition, the labor management tools and the workforce management initiatives the team has laid out, I feel very good about the balance of ticket and transactions in our transaction-based labor model, and that will continue, to be able to deliver on the operational efficiency we need to.", "And then finally, for the spring hiring season, we feel that we've done a nice job addressing any difficult-to-hire markets. We measure the pipeline of sales associates coming in by position by market, so we've made adjustments where we need to and feel confident going forward." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Given the introduction of the PPI initiative, is it likely that you'll come in at the high end of the profitability scenario, even if you don't come in -- even if you come in at the middle end or low end of your sales scenario for 2021?" ] }, { "name": "David Denton", "speech": [ "Hey, Michael. It's Dave here. Clearly, what we're doing is we're working really diligently to improve the productivity across our business. And Joe has kicked off a pretty major effort to do that.", "But we're doing it really across all segments of our operation. That's probably a little bit more specific guidance, if you will, so we're probably not going to go there. But I'll just say that as a management team and as a business, we're controlling what we can control. We're making sure that as we look at these sales scenarios over time is that we're improving our operating income performance.", "And we're dead set on improving that. We're very focused and adamant about going after that. And I think we have a very good line of sight to that." ] }, { "name": "Michael Lasser", "speech": [ "OK. And it seems like you're going to have more takes than puts on your gross margin this year with supply chain pressures, probably inflation drag for at least the near term, and what's likely to be at least some return to a more promotional environment. So in that scenario, with your gross margin already declining in the fourth quarter, how do you keep it flat in 2021? What are the offsets?" ] }, { "name": "David Denton", "speech": [ "Well, listen, we're focused in a few different areas. We've just enhanced our pricing and promotional tools, from a merchandising perspective. I think the merchants have just kind of taken a step back and looked at, from a promotional cadence perspective, how to think of more of an EDLP type environment, at the same time going out and negotiating special buys in certain areas to drive real value from a consumer perspective. I think we're getting a lot more efficient on how we layer in and out of our online business to drive both top line and improve profitability.", "At the same time, we do need to manage our supply chain to be more efficient as we think about same day, next day deliveries to the home and to the job site. So all those levers are things that we're working on that we're actively using to manage our gross margin performance. And yes, we do have some headwinds, but we're also -- that's part of our job is to manage those headwinds to improve performance over time. And again, with a real focus, once again, Michael, on improving our operating income flow through, that's the opportunity we have." ] }, { "name": "Michael Lasser", "speech": [ "OK. And then..." ] }, { "name": "Bill Boltz", "speech": [ "Michael, this is Bill. I'll just add a couple of comments to that. As we've said over the last couple of years, we've been on a journey to get to more of an everyday competitive price. And so getting credit for what we're doing and less of this high-low approach that we had been typically on prior to this leadership team coming in.", "And then we have done a lot of work in the last 18 months around our localization initiative, and it's one of our key unlocks and part of our Total Home strategy as we go forward that gives us the opportunity from a margin perspective as well. So we're confident that we can deliver on what we said back in December." ] }, { "name": "Michael Lasser", "speech": [ "If you could just clarify that, though. Where do you stand today in terms of your pricing position versus where you might have been a year ago? If you can use that as a lever to offset some of the gross margin headwinds that you might experience in next couple of quarters." ] }, { "name": "Marvin Ellison", "speech": [ "Well, look, this is Marvin. What I'll say, Michael, is it's a work in progress. What I can tell you is the set of tools that Bill and the merchants currently have today versus what we had two years ago is truly a night and day difference. So it gives us the ability to have localized pricing and we can price now in more smaller clusters.", "I mean two years ago, we were using blunt instruments to price in broad markets. Now we can get down to individual locations. In addition to that, Joe talked about the expansion of things like digital signs. It may not sound like a big deal, but there are parts of the store where you have frequent, rather volatile price-changing activities, a lot of labor goes into that.", "And if you can put a digital process in place, it allows you to capture the different costs and retail changes in a way that actually can benefit gross margin. And localization, to Bill's point, solves a couple of major significant issues. But one is you have the right product in the right market. So your exit strategy doesn't just destroy your gross margin because you're clearancing everything just to get it out.", "I'd use the example at the December update when Bill, Joe and I walked in the store in West Philadelphia and saw riding lawn mowers and big, deep seating patio sets, and sheds and other products that was just waiting for markdown to happen because it was simply in the wrong location from a geographic perspective. So Bill's team is working to solve all of that, so we can have the right product in the right location so we don't take deep markdowns to exit. So all of those things will play a role in giving us -- to create our own internal headwind to go up against some of the investments we're making, like in supply chain. So we'll keep you updated on the activities." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. I know, as you said, you're kind of trending or contemplating you'll probably be at the robust end of your guidance range. But I guess if you end up actually even slightly better than that, how should we think about operating margin opportunity? Would there be upside to that? Or would you reinvest and kind of maintain the cadence that you'd indicated previously? And then I had one follow-up." ] }, { "name": "Marvin Ellison", "speech": [ "Sure. Yes, ma'am. So Karen, this is Marvin. The best way to answer that question is the simple statement is that we expect to outperform the market and gain share in 2021.", "So if the market performs better than our robust scenario, that would be music to our ears, because we would believe that it would only provide us with upside opportunity on the top line and on the bottom line. So again, we're going to just have a very, very singular focus on taking market share and improving operating income. And if the macro improves better than our forecast and better than we anticipate, that will be only good news for us." ] }, { "name": "Karen Short", "speech": [ "Great. Thanks. And then I just wanted to see, I don't know if you'd be willing to provide this, but would you be willing to give us some color on the number of Pro loyalty members and then just a quick update on timing of combining the Lowe's credit card with the low -- with the Pro loyalty program? Or does all of that happen at the same time as you migrate to the cloud? Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "So I'll take the easiest part of the question, and that is, no, we're not going to provide you with the number of loyalty members from a competitive perspective. What we can tell you is that we're very pleased with the adoption rate and we're very pleased with the returned visit as a result of that. I'll let Joe talk about the merging of credit and the platform." ] }, { "name": "Joe McFarland", "speech": [ "Yes, Karen, this is Joe. And thank you for the question. We will be migrating our credit platforms and our Pro loyalty platforms together. We have every intention.", "That is a part of -- it's a huge part of the benefit. Again, we've been very encouraged by the new sign-ups in Pro loyalty, how the Pro customers are responding. We've been very pleased also with our new credit acquisition from a Pro standpoint. And so with those underlying themes, although we won't release the number of Pros, we're excited about what the platform is delivering and all the work that the Pro team has done." ] }, { "name": "Karen Short", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, everybody. Can you talk about how you think stimulus helped the business there in January? A very strong comp, obviously at 35%. What do you think the lift was? And how would you compare that lift to what you saw last Spring when stimulus hit?" ] }, { "name": "David Denton", "speech": [ "Chris, Dave here. Yes, I do think stimulus, as we cycled into the new year, did help our comps. We estimate somewhere between 50 and 100 basis points from that perspective. I think as stimulus has gone on for a while now, I think the performance and the impact of it has been -- has moderated a little bit.", "So I think we do see it -- when those trap checks do hit, we do see an inflection kind of up a little bit, but it has not been nearly as dramatic as it was when it first hit basically a year or so ago." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. And then as you think about -- just to square the T on the gross margin. So in the slides, you have flat gross margin to 12% in the robust scenario. Is there any potential cadence around that? You do have the freight pressures probably earlier, maybe shrink in supply chain investments.", "So a flat relative to 2020, do you expect it to be maybe down a bit in the first half and then up in the back half and net flat that way?" ] }, { "name": "David Denton", "speech": [ "I think that's a little bit more specific than probably what we could give you some color on at this point in time. I'd just say that at the end of the day, back to Marvin's point, is our focus this year taking market share, improving operating income. That's just are two things that we're focused on just consistently, and you'll continue to hear us talk about that, demonstrate our performance in those two metrics." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. Have a great spring." ] }, { "name": "Operator", "speech": [ "Our next question is coming from the line of Eric Bosshard with Cleveland Research. Please proceed with your question." ] }, { "name": "Eric Bosshard", "speech": [ "Morning. Curious in regards to the supply chain investments, Pro and online obviously areas of growth and accelerating growth. But what I'm curious to understand is the incremental investments you're making in both of those areas, some of them you've made already, some that are in process. How will the customer experience be different in those areas in '21? And where I'm really trying to end up is in terms of the share gains that you're making in both of those areas, what do you think about the future of that, especially in terms of payback from where you're investing incrementally?" ] }, { "name": "Marvin Ellison", "speech": [ "So Eric, this is Marvin. And early on, we committed to a $1.7 billion supply chain infrastructure investment between the years of 2019 and 2023, and we're well on the pathway to achieve that. Specific to your question, we're trying to create a market-based delivery model, which will transition the pressure of delivery from our individual stores to a market-based model. In addition to that, we're trying to develop a fulfillment model that will serve a customer any way they choose to shop in this omni-channel ecosystem that we're creating.", "So relative to a customer, how will it be different? It would be different that you will have a more seamless delivery with better visibility to appointment, scheduling and arrival, specific to any big and bulky items starting with appliances. So for the DIY or the Pro, if you're in the appliance space, you're going to have a more seamless opportunity to purchase a product. Just to take you back to how this has been done historically, when a customer purchases an appliance, the scheduling process is done by an associate calling the customer at home and going through a manual process to try to find a date that best fits the availability of the product and the customers' schedule. To say it's clucky and inconvenient will be an understatement.", "Now we've transitioned to a digital scheduling model where a customer can choose their own date based on prepublished openness in our system. And our associates have total visibility to inventory, whether it's in their store or in a market-based distribution center. What we're doing on the Pro side is also trying to create more of an omni experience. You're going to see us launching Pro lockers later this year.", "And you're going to see us improve our job site delivery with Pro and have a lot more flexibility around that. So those are two ways that those customers will see a difference. And there are a lot of other activities under way that Joe in operations partnering with the supply chain, but we'll wait till a later day to get into those." ] }, { "name": "Eric Bosshard", "speech": [ "OK. That's helpful. And then one question for Dave. The incremental margin of the business in '21, in an upside sales scenario, does the incremental margin change? And I guess what I'm trying to get a sense of is, obviously, in '20, there were incremental investments made through the year as sales came to the upside and were necessary, but diluted the incremental margin of the business.", "Does that same story play in '21 in a better sales scenario? Or can the incremental margin either be sustained or expand in an upside sales scenario?" ] }, { "name": "David Denton", "speech": [ "Yes. Eric, I would say that it should expand a little bit in upside scenario, just given what we've done in 2020, to your point." ] }, { "name": "Eric Bosshard", "speech": [ "Very helpful. Thank you." ] }, { "name": "David Denton", "speech": [ "So great. So Rob, with that, we're going to take one more question, please." ] }, { "name": "Operator", "speech": [ "That question will come from the line of Greg Melich with Evercore ISI." ] }, { "name": "Greg Melich", "speech": [ "Great. Thanks. I'd love to follow-up on inflation. So I think you called out 300 bps in the fourth quarter.", "What percentage of your sales, is that really looking at the commodities? And any number you have for the full year? And if you could even talk about the ability to pass through some rise in input costs outside of those commodities, that would be great." ] }, { "name": "David Denton", "speech": [ "So yes, largely, the inflation has been centered primarily in the lumber category. If you think about it from that perspective, and again, about 300 basis points. This is -- from a commodity standpoint, this is something that we're very used to managing. And largely, those are passed on ultimately to the consumer at the store." ] }, { "name": "Greg Melich", "speech": [ "And for the full year, would that number have been 150 basis points as we're thinking about what it -- how it impacts '21?" ] }, { "name": "David Denton", "speech": [ "Yes. I don't know that off the top of my head. But obviously, inflation in the back half of the year was higher than the first half of the year, so it's certainly less than 300 basis points. And we'll keep -- obviously, we'll keep -- we watch it daily." ] }, { "name": "Greg Melich", "speech": [ "Got it. And then my follow-up question sort of goes back to really supply chain. I know you have the plan, and it's coming along. Just given the investments ramps we've seen on -- particularly in supply chain, not just from your No.", "1 competitor, Home Depot, but from Amazon, from Walmart, where capex is sort of up significantly from where it was a year ago. Is there anything you're seeing that you're planning on leaning more into as you get through the first year or two of that $1.7 billion plan, whether it's more market delivery operations, more centralized fulfillment? Anything on that as to what you're seeing them do and how you want to respond." ] }, { "name": "Marvin Ellison", "speech": [ "No, Greg. I think COVID and the pandemic really taught us all about responding to the needs of the customer in a more dramatic way. And also, it taught us how quickly consumer preferences will shift, specifically when it comes to how customers desire to receive products that they purchase. We feel like our strategy is sound.", "We're the No. 1 appliance retailer in the U.S. and we do it the hard way. We deliver it from every store, and that is not an optimal way to manage such a large amount of inventory and such a large expense from a transportation perspective.", "So going to a market-based model is going to unlock an enormous amount of productivity, not only from a store labor perspective but on how we manage billions of dollars in inventory around the company. So market-based delivery is absolutely the way to go. In the moment, we bill the process for appliances, it opens up other product categories like riding lawn mowers and sheds and patio furniture and grills. So this market-based model is going to be incredibly important for us.", "We opened up a dot-com fulfillment DC in Southern California this past year. It gives us the ability to have two-day delivery from an e-comm perspective to every U.S. location. We're also opening up three additional e-commerce fulfillment centers.", "That's relatively new to our strategy, to answer your question, and that's going to give us the ability to create more same-day next-day delivery opportunities. And we're aggressively building out our bulk distribution centers and our cross docks to help with the market delivery. In addition to that, we're going to be leaning into Pro job site delivery, and we have a couple of initiatives under way that we're working on to make that a reality. So the short answer to your question is we benchmark a lot.", "We look at what's working in the marketplace, but we feel really good about the strategy we've laid out. And there's a reason why most retailers delay supply chain transformations because they're very hard to do. And we're committed to it and we understand the benefit of it. And we're going to make the right investments, and we believe is going to allow us to be competitive in out-years.", "But as an investment, we know we're going to have to lean into for the next couple of years. But again, it's something we're very committed to.", "That's great. Great color. Thanks, guys, and good luck.", "Thank you." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2021-08-18	[ { "description": "Vice President, Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "Chairman, President, and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President", "name": "Dave Denton", "position": "Executive" }, { "description": "Citi -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" }, { "description": "Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone and welcome to Lowe's Companies second-quarter 2021 earnings conference call. My name is Darryl and I will be your operator for today's call. [Operator instructions] I will now turn the call over to Kate Pearlman, vice president of investor relations." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you and good morning, everyone. Here with me today are Marvin Ellison, chairman, president, and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president, stores; and Dave Denton, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2021.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning's press release in our investor relations website.", "With that, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate and good morning, everyone. I'd like to begin by taking a moment to extend my thoughts and prayers to those who are impacted by the ongoing pandemic as well as the many wildfires. At Lowe's, we remain committed to the health and safety of our associates and customers while supporting the communities in which we operate. The resilience of our customers and our associates is something that I admire on a daily basis.", "Now, turning to our results. We are very pleased with the performance for the second quarter. During the quarter, comparable sales declined 1.6% for the total company and 2.2% for the U.S. And on a two year basis, comp sales were positive 32% for the total company and for the U.S.", "Our outstanding two year performance was driven by great execution of our total home strategy, which allowed us to win with both the pro and DIY customers while meeting the aggressive growth demands across Pro, Lowes.com and our installation services business. As anticipated, during the quarter, we saw a decline in DIY demand versus last year as many families transition back to pre-COVID purchase patterns and weekend mobility after Memorial Day. But because of the agility of our total home strategy, we were able to capitalize on pro demand driving growth of 21% this quarter and 49% on a two year basis. This level of pro growth would not have been possible without our intense focus on the pro customer over the past 24 months.", "This intense pro focus includes our U.S. stores reset project that we executed last year. This reset has allowed us to create a more intuitive store layout for the pro aligned across product adjacencies, so pros can quickly and easily locate all products they need for their jobs. And as a reminder, our core pro customer is a small- to medium-sized business owner.", "These customers shop frequently across the store, impacting numerous product categories. And as we continue to capture more of their spend, we will continue to increase productivity across the top and bottom line of our stores. Later in the call, Bill will discuss how we will continue to expand our pro product offerings and then Joe will discuss our enhanced online experience for the Pro. We also delivered double-digit growth this quarter in our installation services.", "We continue to expand the products available for installation and we're leveraging our enhanced e-commerce platform and our revamped business model to deliver a better customer experience. We expect our installation services business to continue to play an important role in our total home strategy as customers increasingly look to us to provide an end-to-end turnkey solution for their home project needs. And at Lowes.com, sales grew 7% on top of 135% growth in the second quarter of 2020, which represents a 9% sales penetration this quarter and a two year comp of 151%. Our enhanced omnichannel offering continues to resonate with our customers who increasingly expect total flexibility in shopping however, whenever and wherever they choose.", "We're also pleased with the performance of our Canadian business. In the second quarter, Canada delivered comp growth in line with the U.S. despite several COVID-related operating restrictions. We also continued to elevate our product offering, which is another pillar of our total home strategy as we help fulfill the aspirations of our customers to upgrade their homes and style.", "And we delivered strong positive comps across kitchen and bath, flooring, appliances and decor on top of 20% growth in these categories last year. The 17% growth we experienced in ticket over $500 was in large part driven by these categories, reflecting continued consumer confidence in investing in their homes. This also reinforces the consumers' confidence in Lowe's as the right destination for their home decor needs. And during the quarter, operating margin expanded approximately 80 basis points leading to diluted earnings per share of $4.25, which is a 13% increase as compared to adjusted diluted earnings per share in the prior year.", "In the face of unprecedented lumber price volatility during the second quarter, our improved operating performance reflects the benefits of our new price management system along with our disciplined focus on perpetual productivity improvement, or PPI. Bill and Joe will discuss both these initiatives in more detail later in the call. I'd now like to take a moment to discuss a very important milestone in the company's transformation. When I joined Lowe's as CEO back in July of 2018, I discussed the importance of transforming and modernizing our supply chain.", "The foundation of this transformation is transitioning the company from a store-based delivery model to a market-based delivery model for big and bulky products. I'm pleased to announce that this quarter, we completed the conversion of our Florida region to a market-based delivery model for appliances and other big and bulky items like grills, riding lawn mowers and select patio furniture. In this new delivery model, product flows from the bulk distribution centers to cross-dock terminals directly to customers' homes, bypassing the stores altogether. This replaces a legacy store delivery model where we hold appliances in stockrooms and storage containers behind our stores and then leverage store-based trucks and associates to deliver these products to customers' homes.", "To say this legacy process is inefficient would be an extreme understatement. The new market-based delivery model is already driving higher appliance sales, improved profitability, lower inventory, higher on-time delivery rates and improved customer satisfaction. And we're freeing up space in our stockrooms, which will enable us to expand our same-day and next-day pro and DIY fulfillment capabilities in the near future. We plan to roll out the market-based delivery model across additional regions by the end of the year and then complete the rollout across the U.S.", "over the next 18-plus months. With this new delivery model, we will continue to drive sales, inventory turns and operating leverage through a technology-driven, simplify and customer-centric process. Before I close, I'd like to share my perspective on the home improvement market as well as Lowe's opportunity to win in this market. The outlook for the home improvement industry remains very positive.", "Residential investment is expected to remain high due to historically low mortgage rates while home prices continue to appreciate. We're also pleased that we continue to see higher household formation trends and longer-term wallet share shift to the home. It's also worth noting that any near-term pressures on housing turnover is not related to an economic downturn as typical. In fact, there is more housing demand than supply, resulting in home prices continuing to rise.", "And because of this, consumers have an increased confidence in repairing and remodeling their homes. As a reminder, approximately two-thirds of Lowe's annual sales are generated from repair and maintenance activity. Further, our research shows that it will take years for the supply of homes to meet the projected demand. This remains a very positive indicator for home improvement.", "In addition, the customers' mindset regarding their home is very straightforward. As long as their home is increasing in value, they see upgrades and enhancements to their home as an investment and not an expense. Looking ahead, although the business environment remains uncertain, we are confident that our total home strategy provides us with the agility to operate with profitability in times of high and low customer mobility. And finally, I would like to extend my heartfelt appreciation to our frontline associates.", "As I travel the country on a weekly basis visiting stores, I'm continually inspired by the hard work and commitment of our associates to support our communities while providing excellent customer service. And with that, I will now turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin and good morning, everyone. U.S. comparable sales were down 2.2% in the second quarter but up 32% on a two year basis. We drove solid positive comps in our building products and home decor divisions.", "And while we delivered a terrific spring over the first half of the year, the pivot in consumer behavior after Memorial Day resulted in negative comps in our seasonal categories this quarter. However, growth was broad-based on a two year basis with all product categories up more than 15% in that time frame. In building products, we delivered double-digit comps in electrical and lumber driven by strong pro demand as well as high levels of inflation. And as Marvin mentioned, our merchandising and finance teams navigated through unprecedented lumber price volatility this quarter.", "Our enhanced pricing systems enabled us to effectively mitigate the impact on our product margins. Dave will provide more detail on the near-term impact of the lumber price decline on our margins and sales, but I'm confident that our talented teams have the right pricing tools and processes to continue to manage through elevated levels of inflation and pricing volatility. I'm also pleased with our performance in home decor as DIY customers continue to rely on Lowe's for their home remodeling needs. By leveraging our total home strategy, we delivered positive comps across appliances, kitchens and bath, flooring and decor on top of over 20% growth in these categories last year.", "Capitalizing on our No. 1 position in appliances, we delivered strong comps in the category this quarter with particularly standout performance in washers and dryers as well as refrigerators and freezers. Countertops, kitchen cabinets and vanities were the strongest contributors to our kitchen and bath comps as our customers continue to appreciate the new on-trend, coordinated styles that are available in our own allen + roth brand. Vinyl flooring was the top-performing category within flooring driven by new and innovative WetProtect product from Pergo.", "It's a leading brand in this category that is exclusive to Lowe's and this product provides peace of mind to our customers with its guaranteed waterproof protection for both the flooring and sub-floor. We also delivered a strong spring season in the first half of the year that kicked off with the launch of our new SpringFest event. We were very pleased that our customers took advantage of the strong product offerings to help make the most out of their outdoor living spaces In this quarter, we delivered over 30% growth in battery-operated outdoor power equipment. Both our DIY and pro customers are drawn to the convenience and the quality of the EGO, Kobalt, CRAFTSMAN and Skill brands with their zero-emission, rechargeable equipment.", "And the addition of the EGO and Skill brands only bolsters our No. 1 position in outdoor power equipment and they truly complement our other leading brands such as John Deere, Honda, Husqvarna, Aaron's and CRAFTSMAN. We continue to add new brands and products to our lineup, especially for our pro customer. This quarter, with the launch of Flex Power Tools, we featured an in-store demo station for our new Flex cordless power tools.", "This brand is exclusive to Lowe's and delivers innovation to the power tool category, bringing more power and faster charging time than its competition. We also introduced the Mansfield brand across our bath department with drop-in tubs, showers and toilets. Another exclusive in the home center space, Mansfield is a strong pro brand and their products are made right here in the United States. And I'm excited to announce that we'll be bringing more U.S.-manufactured product to Lowe's this fall with the launch of SPAX fasteners.", "SPAX is the market leader in multi-material construction screws. Their industry-leading innovation delivers some of the most advanced fasteners on the market. The addition of SPAX to the fastener program now rounds out the pro assortment in this category that our pro customers need. The addition of Flex Power Tools, Mansfield plumbing products and SPAX fasteners, continues to enhance our pro brand arsenal, which already includes strong pro brands such as Simpson Strong-Tie, DEWALT, Bosch, Spyder, GRK, FastenMaster, ITW, Lufkin, Marshalltown, S-Wing, Eaton, SharkBite and LESCO.", "As Marvin previously discussed, we delivered strong sales growth of 7% and a two year growth of 151% on Lowes.com. This quarter, we enhanced our omnichannel customer experience with the launch of our virtual kitchen design, which enables customers to create their dream kitchen, allowing them to work on their projects seamlessly between Lowes.com and the specialists on our virtual central design team. As part of our total home strategy, we are launching virtual search in our stores, which now allows a customer to hover their smartphone over a product and explore an endless aisle of similar items on Lowes.com. This is just one example of how we continue to integrate the online and in-store shopping experiences.", "And looking ahead, we are excited about the upcoming fall and winter holiday seasons as our customers will turn their attention to doing their homes and outdoor living spaces as the weather cools. We are confident that our total home strategy will enable us to continue to elevate our product assortment and allow us to take market share across our DIY and pro customers. We will also continue to leverage our new price management system to effectively manage our product margins with a disciplined approach to vendor cost management and a data-driven portfolio approach to pricing to further enhance and refine our everyday competitive price strategy. And before I close, I'd like to once again extend my appreciation to our vendor partners and our merchants for their commitment to serving our customers.", "Thank you and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Bill and good morning, everyone. For the second quarter, we continued to drive improved execution in our stores with our associates laser-focused on serving customers and maintaining a safe store environment. In early August, in response to the surge of the Delta variant, we reinstated mask requirements for all of our associates regardless of their vaccination status. I'm appreciative that our associates are once again rising to the dynamic challenges presented by this pandemic.", "I'm pleased to announce that for the sixth consecutive quarter, 100% of our stores earned a Winning Together profit-sharing bonus, resulting in a $91 million expected payout to our frontline hourly associates. And because our efforts once again exceeded expectations, this represents an incremental $20 million over the target payment level. We're also very pleased that our PPI initiatives continue to gain traction, driving operating efficiency again this quarter as we leverage store payroll through operational process improvements and technology enhancements, reducing the amount of time our associates spend on tasking activities so they can focus instead on serving the customer. During the quarter, we maintained strong staffing levels despite isolated labor shortages in some areas of the country.", "We continue to enhance the labor scheduling system that we launched in 2019, which allows us to align our payroll hours with customer traffic patterns. It also enables us to respond rapidly and effectively to changing market conditions so that we can ensure that we continue to provide great customer service while also driving operating leverage. This year, we've installed our homegrown self-checkout solution in over 550 stores that did not have any self-checkout capability for our customers. This Lowe's-designed self-checkout was built with the home improvement shopper in mind, featuring a simplified user interface, multiple ways to scan product and the ability to use Lowe's military and credit card discounts.", "This new solution is already driving higher customer adoption rates and incremental payroll leverage. And with the digital signs fully rolled out across lumber and appliances, we are not only driving labor savings but also enhance product margins as we can now adjust prices more quickly to protect share and margins during periods of price volatility. As previously discussed, our online penetration for the quarter was 9%. And with approximately 60% of online orders picked up in the store, our dedicated in-store fulfillment teams are an integral part of the Lowe's omnichannel customer experience.", "We are continuing to leverage technology to improve efficiency in the customer experience, whether customers get their orders the front desk or through curbside or through their favorite option, our new pickup lockers. Now, let's turn to our performance of the pro customer. As discussed earlier, pro continues to outpace DIY with pro comps of 21% for the quarter and 49% on a two year basis. We continue to expand our digital connection with the pro customers.", "We just completed the migration of Lowe's for pros to the cloud. This important step in our pro business evolution enables enhanced features, faster updates, improved site stability and more personalized offers for the Pro. One new feature is rapid reorder, which enables our pro customers to quickly reorder items that they frequently purchase through Lowe's. We are focused on making the pro shopping experience both online and in-store as easy and intuitive as possible.", "We're also growing our pro loyalty program as we look for innovative ways to expand our members-only benefits. Every day, we are striving to demonstrate that Lowe's is the new home for pros . Looking ahead, I'm excited about the second half of the year as we leverage our total home strategy to build on the momentum in pro and installation services while also meeting the needs of the DIY customers as they continue to tackle interior and exterior projects to improve their homes. Before I close, I would like to once again extend my appreciation to our frontline associates along with other executive and senior officers as well as merchants and field leaders.", "I'm out visiting stores on a weekly basis to ensure that we continue to engage with and support our frontline associates in this challenging operating environment. I'm incredibly proud of this team and their continued hard work and dedication. With that, I'll turn it over to Dave." ] }, { "name": "Dave Denton", "speech": [ "Thanks, Joe and I'll begin this morning with a few comments on the company's strong capital allocation program. In the second quarter, we generated $2 billion in free cash flow driven by continued strong operational execution and consumer demand. We returned $3.6 billion to our shareholders through a combination of both dividends and share repurchases. During the quarter, we paid $430 million in dividends at $0.60 per share and we announced a 33% dividend increase to $0.80 per share for the dividend paid on August 4.", "Additionally, we repurchased 16.4 million shares for $3.1 billion and we have $13.6 billion remaining on our share repurchase authorization. Capital expenditures totaled $385 million in the quarter as we invest in the business to support our strategic growth initiatives. We ended the quarter with $4.8 billion in cash and cash equivalents on the balance sheet, which remains extremely healthy. At quarter end, adjusted debt-to-EBITDAR stands at 2.08 times, well below our long-term stated target of 2.75 times.", "With that, now I'd like to turn to the income statement. In Q2, we generated diluted earnings per share of $4.25, an increase of 13% compared to adjusted diluted earnings per share last year. During the quarter, we drove improved operating leverage as we executed against numerous productivity initiatives across the company. My comments from this point forward will include approximations and comparisons to certain non-GAAP measures where applicable.", "Q2 sales were $27.6 billion with a comparable sales decline of 1.6%. Comparable average ticket increased 11.3% driven by over 400 basis points of commodity inflation, mostly in lumber, as well as higher sales of appliances and installations. This was offset by comp transaction count declining 12.9% due to lower sales to DIY customers of smaller ticket items like cleaning products, paint, mulch and live goods. In Q2, we cycled over a period when consumer mobility was limited, so many of our customers were tackling smaller projects around their homes.", "Also in Q2 of this year, DIY customers pulled back on purchasing lumber and related attachments due to extremely elevated lumber prices in the quarter. Keep in mind that comp transactions increased 22.6% last year, which results in a two year comp transaction count increase of 6.8%. As Marvin indicated, our investments in our total home strategy gave us the ability to pivot during the quarter and led to outperformance in many of our key growth areas with pro up 21%, online up 7%, installation services up 10% and strong positive comps across DIY decor categories. U.S.", "comp sales were down 2.2% in the quarter but up 32% on a two year basis. Our U.S. monthly comps were negative 6.4% in May, negative 1.8% in June and a positive 2.6% in July. After Memorial Day, there was a noticeable increase in consumer mobility and consumers engaged in the opportunity to travel and spend in other discretionary categories.", "We saw a related decline in DIY customer traffic in our stores on the weekends while weekday traffic remained strong. Looking at U.S. comp growth on a two year basis from 2019 to '21, May sales increased 32 and a half percent, June increased 32% and July increased 31 and a half percent. Gross margin was 33.8%.", "As expected, gross margin rate declined 30 basis points from last year but was up 165 basis points as compared to Q2 of '19. Product margin rate improved 40 basis points. Our teams effectively managed product cost and pricing this quarter despite unprecedented volatility in lumber prices. Our teams continue to minimize vendor cost increases driven by higher commodity prices and elevated industry transportation costs.", "Also, higher credit revenue drove 30 basis points of benefit to gross margin this quarter. These benefits were offset by 20 basis points of pressure from shrink and live good damages from the extreme weather conditions in the West, also 25 basis points of mix pressure related to lumber and 20 basis points from less favorable product mix in other categories. Supply chain costs also pressured margin by 35 basis points as we absorbed some elevated distribution costs and continue to expand our omnichannel capabilities. Our supply chain team continues to leverage our scale and carrier relationships to minimize the impact of these distribution costs experienced across the retail industry.", "Now, I'd like to spend just a moment discussing the near-term impact from the steep drop in lumber prices beginning in early July. Since that time, we have been selling many of our lumber products at compressed margins because we had previously purchased these products at higher cost. However, we expect that by the end of August, we will have substantially sold through these higher cost inventory layers. And despite these short-term pressures, we are still expecting that our gross margin rate to be up slightly for the full year versus last year.", "SG&A at 17% of sales levered 135 basis points versus LY driven primarily by lower COVID-related costs. We incurred $25 million of COVID-related expenses in the quarter as compared to $430 million of COVID-related expenses last year. The $405 million reduction in these expenses generated 145 basis points of SG&A leverage. These benefits were offset by 20 basis points of pressure from higher overall employee healthcare costs.", "Operating profit was $4.2 billion, an increase of 6% over LY. Operating margins of 15.3% of sales for the quarter was up 80 basis points to the prior year. This improvement was generated by improved SG&A leverage, partially offset by lower gross margin. The effective tax rate was 24.4% and it was in line with prior year.", "At the end of the quarter, inventory was $17.3 billion, down $1.1 billion from Q1 and in line with seasonal trends. This reflects an increase of $3.5 billion from Q2 of 2020 when our in-stock positions were pressured due to elevated demand levels and COVID-related supply disruption. Current inventory includes a year-over-year increase of $665 million related to inflation, the majority of which is attributable to lumber. Now, before I close, let me comment on our current trends and how we are planning the business for the second half of this year.", "Clearly, we continue to manage our business in a very fluid environment with the Delta variant trends injecting new uncertainty into the forecast. However, given our strong first half performance, Lowe's is clearly tracking well ahead of our robust market scenario that we shared with investors back in December of 2020. Our outlook assumes that the home improvement market will moderate somewhat in the second half given lower levels of commodity inflation and a continued increase in consumer mobility driven by return to work and school. We are expecting Lowe's mix-adjusted market demand to be essentially flat for the full year.", "This relevant market view reflects Lowe's higher DIY mix and lower online penetration. Now, in this revised scenario, we expect Lowe's to deliver sales of approximately $92 billion for the year, representing two year comparable sales growth of approximately 30%. Month-to-date, August U.S. comp sales trends are materially consistent with July's performance levels on a two year comparable basis.", "As expected, we are already seeing a several hundred-basis-point improvement in comp transaction count over the Q2 levels, partially driven by increased unit sales of DIY lumber and related attachments as DIY customers who were sitting on the sidelines reengaged after lumber prices dropped. Importantly, we expect gross margin rate to be up slightly versus the prior year as we leverage our pricing and promotional strategies to mitigate the impacts of product and transportation cost inflation. With elevated sales levels projected and our current productivity efforts taking hold, we are now raising our outlook for operating income margin to 12.2% for the full year. We are expecting a 10-basis-point negative impact from elevated cost inflation.", "Furthermore, we are tracking well ahead of our operating plans. And as such, we now expect to incur higher-than-planned incentive compensation, resulting in 20 basis points of pressure. Together, these expenses represent 30 basis points of operating margin deleverage relative to the $92 billion revenue outlook. Without these offsets in expenses, we would be expecting an operating income margin of 12 and a half percent for the full year.", "When I consider our outlook for the business for the remainder of this year, I'm very pleased that we are now expected to deliver approximately 145 basis points of operating margin improvement over 2020. This reflects a disciplined focus on driving productivity and operational excellence across the organization. We are planning for capital expenditures of $2 billion for the year. Furthermore, we expect to execute a minimum of $9 billion in share repurchases.", "In closing, we are operating in a great sector expected to benefit from the secular tailwinds over the next several years. We are investing in the business and our total home strategy to drive long-term growth so that we continue to outperform the market and drive meaningful long-term shareholder value. With that, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first questions come from the line of Kate McShane with Goldman Sachs. Please proceed with your questions." ] }, { "name": "Kate McShane", "speech": [ "Hi. Good morning. Thanks for taking our question. Just given the changes in the pro with all the brand additions you've made and the changes you've made to the store plus the change we've seen in terms of sales mix toward the Pro, can we assume that the sales mix for pro for Lowe's is higher than the 20% to 25% you've quoted in the past? And how did the pro comp of 21% compare to your plan for the quarter?" ] }, { "name": "Marvin Ellison", "speech": [ "Kate, this is Marvin. I'll take the question. I would say that pro outperformed our original plan. We knew that we would see a greater shift to pro versus DIY based on what we saw in the first quarter.", "But the 21% comp and the 49% two year comp is something that exceeded our original expectations. Having said that, if you take a look at our pro penetration from 2018 to today, it's roughly a 300-basis-point improvement. But as our total sales continues to grow, the overall pro penetration still hovers around 25%." ] }, { "name": "Kate McShane", "speech": [ "OK, thank you very much. And just with regards to gross margin as a follow-up question, it seems that your guidance for gross margin being up slightly for the year implies that gross margins can be flat to up in the back half. Is there any way to delineate what Q3 looks like versus Q4?" ] }, { "name": "Dave Denton", "speech": [ "Kate, it's Dave. I'm probably not going to give that level of granularity. I would say what is important, you have it exactly right, we do expect gross margin in the back half to be up slightly and certainly up for the full year." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next questions come from the line of Simeon Gutman with Morgan Stanley. Please proceed with your questions." ] }, { "name": "Simeon Gutman", "speech": [ "Hey. Good morning, everyone. Thanks for the question. My first question, it's a little theoretical on actually '22 and I know you haven't given guidance on this yet.", "The question is, if the business grows next year, if the industry grows next year, is there any cost pressure that we're seeing from this environment that could preclude margins from growing in a sales growth environment? And then alternatively, if sales are flat or decline slightly, are there enough levers in the transformation of this business to allow margins to grow? And I'm just trying to understand what sort of buttons in Flex and how you think about managing the business going into next year." ] }, { "name": "Dave Denton", "speech": [ "Simeon, this is Dave. Maybe I'll start. I'm sure Marvin will maybe chime in here a bit as well. Is -- clearly, as we stated today, we had an objective to get to 12%.", "Now just with the strength of the business, seeing line of sight to above 12% at this juncture, clearly, we have aspirations and targets to get to 13% and we're still tracking nicely to those -- to that objective. As we said, we are experiencing cost pressures from an industry perspective. Our model and what we put into the business and invest in the business allows us to be flexible and pivot such that in periods when sales are flat or sales are going up slightly, we can actually lever the business. So it's our expectation that we would continue to make progress as we continue to march to that longer-term goal of 13%." ] }, { "name": "Marvin Ellison", "speech": [ "Simeon, this is Marvin. The only point I'll add is we're very pleased that over the last three years, we've been able to put systems and organizational structures in place that really supports Dave's point of the agility we have. If you go back to first quarter of 2019 when we had the cost and price issues, we had no internal mechanisms to manage that effectively. We've now rolled out a new modern price management system.", "Bill Boltz, Dave Denton and the merchants and finance team have created cost mitigation teams that work on a daily basis, helping us to manage cost retail and making the right decisions that first we'll think about the customer and how we can deliver value on an ongoing basis. So in summary, we now have levers that we can pull that we didn't have in the past. And so Dave's point is exactly correct, we think we can manage this effectively today and in the future." ] }, { "name": "Simeon Gutman", "speech": [ "And then maybe the related follow-up and thinking about the composition of the different margins, the gross margin and the SG&A, I know -- I think conceptually, the growth shouldn't really be going up much. But within the transformation, there are certain things that are targeted on the gross margin line like some of the supply chain initiatives that should lower some -- take some costs out of the business. So is the principal still the same where gross is still sort of rangebound and it's SG&A leveraged is how the margin expansion should come from here?" ] }, { "name": "Dave Denton", "speech": [ "Yeah. Simeon, that is correct. Keep in mind that we're making really nice progress from a product margin perspective. We continue to expand in that area.", "At the same time, we're investing in supply chain. And as we invest in supply chain, that essentially dilutes gross margin, but it relieves us of SG&A in the store. So therefore, the flow-through is very productive on the bottom line. But again, you have a geography shift as costs move up in the gross margin but out of SG&A." ] }, { "name": "Simeon Gutman", "speech": [ "OK, that's helpful. Thanks guys. Good luck." ] }, { "name": "Operator", "speech": [ "Thank you. Our next questions come from the line of Zach Fadem with Wells Fargo. Please proceed with your questions." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. So within the context of your 12.2% EBIT margin outlook, could you parse out the impact from the productivity enhancements you've been making across the business, things like market-based delivery, labor scheduling, digital signage, etc.? And as we think about the back half of the year, should we expect these benefits to widen or are there any offsets from incremental investment like resets, etc.?" ] }, { "name": "Joe McFarland", "speech": [ "There's no incremental projects that we're putting on our plate at this point in time for the balance of the year. I think the playbook that we launched at the beginning of the year continues to hold true because we're making the right investments in our business and we don't see a need to change that. Having said that, if you look at the back half of the year, we are making investments in supply chain. We're -- as Marvin indicated, we now have launched Florida.", "We're going to roll it out into other markets for the balance of the year. So that's putting some pressure on us as we plan, but you're going to see SG&A leverage come through as we continue to invest in productivity. It's going to drive performance and we're going to overlap COVID-related expenses that are nonrecurring in the back half of this year, both of which is really driving SG&A productivity." ] }, { "name": "Marvin Ellison", "speech": [ "And Zach, this is Marvin. The only thing I'll add is, Joe mentioned in his prepared comments our rollout of our proprietary developed self-checkout and how that's not only creating a better customer experience, it's also helping us to leverage payroll expense the correct way by implementing technology that reduces manual labor spend. And we talked about our PPI initiatives where we have a long list of technology enhancements that Joe is working with Seemantini, our chief information officer, that's allowing us to improve productivity, improve the customer experience and reduce tasking hours and all of that is part of the equation of us now tracking toward our 13% operating income long-term target." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And then you called out some reluctance or elasticity in the first half of the year given the rise in lumber and building material prices. So with pricing now starting to come in a bit and July, August comps inflected positive, could you talk about whether you think projects were delayed at all in the first half and to what extent this could be a driver of reacceleration in the second half?" ] }, { "name": "Marvin Ellison", "speech": [ "So I'll let Joe take that and let him just talk specifically about what we're hearing from our pro customers about their book of business and also as we look at our installation services business, what we see in our own pipeline." ] }, { "name": "Joe McFarland", "speech": [ "So Michael, a couple of things. First, starting with the services, we definitely believe in the project business of this install business. And when you look, there were definite categories delayed, things primarily outdoor projects, fencing, decking. As you looked at the peak in lumber prices, we found where customers were not willing to continue to invest based on the price.", "At the same time, we mentioned in the prepared remarks the strength in kitchen and bath, our interior category has really outperformed in the second quarter, delivering over 20% comp. So as we look at the shift from exterior to interior, we look at the focus of the total home, we look at our focus on the pro business, we migrated to the Google Cloud, we rolled out pro loyalty and we continue to add enhanced features and we're seeing great response from the customers from services standpoint, also the pros from Lowe's being the new home for pros." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Appreciate the time guys." ] }, { "name": "Operator", "speech": [ "Thank you. Our next questions come from the line of Michael Lasser with UBS. Please proceed with your questions." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thank you all for taking my question. Marvin, the general perception is that the DIY market is going to slow considerably and Lowe's will be disproportionately negatively impacted by that given the mix of business. How would that be wrong?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, I'm not saying that is wrong. I think that also may consider that we're not going to improve our pro business. So as I mentioned in my prepared comments, we've been working diligently for 24 months to really have a solid pro business. One of the reasons why we delivered a 32% two year comp is because 49% of our pro comp drove that in that two year basis.", "So if you look at it in isolation, Michael, that probably is a true statement, but it's a dynamic business. Dynamic in the nature that we're improving our pro business reflected by the results, dynamic in the nature that we're going to continue to take market share with the DIY customer with the things that we're launching in Decor, how we're enhancing the allen + roth brand. We just acquired STAINMASTER as a brand that we're going to expand. So I think that the dynamic nature of DIY and our growth in pro I think will put that synopsis into questions." ] }, { "name": "Dave Denton", "speech": [ "Yeah. Hey, Michael, this is Dave. Just don't forget that what has happened here over the last 18 months is a reemphasis back on the home and what you're seeing is despite the fact that the market is open -- or the U.S. market is opening up, you're still seeing a large contingent of work from home, school from home, utilizing their home for other activities other than just dwelling.", "So I believe that over time, there is a secular trend and tailwind to this industry both from a pro and from a DIY perspective. I assume demand will mitigate a little bit, but it's not going to fall off the floor either." ] }, { "name": "Michael Lasser", "speech": [ "Got it. Super helpful. My follow-up question is, can you quantify the comp and margin lift that you've seen in Florida? And you mentioned that you're going to roll this out to other markets through the rest of the year. How quickly can you have this up and running across the country across all of your markets?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, I mentioned in the prepared comments, we're looking at an 18-plus month rollout cycle because we want to ensure that we do it efficiently and there is a significant amount of change management, change management from a process standpoint for our associates and change management in putting new systems in so that we can basically create virtual inventory and not have inventory on hand to sell, which is exactly what a market-based delivery model is. We're very pleased with what we're seeing in Florida. We're pleased with the inventory reduction, the lift in sales, the productivity, the expense reduction. But we're a big company.", "And we want to make sure, as the old saying goes, we go slow to go fast, so we can do this efficiently. But we're excited about the possibilities. And as I said, this is the foundation of our supply chain transformation. And Don Frieson, our lead in supply chain, joined the operations team, deserve a lot of credit along with IT for allowing us to have the success in Florida that we're now confident that we can roll this out to the whole company." ] }, { "name": "Michael Lasser", "speech": [ "Very helpful. Thank you so much and good luck." ] }, { "name": "Operator", "speech": [ "Thank you. Our next questions come from the line of Christopher Horvers with J.P. Morgan. Please proceed with your questions." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, everybody. Can you talk -- just to check our math. So it seems like you're a 1% to 2% comp quarter to date.", "Is that right? And can you talk about what you're seeing on the pro versus DIY trend as some of the schools have gone back? Maybe in the south, are you seeing more of a focus on the home and expect that sort of the DIY business can hold in as people get back in their homes?" ] }, { "name": "Marvin Ellison", "speech": [ "Chris, as you can respect, we want to -- we don't want to get too granular on our inter-quarter data. We felt it was prudent to share August trends just based on the unique nature of our business environment. But if you go back to Dave's comments, we compare August month to date to July on a two year comp basis. That -- so that's how we're looking at the business.", "We think with the extraordinary business results we saw in 2020, the best way for us to measure our business is to look at it on a two year basis. Now, having said that, we feel great about the trends that we're seeing across pro and DIY. We believe that for the balance of the year, the pro customer will outperform DIY just based on the year-over-year overlaps. But as Dave said, we're equally confident that the DIY will continue to invest in their home because of home price appreciation, because of the age of housing stock and because of the simple nature that as your home increases in value, you have more confidence to invest.", "So we feel great about our performance. We feel so much in strong support that we raise our outlook on the top and bottom line and that reflects that we have a pretty good line of sight to how the rest of the year should play out." ] }, { "name": "Christopher Horvers", "speech": [ "Yeah. Absolutely." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah, and I'll just an additional comment. Your question specifically on south and performance in the second quarter, we were very pleased with Southern division's performance from a pro standpoint." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Yeah, the two year CAGR sequentially was very strong. And following up on the gross margin side. So you did go slightly above the prior guidance.", "So is the pricing sophistication and maybe credit driving that improved outlook? And just to foot back to that 10 basis points, it sounds like lumber pressure, that would all accrue, that's an annual impact and that's basically all going to impact the third quarter." ] }, { "name": "Dave Denton", "speech": [ "Well, I think what we said is we're now, at the moment, experiencing margin pressure in lumber and that's going to cycle through here by the end of August. We feel good about that. We continue to invest and focus on both our cost management and our pricing ecosystem here at Lowe's. And I think between the merchant and finance team, we have a really good analytical process that we're driving performance in those areas and we have now really good line of sight to seeing gross margins up this year despite the fact that we are making investments in supply chain that is compressing margin from a cost perspective." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Thanks very much. Good luck." ] }, { "name": "Operator", "speech": [ "Thank you. Our next questions come from the line of Steven Zaccone with Citigroup. Please proceed with your questions." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Thanks for taking my question. I wanted to focus on the pro side of the business since you're having outperformance thus far in 2021. Can you talk a bit about market share performance, maybe how you feel relative to the competition thus far?" ] }, { "name": "Marvin Ellison", "speech": [ "Steve, I would say, as I have said in previous calls that home improvement market share data is suspect at best because the data set is not great. As we look at our growth in Pro, anytime you grow the business, 49% on a two year basis, you can assume pretty confidently that you're taking market share. And we think that, that market share is coming from a host of competitors, both small and large. I think it's also reflective that Lowe's has not had a coherent pro strategy in the past 10 years.", "And I think Joe McFarland and his team along with Bill Boltz and the merchants have done a really nice job of getting us a line on Pro. What I'd like to do is I just want to be able to take a moment and talk about some of the pro brands that we've been able to add in brands that are untapped that we think will continue to allow us to take share in this business." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. Thanks, Marvin. So Steve, in my prepared remarks, I mentioned we're getting ready this quarter to round out our fastener program with the launch of SPAX, just a great program in the fastener segment, already complementing other brands that the merchants have brought in with the likes of GRK, FastenMaster, Power pro One. And then across other parts of our business, we announced Mansfield, that's a strong pro brand in the plumbing space.", "We've had success getting Honda to join the Lowe's family, which is a big deal for us, another great program, LESCO fertilizers that we talked about in the first quarter. And then we've had just real good success of getting other brands like Marshalltown, ITW, Lufkin. I named a bunch of them and we're just -- we're fortunate that these brands have recognized the value of what we're doing at Lowe's with the pro strategy and recognize that it's an opportunity for them to grow as well." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Thanks. Just a follow-up on the e-com side of the business since you're still seeing some growth there on top of the strength last year, what are the priorities to continue to drive growth there this year? And I guess longer term, where do you think penetration could fall for that side of the business?" ] }, { "name": "Bill Boltz", "speech": [ "So Steve, this is Bill. So on the Lowes.com side, obviously, continuing to enhance product assortments, continuing to make sure that content is enriched in all of the kind of the basic fundamentals are key to continuing to build this out. But as we said in our prepared remarks, we've had new enhancements that we've been able to leverage, the kitchen design program, virtual search. We've also, as Joe mentioned, migrated the Lowe's for pros over to the cloud.", "We moved all of Lowes.com to the cloud a few months back. All of those initiatives are helping, making it easier and faster to make enhancements to the Lowes.com business on a weekly basis. And then the merchant teams are continuing to look at ways in which we test new products and test new brands and doing different things. So working with our brand advocates to make sure that we're putting the right stuff out there in front of the customer, the recommended products that go with a product so that you can buy the whole project.", "So just a lot of great things going on with the Lowes.com team. And they continue to bring enhancements on a weekly basis to make sure that we're relevant. And we see this as a nice opportunity for us over the next three plus years to continue to grow our business." ] }, { "name": "Marvin Ellison", "speech": [ "And on the penetration question, we'll probably end the year around 10%. And we are purposely not trying to set penetration targets. We're really trying to be more customer-centric and create an environment for a customer to shop any way they choose. I mean we talk about omnichannel and that's an overused term lately.", "But in essence, we just want to give the customer choices to shop, in store, online, pick up in a locker, curbside, in store, ship from store and just provide a multitude of options. And we'll let the penetration kind of land where it lands." ] }, { "name": "Steven Zaccone", "speech": [ "Very helpful. Thanks guys." ] }, { "name": "Operator", "speech": [ "Thank you. Our next questions come from the line of Eric Bosshard with Cleveland Research. Please proceed with your questions." ] }, { "name": "Eric Bosshard", "speech": [ "Good morning. Thanks. Two things. First of all, the lumber gross margin impact on the year is likely worse than what you initially anticipated.", "Can you talk a bit about what's better on the other side of that? And within this, could you also address the promotional investment in 2Q and 2H and what you're doing there and how that's having an influence on gross margin as well?" ] }, { "name": "Dave Denton", "speech": [ "Eric, this is Dave. Obviously, it was hard to predict how gross margin was going to play out specifically for lumber this year, but obviously, we are experiencing some pressure at this point in time. I would say what we've done is taking a portfolio approach across our business and making sure that we're managing gross margin holistically such that we can deliver upon the objectives and the commitments we have from an investor perspective. So there's -- the offsets to that are fairly comprehensive across the portfolio of products.", "And I'd say from a promotional standpoint, I'll ask Bill to comment on this, but we want to make sure that we're relevant on key holidays and Tier 1 events, but we're not nearly as broad and/or as deep from a promotional standpoint as we would have been back in 2019." ] }, { "name": "Bill Boltz", "speech": [ "Yeah, Dave. And Eric, I think I'd add, we've talked about this in the past. We've been on this march for an everyday competitive pricing strategy. And we wanted to make sure that when we got here, we wanted to unwind this high-low strategy that had been in place across a lot of categories.", "So when you think about pressure from lumber, how does it get offset elsewhere, it gets offset elsewhere by not having some of these categories on a heavy promotional drug. And so we know that we can compete every day on a competitive pricing basis and that's the work that the team has been doing. And then you put all the efforts that we've talked about with the pricing, the cost team, the finance team collaboration with the merchants in addition to our field merchants and our field leaders out in the field, we can -- we're on this march now for opportunities local to do different things and to enhance margins that way. So from an event standpoint, very typical events in Q2 with Memorial Day, Father's Day, July 4 and a kind of a more normal event approach.", "And as we look at the back half of the year, similar trends as we look at the second half. So nothing crazy." ] }, { "name": "Eric Bosshard", "speech": [ "Great. And then just one follow-up. The sales guidance for the second half implies some degree of moderation from 2Q or July, August and there's lots of ways to look at the numbers. Encouraged by the operating margin move up, but the sales guide still seems a little bit conservative.", "How would you characterize the sales guidance? And is there something else we should be thinking within what that considers?" ] }, { "name": "Dave Denton", "speech": [ "Eric, this is Dave. I don't think you should read into that too much. I think at the end of the day, we're just operating in a very fluid environment. We just want to make sure that we have line of sight to what we're going to deliver for the full year.", "Yes, typically, sales do moderate in the back half of the year. I think we've just taken a realistic appropriate approach to thinking about how our back half is going to play out and this is how we're planning it." ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Eric. This is Marvin. The point I'll add to that is, you can appreciate that this is a really unique environment and a very difficult environment to forecast. And you have quite a few retailers who's not even given any guidance at all or outlook on the second half of the year because of that.", "We wanted to be as transparent as possible, but we also wanted to be slightly conservative. Because there's so much fluid activity happening in this environment, we felt that it was prudent to be conservative, but also, we felt it was equally prudent to be as transparent as possible on how we're seeing the business. But to Dave's point, don't read too much into that. We're going to take one more question, please." ] }, { "name": "Operator", "speech": [ "Thank you. Our next questions are from the line of Greg Melich with Evercore ISI. Please proceed with your questions." ] }, { "name": "Greg Melich", "speech": [ "Thanks. I'd like to start just to make sure I got the inflation number right. The 400 bps, was that just lumber or was that inflation that we could compare to the average ticket growth of 10%?" ] }, { "name": "Dave Denton", "speech": [ "It was everything, but it was primarily focused on lumber, though. It's predominantly lumber." ] }, { "name": "Greg Melich", "speech": [ "Got it. So it's probably lumber commodities, but it's not like there's another 200 bps there that would have been rest of box inflation." ] }, { "name": "Dave Denton", "speech": [ "That's correct." ] }, { "name": "Greg Melich", "speech": [ "Got it. And then the follow-up was really, Marvin, you spoke in the prepared comments and there were several questions along the way on the marketplace rollout for big and bulky. Could you help describe what that means in practical terms to both the DIY and the pro business? Some of that -- what it does to opex and capex for the next 18-plus months as you're rolling it out?" ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. We talked early on in the supply chain transformation that we're going to be making a $1.7 billion investment over a four year span. This whole market delivery transformation is included in that overall supply chain transformation. So we're not increasing any capital spend to achieve this or to roll this out over the next 18-plus months.", "But really what this means, it just gives us the ability to create a more efficient, modern delivery process. So as an example, in the markets today where we don't have market delivery, when you come in to buy an appliance, the associate is going to sell you an appliance based on the in-stock that they have in their store or in a storage container. If it's not physically within their eyesight, they will not sell that appliance. And let's say you do sell it, then you will literally have to call the customer via telephone to arrange a delivery scheduled time.", "So imagine in 2021 that you don't have the ability to go online and create a virtual schedule for delivery. So all of that is being shifted and transformed to a more modern delivery model. So we keep the inventory centrally, so we got inventory reduction, we have less damage. Joe and team are using less SG&A in the stores to move things around, load things up, drive trucks.", "And more importantly, it gives us the ability to hold inventory centrally to create, in some cases, same-day, next-day delivery options for customers in a model that we just can't replicate without having this fully rolled out. So we're very excited about it. This is just one of the many steps in our supply chain transformation, but this is a foundational step. And again, we're going to get this done.", "We just want to be prudent and not get over our skis and overburden the company from a change management standpoint, but we couldn't be more excited about what we're seeing in Florida." ] }, { "name": "Joe McFarland", "speech": [ "Yeah. And listen, Greg, to Marvin's point, this is a really innovative approach to kind of how we're going to market from a supply chain perspective. But as we roll this out, to your point, we do experience some compression because as we ramp these up the first few months, we're not at full capacity. And so we experienced some margin headwinds as we get up to speed.", "But that is all contemplated in our 12.2% guide and our objective to get to 13% as well. So this is consistent with that narrative over the long term." ] }, { "name": "Greg Melich", "speech": [ "That's great. Good job. Thanks guys." ] }, { "name": "Operator", "speech": [ "Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation." ] } ]
LOW	2022-08-17	[ { "description": "Vice President, Investor Relations", "name": "Kate Pearlman", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Brandon Sink", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "Robert W. Baird and Company -- Analyst", "name": "Peter Benedict", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Cleveland Research Company -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Michael Baker", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies second quarter 2022 earnings conference call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, vice president of investor relations.", "Please go ahead." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning. Here with me today are Marvin Ellison, chairman and chief executive officer; Bill Boltz, our executive vice president, Merchandising; Joe McFarland, our executive vice president, stores; and Brandon Sink, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2022.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties, and important factors, including those discussed in the risk factors, MD&A, and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our Investor Relations website.", "Now I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate, and good morning, everyone. In the second quarter, our total company comparable sales declined 0.3%, while U.S. comps increased 0.2%. For the quarter, Pro sales remained strong.", "In fact, this is the ninth consecutive quarter that we've driven double-digit Pro growth. As a reminder, at Lowe's, 75% of our sales are driven by the DIY customer while 25% of our sales is from the Pro. And while underlying home improvement trends remain strong, our DIY sales were lower than expected in the second quarter and the first half of the year. As I mentioned on our previous call, the timing of spring disproportionately impacts DIY sales as many seasonal categories like lawn and garden are heavily concentrated in DIY.", "In addition to spring arriving late, it also ended early, quickly moving from a cold winter to a hot summer in some regions. This showed in the planting season and pressured lawn and garden sales. Also, while we plan for a modest sector pullback this year as we lap outsized DIY consumer demand, we now believe that certain categories like patio and grills are disproportionately impacted by the unprecedented demand from 2020 and 2021. This unprecedented demand was likely fueled by the combination of three rounds of government stimulus, an increase in consumer savings rate, and a temporary shift away from spending on services toward spending on goods, including home improvement products.", "These factors drove more discretionary purchases over the past two years then it was possible to precisely measure at the time. And some of you have asked whether we're seeing consumers trade down in their purchase activity. At this point, we are not seeing indications of material trade down. If anything, we're seeing the opposite with continued strong demand for our new and innovative products at higher price points.", "Bill will provide more contexts on our customer spending trends later in the call. To summarize, our DIY trends, despite slower sales in select discretionary categories like patios and grills, the DIY customer remains resilient, which reflects continued strong home improvement demand trends. Now turning to Pro. We continue to outperform the market, delivering growth of 13% and 37% on a two-year basis.", "We're particularly pleased with the momentum we're seeing with our Pro loyalty program, MVP's Pro Rewards, which is designed to make every Pro feel like an MVP regardless of the size of their business. Because time is money for Pros, one of the most valuable ways that we can serve them is by saving them time with enhanced fulfillment. Therefore, we are actively piloting convenient fulfillment options, including a new Pro fulfillment center in Charlotte, and gig network solutions that offer same-day delivery for both Pro and DIY. Joe will provide a further update on our strategic initiatives to improve Pro penetration later on the call.", "On Lowes. com, sales grew 7% this quarter, representing a sales penetration of nearly 10%. We're continuing to invest in omnichannel capabilities because we believe there is still tremendous runway for further growth ahead. In Canada, Q2 performance lagged the U.S.", "And as a reminder, because our Canadian business is more heavily weighted toward lumber, it disproportionately benefited from record high lumber prices last year. Let me now discuss our operating performance for the second quarter. I'm particularly pleased with the operating discipline that we've developed across our business, which is demonstrated by our ability to improve operating margin once again despite lower sales. During the quarter, operating margin expanded 12 basis points, and we delivered diluted earnings per share of $4.67, which is an increase of nearly 10% versus last year.", "The progress also reflects our team's disciplined focus on our perpetual productivity initiatives or PPI. Not only did PPI support our first half operating margin improvement, it will also help to drive operating leverage for the balance of the year and for the next several years. Joe will discuss the success of our PPI initiatives in more detail later in the call. Now I'd like to address some concerns that I've heard from our shareholders about the home improvement market.", "I want to begin by clarifying that the market dynamics that pressure the home builder are not necessarily the same market dynamics that pressure the home improvement retailer. At Lowe's, the three highest correlating factors of home improvement demand are home price appreciation, the age of the housing stock and disposable personal income. While housing turnover is important, it does not index at the same rate as home price appreciation, housing age and disposable personal income. And while we acknowledge that housing turnover has slowed, home prices and home equity remains at record highs, which gives customers confidence that they will get a return on the investment that they make in their homes.", "And also importantly, those homes keep getting older. More than half of the homes in the U.S. are over 40 years old and millions more built at the peak of the housing boom in the early 2000s are now starting to turn 20 years old, which is a key inflection point for big ticket repairs. In terms of disposable personal income, household wealth is still at an all-time high.", "Consumer savings are roughly $2.6 trillion higher than they were pre-pandemic. And 75% of that excess savings is concentrated in middle- and high-income households who are more likely to be homeowners, which highlights another key benefit of our industry. Our core customer is the homeowner. In addition to having significantly more disposable income, most homeowners are benefiting from lower fixed mortgage rates.", "And as low housing supply and high-interest rates make moving less desirable, homeowners are motivated to invest in their current homes to fit their needs. This is one of the key reasons that home improvement can win in markets when housing turnover is strong and when it slows as we saw in the mid-1990s when home improvement spend grew despite rising interest rates and a slowdown in housing turnover. Now shifting to trends in Pro. We continuously survey our Pros and their confidence in their job prospects is the highest it's been in years.", "The Pro is busier than ever, and the strength of the Pro backlog speaks to the significant pent-up demand for their services. In short, we are fortunate to operate in this retail sector and despite the macro uncertainty and unprecedented seasonal demand in the past two years, our long-term outlook for the home improvement industry and the Pro customer remains positive. As I close, I would like to personally thank our associates for their hard work and dedication. In recognition of some of the cost pressures they are facing due to high inflation, we are providing an incremental $55 million in bonuses to our hourly frontline associates this quarter.", "These associates have the most important jobs in our company, and we deeply appreciate everything they do to serve our customers to deliver a best-in-class experience. And with that, I'll turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. In the second quarter, U.S. comparable sales were up 0.2%. I'd like to walk you through the trends that we are seeing in the business, beginning with our DIY results.", "As Marvin mentioned, we had a short spring moving directly from winter to summer in many areas of the country, impacting demand for outdoor garden products like fertilizer, chemicals, and live nursery. After two years of outsized growth in home-related sales, we plan for sales to slow in certain categories this year. And our disciplined planning process enabled us to mitigate many of the inventory pressures you're seeing across the retail industry. But certain categories were still down more than expected, like patio furniture and outdoor grills, which is consistent with trends across the broader market.", "But even within patio, our newly designed Origin 21 items sold out first in most stores, like our exclusive Benfield ag chair that retailed at $628. Another interesting trend from the quarter is the ongoing demand for innovation, reflecting underlying consumer strength. Rather than seeing trade down, in many cases, we are seeing customers trade up, spending more to purchase the latest technology like battery-powered products available in the EGO, Kobalt, Craftsman, and Skill brands. In fact, one of our top-performing products this quarter was an EGO 56-volt self-propelled mower that retailed for over $700.", "This unit dramatically outperformed our sales forecast despite being one of the most expensive battery mowers in our assortment, proven what we have said before that value doesn't have to be low priced. In refrigeration, we continue to see consumers trade up to higher-priced products in brands like KitchenAid, Samsung, and LG, with features and benefits that serve a busy family's lifestyle. And while client sales were below our expectations, we continue to take incremental share and lead the market as the number one appliance retailer in the U.S. We also continue to source new products that make projects easier for our DIY savvy customers, like our expanded STAINMASTER lineup, including laminate flooring, sheet vinyl, and tile which are getting overwhelmingly positive customer feedback due to how easy they are to install and keep clean.", "Or how about our new BUILD and BATTEN product, a Lowe's exclusive. This new pre-sized and miter molding makes it easy and cost-effective for the do-it-yourself or to do highly intricate designs like wanes coating. And for the Pro, it saves them time on these jobs as well. Customers can transform a wall in a day for less than $300.", "And across the store and within each of our merchandising categories, we offer value at all price points and feature leading products from our all-star brands like Trex, Owens Corning, John Deere, EGO, Honda, KitchenAid, Samsung, LG, Kohler, Moen, Whirlpool, Husqvarna and Aaron's. Shifting gears now to our Pro customer, we delivered broad-based and strong results with positive comps across rough plumbing, building materials, paint, electrical, millwork and hardware. We are pleased with the traction that we are making with this important customer and we continue to optimize our Pro assortments to ensure we offer the products Pros need from the brands that they know and trust. This quarter, we launched EdenCrete, a liquid additive that improves the quality, durability and sustainability of concrete projects.", "We also launched the new stack lithium battery technology in our line of FLEX cordless power tools, making Lowe's now the only destination to have this new battery technology available in both FLEX and Dewalt, which brings more power in a smaller package. And in millwork, we also were the first to market with our own reliable stock exterior black trim vinyl window, an increasingly popular trend to give homes a more premium look, with some Pros even buying pallets of these products before they even hit our shelves. We also added JELD-WEN prefinished interior doors, which come pre-painted from the factory, saving Pros the time and expense required to paint the door. These additions have further strengthened our portfolio of trusted programs like Bosch, Crescent, Dewalt, Eaton, Estwing, FastenMaster, FLEX, GRK, ITW, Lesco, Little Giant, Lufkin, Mansfield, Marshalltown, Metabo, SharkBite, Simpson Strong-Tie, SPAX, Spyder, and Werner.", "In our lumber business, comps declined modestly as we cycled over record high prices in the previous year. However, unit volumes were up significantly year over year, which reflects the strong underlying project demand. Turning now to Lowes.com, sales grew 7%, building on top of the tremendous growth we have seen over the past few years. We continue to invest in the online user experience by expanding and enhancing our assortments, building out and improving our visualizer and configurator tools, and enhancing the delivery experience to make it easier for our customers to track their orders.", "As I close, I'd like to thank my entire merchandising team, along with our finance, inventory, and supply chain teams for their disciplined inventory management and planning process in a complex retail environment. And lastly, I'd also like to thank our vendor partners for their continued partnership and hard work to ensure our customers have the products they need for every home improvement project they tackle. Thank you and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thank you, Bill, and good morning, everyone. Let me begin by expressing my appreciation for our associates. They delivered strong customer service and profitability this quarter due to their commitment to our perpetual productivity improvement initiatives or PPI. Over the first half of the year, we have made meaningful strides.", "I'd like to spend some time now discussing what we are focused on for the remainder of 2022, including how we continue to simplify our store processes. Earlier this year, we launched what we call Project Simple in our stores, one of our many PPI initiatives with a focus on further reducing daily duplicative tasks that distract from customer service and drive needless expense. In fact, as we continue rolling out Project Simple, we expect that it will eliminate over 80 nonproductive hours per store per week in the second half. In February, I discussed the launch of our game-changing, new store inventory management system, or SIMS.", "While we are just six months into the implementation, we are already seeing strong results. With the improved inventory visibility, we are reducing nonproductive hours the associates spend searching for product while also improving the customer shopping experience in-store and online. And in the second half, we will leverage SIMS for an exciting new feature, prescriptive pack down. This new process will provide specific down-stocking instructions to our associates based on sell-through rates.", "So, they know whether the product needs to go directly onto the shelf or the end cap bypassing the top stock altogether. This drives a more efficient, proactive replenishment and inventory planning process. As these examples illustrate, PPI is not a static set of initiatives that will expire at a predetermined date. PPI's perpetual process of ongoing initiatives that will continue to deliver productivity, not only in the second half, but for many quarters to come.", "Now shifting our focus to the Pro. We continue to deliver incredible results with Pro comps of over 13% in the quarter. In fact, this is the ninth quarter in a row that we have driven double-digit Pro comps. Even in a quarter that is traditionally our most DIY-heavy, we saw Pro penetration of over 23% in the U.S., an increase of over 500 basis points from 2019.", "And we are further enhancing our Pro offering with our new MVPs Pro Rewards and partnership program. This Pro loyalty program launched in the first quarter, and it continues to outperform our expectations. In July, we launched MVP's bonus points in conjunction with our first-ever Lowe's MVP bonus days event with a focus on the products that Pros use every day. Pros earn extra bonus points on our leading brands such as Dewalt, Valspar, FLEX, Metabo, A.O.", "Smith, and Frigidaire. Our Pros can redeem their points for other products or gift cards in the MVP Pro Reward Center. It is their choice, and we made it easy for all Pros to benefit. As our MVP's Pro Rewards program continues to mature in the second half, we are excited to present our Pros with compelling offers that will be tailored just for them.", "Before I close, let me discuss the investments that we are making in our most important asset, our associates, as we strive to become the employer of choice in retail. We recently announced expanded scheduling options for our full-time associates. Most full-time associates can now request a fixed four-day work week, fixed days off or even choose their preferred shift providing them with predictability on their terms. This is a significant improvement in our associates' quality of life, and it is another way that we are differentiating ourselves from other retailers.", "As Marvin mentioned, to help our frontline hourly associates during this period of high inflation, we are awarding an incremental bonus of $55 million. Also for a designated time frame, we are providing our associates with an additional 10% discount on everyday household and cleaning items. Associates can now purchase these products at a 20% discount, which we hope will ease the burden of inflation impacting many of these items. We will continue to look for meaningful ways to improve our associates' work-life balance, while providing them with the tools to build a career at Lowe's.", "I would like to thank our associates once again for their commitment to Lowe's and to our customers. Now, I'll turn the call over to Brandon." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Joe. Let me begin with our Q2 results. We delivered diluted earnings per share of $4.67, an increase of 9.9% compared to prior year as we drove productivity in a dynamic operating environment. Q2 sales were $27.5 billion, with comparable sales down 0.3%.", "Comparable average ticket increased 6.1% as higher Pro sales and product inflation drove higher average ticket. This was offset by comp transactions declining 6.4% as we cycle over two years of outsized growth in DIY sales. Comp transactions improved over 650 basis points sequentially from Q1. U.S.", "comp sales were up 0.2% in the quarter. Our sales were impacted by the shortened spring season, lower demand in certain DIY discretionary categories and lower-than-expected lumber prices. This was partially offset by a 13% increase in Pro customer sales. On Lowes.com, sales increased 7% in the quarter.", "Our U.S. monthly comps were down 1.5% in May, up 0.9% in June, and up 1.1% in July. Gross margin was 33.24% of sales in the second quarter, down 54 basis points from last year. This is consistent with the expectations that we discussed in May.", "As expected, product margin rate was down 35 basis points versus the prior year. Lumber prices declined significantly from late April through mid-June. As we sold through our higher-cost inventory layers, product margin rate was pressured. Higher transportation costs, both import and domestic as well as the expansion of our supply chain network, also drove 35 basis points of pressure.", "Additionally, we experienced 10 basis points of shrink pressure largely due to live goods damaged by unseasonable weather. These impacts were partly offset by 30 basis points related to more favorable product mix. Despite the product cost pressures in the quarter, gross margin for the first half was up slightly compared to the first half of 2021. This reflected our ability to effectively navigate a volatile lumber market over the first half of the year as well as product cost inflation.", "I'm very pleased with the strong cross-functional collaboration from the teams as well as our diligent planning efforts. SG&A of 16.22% levered 80 basis points relative to Q2 2021. We drove substantial productivity across the enterprise in the quarter against slightly lower sales. Operating profit was $4.2 billion, up slightly versus the prior year.", "Operating margin rate of 15.39% of sales levered 12 basis points as SG&A leverage was partly offset by lower gross margin rate. The effective tax rate was 24.5%, in line with prior year. Inventory ended the quarter at $19.3 billion, up $2 billion or 11.6% from Q2 last year driven by product cost inflation of 15%, while units were down low single digits. This morning, we are affirming our full year 2022 financial outlook.", "We now expect that our 2022 sales will be near the bottom of our range of approximately $97 billion to $99 billion for the year, representing comparable sales toward the bottom end of the range of down 1% to up 1% for the year. This reflects our first half results and our second half expectations of continued Pro momentum and improving DIY sales trends. We continue to expect Pro to outperform DIY for the remainder of the year. As a reminder, our 2022 sales outlook includes a 53rd week, which equates to approximately $1 billion to $1.5 billion in sales.", "We continue to expect gross margin rate to be up slightly as compared to the prior year. Given our better-than-expected flow-through in the first half, we now expect operating margin to be at the top end of our range of 12.8% to 13% for the full year. Our ability to lever gross margin and SG&A despite lower-than-expected sales reflects the Company's focus, hard work and effective investments over the last several years. Taking all of this into consideration, we now expect diluted earnings per share for the year to be at the top end of the range of $13.10 to $13.60.", "At Lowe's, we remain committed to our best-in-class capital allocation strategy. For 2022, we continue to expect approximately $2 billion in capital expenditures and $12 billion in share repurchases. Finally, we are affirming our outlook of return on invested capital above 36% for the year. Turning to our shareholder-focused capital allocation strategy.", "In Q2, the company generated $2.7 billion in free cash flow. And through a combination of both dividends and share repurchases, we returned $4.5 billion to our shareholders. During the quarter, we repurchased 21.6 million shares for $4 billion. We also paid $524 million in dividends at $0.80 per share, and we announced a 31% increase to $1.05 per share in support of our 35% target dividend payout ratio.", "Capital expenditures totaled $344 million in the quarter as we invest in the business to support our strategic growth initiatives. We continue to make progress toward our target of 2.75 times adjusted debt-to-EBITDAR, ending the quarter at 2.23 times, and we remain committed to maintaining our BBB+ rating. Finally, we delivered return on invested capital of 34.5% in the quarter, up 548 basis points versus last year. As I look ahead, I'm highly confident that we are making the right investments in our people and capabilities to support our business and drive meaningful long-term shareholder value.", "And with that, we will open it up for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator Instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Sorry. Good morning. My first question is DIY comps are negative and units are down. The units appear to be bottoming or still decelerating.", "And do you have a view if we rebaseline this year or there's more to go in '23?" ] }, { "name": "Brandon Sink", "speech": [ "Yes. So, Simeon, this is Brandon. Just as we look at DIY specifically, the business was heavily weighted to DIY seasonal in the first half of the year. I think, underperformed a bit just due to the weather, the pull forward that we mentioned in patio and grills.", "Second half of the year, transitioning more to the core the interior of the store, and in particular, post July 4th, over the last six weeks, we've seen continued momentum building in these categories. We've seen a clear step-change in the business, one- to three-year comps improving, again, in particular, in Pro and core interior. And then, I'll point back to transactions, Q1, Simeon, down 13. We saw improvement in Q2 down six.", "So, we like the momentum we're seeing and optimistic around the step-changes again that we're seeing in the second half." ] }, { "name": "Marvin Ellison", "speech": [ "Simeon, this is Marvin. I think it's important to note that when you look at the first half of the year, the first half is obviously more seasonal. And so we had weather impacts that drove a lot of our negative units, if you think about outdoor lawn and garden, chemicals, etc. And then if you think about what we talked about the unprecedented demand we saw the last couple of years in some of these DIY discretionary categories, specifically, patio and grills.", "We're not going to experience the seasonality of the business in the second half of the year, and we're not going to experience that unprecedented overlap in those two highly seasonal discretionary categories." ] }, { "name": "Simeon Gutman", "speech": [ "And maybe, Marvin, if I can ask you a follow-up. I know we have this Analyst Day later in the year, and you're coming off of a couple of years of historic top-line growth, and you've been able to get to margin goals much faster. Do you sense or do you feel that these gains keep going as long as sales productivity keeps rising? Or do you feel like there's any part of you that says, hey, we could pause, reinvest, and then we can even drive faster growth in the out years?" ] }, { "name": "Marvin Ellison", "speech": [ "Simeon, it's a really good question. I think it depends on the financial category. So I'll remind you that home improvement is a $900 billion marketplace. And I think it's easy to just focus on the two largest players and determine the overall market share gain just based on that, but this is a really fragmented marketplace.", "So on the revenue side, we absolutely believe that we have an incredible wrong way to continue to grow, just focus specifically on the fact that our Pro penetration is hovering around 23% to 25%. And we know we can get that number significantly higher. Now the good news is, as Joe mentioned, is increased 500 basis points since 2019. So, on the sales revenue side, we think we have an incredible opportunity to continue to grow.", "On operating margin, I mean, we said consistently that 12% was not a plateau. It was a baseline. Now we're going to say the same thing about 13%. We think when we hit that plateau, it's just going to be another baseline that we can continue to grow from.", "Joe talked about the importance of our PPI initiatives that is not a static list, but this is something that we see benefit in future quarters and candidly future years. So in both those areas, we think that we have room to grow, and we look forward to providing a very detailed outlook at the December conference." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, everyone. Good luck. Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Next question comes from the line of Kate McShane with Goldman Sachs. Please proceed with your question." ] }, { "name": "Kate McShane", "speech": [ "Hi. Good morning. Thanks for taking our question. We wondered if you could talk a little bit more about your inventory composition cost per unit versus units? And then this inventory seemed to be lower than your competitor.", "Just what is your view on current in-stocks? And are you chasing any categories?" ] }, { "name": "Marvin Ellison", "speech": [ "So, Kate, I'll take the first part of that, and I'll let Brandon and Bill jump in. I would say, first and foremost, I am extremely pleased with the disciplined collaboration and planning that's taken place to put us in a really good inventory position vis-a-vis the retail industry. Any time you could have units declining in this environment with supply chain constraints and just incredible difficulties in forecasting, it points to a lot of hard work. So, the headline is we feel really good about our current inventory position, and we feel good about our in-stock position in the second half of the year versus last year.", "So I'm going to let Brandon talk a little bit about the financial expression and I'll let Bill talk about where we are and where we feel like that we're in a much better position versus what we've been in past years and past quarters." ] }, { "name": "Brandon Sink", "speech": [ "Hey, Kate. This is Brandon. The only thing I would add in the prepared remarks, we talked about units being down. I think it has allowed us to make the needed investments, in particular, in the Pro space as we've seen momentum there.", "To continue to support demand, we've had improved in-stocks in certain areas that we struggled a bit through the pandemic. So as Marvin said, really pleased where we are from an inventory position. We're managing seasonal just like we would every year and stock levels are better than they've been here over the last two and a half years. And any expected exit of seasonal fully included in the margin expectations that we have for second half." ] }, { "name": "Bill Boltz", "speech": [ "And Brandon, the only thing I would add is that the quality level of the inventory is good, although there are still categories across the store that we want to see improvements in. And so, we're continuing to work with our vendor partners to do that, working with our supply chain teams in order to expedite that product to the store into the shelf and the teams are working on those. And -- but the quality level of inventory this year versus last year is dramatically better than it's been." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Peter Benedict with Baird. Please proceed with your question." ] }, { "name": "Peter Benedict", "speech": [ "Hey, guys. Good morning. First question, just like the operating agility you guys have shown has been impressive, clearly. How do you ensure you're not sacrificing service levels as you manage these SG&A dollars? Any metrics that you can share that maybe give you confidence that service levels in the stores are still holding up?" ] }, { "name": "Marvin Ellison", "speech": [ "Peter, it's a really good question. Obviously, we pay very close attention to what we describe as service levels versus as task levels. And the thing that Joe and the store operators have done an incredible job is investing in service while taking hour away from tasks. So when you see that SG& A leverage, it's not like the old days where you just kind of rip pay roll out and you risk service.", "What Joe and his team have done a masterful job of is pulling our hours away from non-customer-facing parts of the store, taking some of those dollars to the bottom line, but then reinvesting dollars on the service side. So I'll let Joe give you some specifics. But the headline is likelihood to recommend up for both DIY and Pro in the quarter with SG&A leverage, and that is not easy to do. So, Joe, you could provide some detail." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Marvin. And listen, I think it goes back to the focus that we've had on our associates. And again, with the PPI initiatives, we're moving unnecessary daunting tasks replacing them with and just enabling the associates' time on the floor to be more productive. We've done things, the flexible scheduling.", "We've talked many times in the past about our new labor management engine. And so, as we continue moving forward, we measure every single day, every single week, and we're very pleased with the progress we've made both in the operational expense and the customer experience." ] }, { "name": "Peter Benedict", "speech": [ "That's helpful. That's great. Thank you. And then just I guess -- next question would just be around what kind of metrics do you guys watch internally that would maybe signal to you maybe a softening of demand, whether it'd be Pro or DIY relative to trend? Are there any categories? Are there any behaviors? I know you're watching it constantly.", "But just curious kind of what you have your eyes on as you kind of navigate this volatile environment. Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "Look, as you can imagine, there are quite a few things that we look at. And I think the thing that I'm most pleased with, when I look around the table, of my team is there's a lot of experience, a lot of people who live through quite a few different iterations of macro slowdowns in the home improvement space. So we have some pretty effective playbooks on the merchandising side, on the store operations side, on managing cost and inventory. I think it's one of the reasons why we've demonstrated quite a bit of agility in some of these unique times.", "Having said that, I'll let Brandon give you a little bit of the things that we look at just to make sure that we have our fin on the pause of the health of the business." ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Peter. I would just call out just in this dynamic environment, I think really important for us to look at unit trends in particular. So between the merchant teams, the finance teams, week in, week out, we're down at a very detailed category assortment level. We're looking at one-, two- and three-year trends and what -- how much of the business is being driven by inflation, ticket, the offset, how much we're driving in terms of units and demand.", "We've mentioned some of these categories in seasonal where we've seen units get back to pre-pandemic levels. We talked about patio and grills. So starting to understand and get comfortable and the flip side is we're seeing great unit growth in other areas like the Pro business that we want to continue to feed. So looking across the assortment, looking at those impacts, how that impacts inventory replenishment ordering and the drivers of the business teams are really focused on that." ] }, { "name": "Peter Benedict", "speech": [ "OK. Great. Thanks so much, guys. Good luck." ] }, { "name": "Marvin Ellison", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Forbes with Guggenheim Securities. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. I wanted to start with the Pro. So Marvin or Joe, you mentioned Lowe's MVP loyalty program, and I realize it's new, but curious if you can note what tier the majority of your Pros sit in today and whether you saw any sort of early signs of Pros gearing up during the quarter as we look out to the back half?" ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Steve. So let me just -- I'm not going to answer that question specific, let me say that first. So but I'll give you just some thoughts on the Pro loyalty program. We talked about the 30% comp growth in Pro and 37% growth on a two-year basis.", "And we think that the foundation of what's driving that is really monetizing the investments we've already made from a service staffing and technology. I think the second reason why you're seeing growth is the investment in brand that Bill talked about in his prepared comments, and that's an ongoing process. Fulfillment is improved as a third kind of component of improvement. And we know that we have work to do to continue to make fulfillment easier for our Pro customers.", "And that's one of the things that, as I mentioned, that we're piloting a fulfillment center gig network, and we're excited about the possibilities. And then the last foundational point is what you asked is loyalty. And we think our new MVP program is incredibly successful in the early stages. And so, how do I define that? Customers that are engaged in Pro loyalty and credit spend three times more than Pros that don't.", "I mean, to me, that's the key metric that we look at. Do we understand the level of Pros that's tiering up we do, we don't want to discuss that externally. But what I will tell you is all the events that we've launched this year, leveraging points and Pro loyalty have exceeded our expectations, and we have a lot more to come. And we'll provide some level of granularity in the future, but it's too early to share it externally, but I will tell you that we're pleased with the progress." ] }, { "name": "Steven Forbes", "speech": [ "I appreciate the color, Marvin. And then maybe just a quick follow-up for Brandon. Based on the gross margin guidance, it sort of implies a relatively flattish outlook for the back half. Clearly, we got the supply chain build-out and transportation cost pressure.", "So maybe there's any help on the offset if it's from mix or just product margin strength?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah. We have -- we feel like we have a pretty good handle on the gross margin drivers of the business here over the second half. We expect modest product margin improvement, as you mentioned, offset by higher supply chain costs. That's inclusive of distribution, transportation.", "We mentioned the drag in Q2 and the expanded network. Shrink credit, fairly neutral as we look across the second half as it relates to other contributors to margin. So full-year unchanged as it relates to guiding to slightly up from a gross margin standpoint. We feel really, really good about our ability to deliver that." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Brandon Sink", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Scot Ciccarelli with Truist Securities. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. So another DIY question. I know you bounced around this a little bit, but we -- the cycling of little bit, but we -- the cycling of is, what gives you confidence that the softer trends you've seen in DIY over the last few months, isn't the beginning of the slowdown following several years of accelerated demand?" ] }, { "name": "Marvin Ellison", "speech": [ "It's a fair question. So, Scot, I'll take the first part, and I'll let Brandon provide some context. So when you look at DIY and you look at the first half, I think it's important to understand that a lot of the negative impacts have been relatively isolated in discretionary categories. We talked a lot about patio and grills.", "But candidly, for the last two or three years with the lack of mobility that we've all had and the amount of time we spend at home, once you make an investment for patio furniture and grill is really not an overriding demand to do it again a year or two later, and we understand that. And also, we talked quite a bit about the shortened weather season of spring and how that put a lot of pressure on lawn and garden outside categories, and that's almost exclusively for us, DIY-specific. So when we try to put in characterization, what drove the DIY slowness in the first half, we can be very specific on that. But as we look at the back half, we know that a shift is coming based on our business trends.", "And I'll let Brandon just provide a little context on the trends we are seeing. And when we look to the interior of the store, what we believe will happen in the back half of the year." ] }, { "name": "Brandon Sink", "speech": [ "Yeah. So, Scot, I think confidence just given the first half isolated impacts that Marvin called out around the weather, the DIY discretionary, I mentioned earlier just momentum that we're seeing in the business, in particular post July 4th and again, looking at one-year and three-year comps, clear step-change that we're seeing in the business there. And then I think last, just as we look at the second half and the structural sort of setup of the business, it's less seasonal. It's definitely interior-focused as we get into the core categories.", "And we think that, just coupled with the momentum, again, that we're seeing with the Pro, we feel like that plays really well when we look at the second half outlook that we have on the business." ] }, { "name": "Joe McFarland", "speech": [ "Yeah, Scot. Just add one thing to that. So in a recessionary environment, as you look at the DIY, that tends to shift more to the repair categories versus the big ticket. So, there's a lot of indicators out there that we watch on a very regular basis." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thanks a lot, guys." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Scot." ] }, { "name": "Operator", "speech": [ "Next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. The lower the comp outlook to the lower end of the range, but articulated the view that your earnings will be at the high end of the range, how low could your comps be in the back half of the year and you still hit the EPS guidance for the full year?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah. So, Michael, this is Brandon. I would just tell you, we're very focused on delivering what the most likely scenario that we have with the business, which that's updated in our outlook. So, we're looking at top line being down 1%.", "We're really confident given the ability to manage gross margin, the step-up that we're seeing with SG&A leverage, and how that's translating to profit expansion and EPS. Confident in that scenario, confident delivering on what we have in the guide, and that's where we are at this point in time." ] }, { "name": "Marvin Ellison", "speech": [ "And Michael, this is Marvin. The thing that we often talk about internally is that, expense is typically relative to sales. And expense as a percent of sales and percent of revenue. And so, we have proven that we have levers that we can pull so that we can ensure that as revenue goes down, then we can, at the same point, bring our rate of expense down.", "And that's something that we feel very confident in our ability to deliver upon. And I think Q1 and Q2 of this year should represent that." ] }, { "name": "Michael Lasser", "speech": [ "OK. Thank you very much, guys. And my follow-up question is on the nature of where sales stands today versus where they were in 2019. Marvin called out patio furniture and grills as categories that have been well above the trend line in demand.", "Seasonal and outdoor is about 20 -- excuse me, 10% of the business, appliance is another 10% to 15% of the business. Is that the right way to think about the risk of those sales being kind of over-earning from the last couple of years? And how much risk is there that this above trend performance in those categories start to leak into other areas of the business, lighting, flooring, other areas that could be more episodic in nature?" ] }, { "name": "Marvin Ellison", "speech": [ "Michael, it's a really good question. I think you can appreciate that this has been one of the most difficult environments to forecast and to build any kind of consistent modeling on. So what I will say to you is we pay close attention to all the trends and we are obviously now looking at what we call pre-pandemic sale rates and understanding where we have reverted back by category to those pre-pandemic levels. And so we know where we are and what categories are in those specific run rates, and we know which categories are not.", "And our job is to pay really close attention to those merchandising categories to ensure that we're in a good insight position, that we have good presentation, that were priced right. And that's our best attempt to try to manage it. We'll have a much better answer for you as we wrap up the kind of the back end of the year. Because of the uniqueness of these overlaps, it's really tough to answer that question with any precision just coming out of the second quarter." ] }, { "name": "Michael Lasser", "speech": [ "Understood. Thank you very much and good luck." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Eric Bosshard with Cleveland Research. Please proceed with your question." ] }, { "name": "Eric Bosshard", "speech": [ "Good morning. Thank you. Curious for your strategy in regards to promotions and pricing as we move into the back half, considering what you're seeing with units and where you sit with inventory if you're changing relative to the first half?" ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Eric. This is Marvin. Short answer is no plans to change any of our philosophical approach to promotions and pricing. Our key is to be competitive.", "And again, we've invested in some sophisticated tools that give us real-time visibility to our competitors so we can be price right every single day. I'll let Bill talk more about his thoughts on promotion and pricing just to reinforce that we have a consistent philosophy that we plan to stick with." ] }, { "name": "Bill Boltz", "speech": [ "Yeah. Good morning, Eric, and thanks for the question. Just a couple of things and just a couple of reminders. We've been on this journey for our merchandising strategy, pricing strategy over really the last three-plus years.", "And that has the playbook that we're working to follow and really trying to unwind from what was a high-low pricing strategy to an everyday competitive price strategy. And so, the work that we've done between the merchants, the finance team to prop up, the resources to manage and monitor price on a daily, weekly basis is really allowing us to do that. And we feel really good about being very competitive, good line of sight on those key SKUs that matter. And then from a promotion perspective, it's all about being there when the customer expects us to be there.", "So obviously, we've got Labor Day event coming up here in the next couple of weeks. You go into the holiday season, Black Friday. And so, we'll continue to supplement those events with key offers and be there with value for the customer and then work really hard to provide that value day in and day out in the store with the changes that we've made through our end cap strategies, flex strategies, etc." ] }, { "name": "Eric Bosshard", "speech": [ "Just a follow-up within that. What have you seen when you have run events, you ran some July 4th events. And I'm just curious, have you seen different consumer engagement with promotions in this environment? Or now relative to the past, are these resonating? Again, I'm just asking, as you look at negative units and a bit softer sales and a bit more inventory. Historically, you promote more, I understand the new Lowe's is less focused on that, but is the payback from those things similar or different? Is the consumer responding similar, different on those?" ] }, { "name": "Bill Boltz", "speech": [ "Yeah. I think there's a couple of things, there's -- first, there's a time and an opportunity to put stuff on value. And so if you think about first half of the year and you think about mulch and live goods promotions and those types of things that get the customer in the door and drive traffic, they play a certain role for us in the role of the category of certain merchandising businesses. And then you have new and innovation, as I said in my prepared remarks, where the customer is finding value in that.", "And a good example is that Eagle lawnmower that I talked about in my opening remarks, it's a $700 unit, and it was by far one of our best-selling products, best unit driving products in the assortment. So it's not low priced. It's not on promotion, and it was just out there and the consumer has adopted that battery platform, and they love the product. So, it's really a combination of both, and that's the blend that we're trying to manage.", "And in the appliance business, as you know, hundreds of thousands of appliances break every day. So, you've got to be out there with an offer in the appliance business day in and day out. So that's how we're playing it." ] }, { "name": "Marvin Ellison", "speech": [ "Eric, this is Marvin. And I really appreciate the question because we're in this unique environment with customer demand, especially coming out of that outsized demand in certain discretionary categories during the pandemic. So, we are closely monitoring any of our -- we call it, Tier 1 holiday promotions just to see our customers respond. The biggest difference at Lowe's today versus when I arrived about four years ago is that there is a rigorous analytical process that we go to coming out of all types of promotions just to look at, did we get the return on investment.", "And so, what we're not going to do, to Bill's point, is just kind of follow historical trends just because we're going to evaluate whether or not we got a return when the customer responded and we'll adjust accordingly. And we've been doing quite a bit of adjusting because the customers are responding differently because this is such a unique environment. But as I said earlier, we're anxious now look at the back half of the year, we feel good about the trends as Brandon outlined. We feel good about how the customer is shifting on the interior parts of the store because that's where we're really strong and we feel we're well-positioned.", "And we'll have a much better assessment looking at the full year going into next year relative to some of these customer engagements to some of these events." ] }, { "name": "Eric Bosshard", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, everybody. So my first question is also a follow-up on the DIY side. Marvin, there were some headlines that talked about the improvement continuing into August and Brandon's comments certainly echo that.", "Have you seen DIY flip to a positive trend? And then as a follow-up, last year, post Labor Day, you talked about that consumer coming back from sort of vacation and reengaging in DIY. So how are you thinking about the ability for that to sustain -- what you're seeing now to sustain against the step-up you saw last year?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, I'll repeat what Brandon said. We've seen a step change post July 4th in our business, and that continues into the month of August. But it's early, but early means that the trends that we anticipated, we're seeing those trends, and we're seeing even better than we anticipated in certain categories. So that's a good news.", "But I'll just let Brandon kind of reiterate why we have confidence in the DIY consumer as we look at the back part of the year." ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Chris. I'm not going to get into too much detail just specifically on DIY comps. But I would say just a response, as I mentioned over the last six weeks, especially as we've moved more to the interior of the core, the DIY business within the home decor categories, I think, has been notable, and that's where we're seeing momentum. And then I'd also just call out there's other areas, lumber is going to be a mix between Pro and DIY, but sort of just given where pricing is at that point, too, we're seeing nice response there, and we're seeing activity that we continue to see momentum building as we get into August here." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And then some of the commodities of -- some of the input commodities for a lot of your products have come down recently. You've -- Marvin, since you came on board, you've introduced some very sophisticated pricing and cost deconstructing capabilities? How are you thinking about your intent in the near term to go back at the vendors from -- for some price rollbacks?" ] }, { "name": "Marvin Ellison", "speech": [ "Well, before Brandon was elevated to his more prestigious position, he did that work for us in merchandising with Bill. So I'll let him give you some specifics on that." ] }, { "name": "Brandon Sink", "speech": [ "Thanks, Marvin. So yes, Chris, I would say, just given rate tightening that we're seeing from the Fed, monitoring the commodity markets, we're definitely expecting some normalization as we move across the second half and into next year. We have built as Marvin has mentioned, the disciplined product cost management process. We feel like we have the insights to the cost drivers across our suppliers.", "We understand where it's coming from in terms of commodities, labor, transportation. And as raw materials down, we're positioned and prepared to renegotiate prices with our suppliers. We're actually very much underway in certain areas with Bill and his team. And then from a pricing perspective, like we always do, we're going to leverage a portfolio approach if and when we call back the dollars, but we're always going to ensure that we're going to be competitive there as we approach pricing." ] }, { "name": "Christopher Horvers", "speech": [ "Thank you. Best of luck." ] }, { "name": "Brandon Sink", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Next question is coming from the line of Michael Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "Hi. Thanks. Maybe a follow-up. I did want to question the Pro business a little bit and two questions.", "One, Pro business, up double digits for Pro, that's great, but it did slow a little bit from last quarter on a one-year and a two-year basis. So wondering what to make of that. And then these comments on this being a little bit better. I guess DIY, but any comment on how the Pro business is doing in the last six weeks or so? Thank you." ] }, { "name": "Marvin Ellison", "speech": [ "Yeah. Thanks, Mike. This is Marvin. We feel good about the overall sales volume in the Pro business.", "And as Joe noted, second quarter is typically our highest DIY penetrating quarter of the year. But when we look at the Pro business, we feel incredibly positive on the momentum and just the daily volume we're seeing across all geographies relative to what we were seeing two or three years ago. And we think it's very sustainable and it's proven to be. And we think as we get into the back half of the year with our new Pro loyalty program, with improved job like quantity in stocks with some of the brands that Bill outlined that we're going to see this momentum continue.", "And as I said, it's not just about Pro loyalty. Pro loyalty is one of the foundational pieces of the strategy in addition to all the investments we've made in the store, the brands, the fulfillment improvement. And also, just as a reminder, our U.S. reset project last year, literally improved all the adjacencies, specifically for the Pro customer, and we think those things are paying dividends.", "So, that business is performing really well and is performing really well vis-à-vis the DIY and the same trends we're seeing post July 4th for DIY. Pro is also taking those we're seeing post July 4th for DIY. Pro is also taking those" ] }, { "name": "Michael Baker", "speech": [ "Thank you. That's helpful. I appreciate the color." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you all for joining us today. We look forward to speaking with you on our third quarter earnings call in November." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2020-02-26	[ { "description": "President & Chief Executive Officer", "name": "Marvin R. Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "William P. Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joseph M. McFarland", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "David M. Denton", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Gordon Haskett -- Analyst", "name": "Charles Grom", "position": "Analyst" }, { "description": "Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to the Lowe's Companies' Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions] Also supplemental reference materials are available on Lowe's Investor Relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call.", "During this call, management will be using certain non-GAAP financial measures. The supplemental reference materials include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks and the company can give no assurance that they will prove to be correct. Those risks are described in the company's earnings release and in its filings with the Securities and Exchange Commission.", "Hosting today's conference will be Mr. Marvin Ellison, President and Chief Executive Officer; Mr. Bill Boltz, Executive Vice President, Merchandising; Mr. Joe McFarland, Executive Vice President, Stores; and Mr. Dave Denton, Chief Financial Officer.", "I will now turn the program over to Mr. Ellison for opening remarks. Please go ahead, sir." ] }, { "name": "Marvin R. Ellison", "speech": [ "Good morning, everyone. In 2019 we made significant progress in transforming our company. While we're only one year into a multiyear transformation, we're confident that we're on the right path to capitalize on solid demand and a healthy home improvement market and generate long-term profitable growth.", "I'll now take a moment to discuss our fourth quarter results. For the quarter, to accompany, comp sales grew 2.5%. Our U.S. home improvement comps were a positive 2.6%. Our U.S. monthly comps were negative 0.7% in November, positive 6.2% in December and a positive 2.1% in January. However, when you normalize for Black Friday holiday shift from 2018, our U.S. monthly comps were relatively balanced with growth of positive 2.8% in November, positive 2.9% in December and positive 2.1% in January.", "While our monthly comps were relatively balanced, Q4 sales were softer than our expectations. This stems from three factors. First, we did not optimize our marketing execution to align with the compressed holiday season. Our November holiday marketing activity was concentrated closer to Black Friday. And as a result, we didn't fully capitalize on demand for appliances and other key holiday categories earlier in the month. Second, in Q4, we're lapping the exit of our Project Specialist Interior or PSI program in the prior year, which pressured in-store sales growth more than we anticipated during the quarter. And finally, as we discussed, Lowe's.com is still under construction. As customers increasingly utilize online shopping options for convenience and efficiency in the shorter holiday selling season, Lowe's.com lagged market growth, delivering comp growth of approximately 3% for the quarter.", "Let me remind you at the beginning of 2019, Lowe's.com was sitting on a decade old platform. And although, we're in the process of replatforming the entire site to Google Cloud that work will not be completed until Q2. The good news is at Lowe's.com we know exactly what our issues are, and we have temporarily slowed our dot com growth to resolve those issues. We recruited a very experienced and talented team, and we have a detailed project roadmap to modernize our website. We expect to see a trajectory change in this business in the second half of 2020, which we are very excited about.", "While e-commerce business is on the repair, I'm very pleased with the strength and productivity of our brick and mortar stores. There are very few large retailers in America delivering a 2.6% comp growth almost exclusively from the brick and mortar stores. This underscores the sales productivity improvement of our physical stores and our opportunity to unlock additional growth when Lowe's.com sales accelerate.", "One of the key strategic steps improving Lowe's.com is the transformation of our supply chain. Consequently, we are also investing $1.7 billion in our supply chain over a five year period. And in 2019, we opened three new bulk distribution facilities and four new cross-dock terminals. I look forward to updating you on our ongoing improvements of Lowe's.com and our supply chain on future calls.", "Let me now take a moment and discuss the drivers of our sales growth in the fourth quarter. Our focus on Pro continues to be a catalyst for our U.S. sales growth with our Pro comps outpacing DIY in the fourth quarter. Our commitment to implementing retail fundamentals in 2019 has paid dividends in our Pro business. We're seeing compounding benefits from our investments in job lot quantities, department supervisors and our improved in-store experience. These investments not only drove improved trends in Pro comp sales, they also drove a 400 basis point improvement in Pro customer service scores in the fourth quarter.", "As Joe will detail, in 2020, we are transitioning to a more strategic investments for our Pro customers, such as designated loyalty and CRM programs to advance the Pro experience and drive future growth with this critical customer. Our success focusing on retail fundamentals is also evident as we again drove strong sales performance in merchandising departments that have historically underperformed. Bill will add additional insight on our merchandising performance shortly.", "From a geographic perspective, we saw a consistent growth across the business with all three U.S. divisions and 14 of 15 U.S. geographic regions generating positive comps. And during the fourth quarter, regions that outperformed the total company comps were; Atlanta, Baltimore, Dallas, Houston, Nashville and St. Louis. And once again the West was our top performing geographic division.", "Turning to Canada. In the fourth quarter we posted comp sales that were slightly negative in local currency. As we outlined on our third quarter earnings call, we're making foundational changes to improve execution and deliver long-term improved profitability in Canada. The initiatives we laid out as part of our strategic reassessment remain on track, including closing 34 underperforming stores, rationalizing SKUs to present a more coordinated assortment to the customer across our banners, reorganizing our corporate support structure across Canada to more efficiently serve our stores and migrating Canada to a U.S. IT platform to eliminate inefficiencies and unnecessary technology duplication.", "We've also implemented key leadership changes in Canada. Last month, Tony Hurst was appointed President of Lowe's Canada. Tony is a strong and accomplish leader with more than 25 years of retail and home improvement leadership experience. And during the fourth quarter, we also appointed Chris West as our Senior Vice President of Merchandising in Canada. Chris has over 20 years of experience in retail merchandising and is excited to return home to Montreal. We remain confident in the long-term potential of our Canadian business. And I know that Tony and Chris are the right people to lead Lowe's Canada into this exciting new chapter for our customers and associates. Despite pressure from lower than expected comparable sales growth in the fourth quarter, we delivered adjusted diluted earnings per share of $0.94, which exceeded expectations supported by improved gross margin trends, enhanced process execution and strong expense management.", "Turning to 2020. We're pleased to enter the year from a position of strength as we look to build upon the strong foundation we established in 2019. We expect to capitalize on a supportive macroeconomic environment by executing on our four strategic areas of focus. Driving merchandising excellence, transforming our supply chain, delivering operational efficiency and anticipate customer engagement by focusing on the Pro. Our improved Lowe's.com platform will allow these four strategic areas of focus to create a true omnichannel ecosystem for Lowe's so we can efficiently serve our customers anyway they choose to shop. And our intense focus on retail fundamentals combined with improving systems and technology will continue to pay dividends across the business in 2020.", "And in closing, I'd like to take a moment to thank our associates for their hard work and commitment to serving our customers and our communities. I spend quite a bit of my time in stores and our associates continue to demonstrate that they are the cornerstone of our current and future success. We're looking forward to a great 2020.", "And with that, I'll turn the call over to Bill." ] }, { "name": "William P. Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. As Marvin mentioned, we posted U.S. home improvement comparable sales growth of 2.6% in the fourth quarter. We are especially pleased with these results when you consider that our Q4 comp sales were driven almost exclusively by our brick and mortar locations. We continue to see strong customer demand and our stores executed very well, delivering a strong Black Friday event. However, as Marvin indicated, our November marketing cadence didn't fully capture expected sales early in the compressed holiday period.", "Turning to our merchandising department performance for the quarter. We delivered above average comps in appliances, decor, hardware, lawn and garden, lumber and building materials, millwork, paint and tools. We continue to be pleased with our paint business as it outperformed the company average again this quarter. As we continue to grow our paint business, we will continue to work closely with our suppliers to introduce an improved propane offering to better serve the repair remodelers who need paint to complete a larger project such as a kitchen or bathroom remodel.", "After previously performing below the company average for years, in Q4, decor performed above the company average for the third consecutive quarter with double-digit comp growth supported by strength in home decor, blinds and shades and home organization. In Q4, our millwork business remained strong and outperformed the company average, driven by our strength in doors and windows along with our garage door opener program where we are the only retailer to carry the top three brands of garage door openers in Chamberlain, Genie and Craftsman. The traction that we've built in these departments is a clear indication that the implementation of our retail fundamentals has been effective, and we look forward to taking this momentum in the 2020.", "In tools, we are still seeing a strong customer response to our Craftsman offering. We continue to leverage this iconic brand and our home center channel exclusivity to drive market share gains within key tool categories. We also continue to gain traction within our key programs with our exclusive Dewalt 12 volt compact line of power tools, which delivers more power in a smaller and lightweight tool. We are also proud to announce an extension to our Dewalt power tool program with the launch of the new 20-volt MAX XR power tools with the power to tech system in the first quarter, another home center channel exclusive. These tools are optimized to deliver more power than their predecessors, giving pros better performance to complete their jobs.", "In addition, we will also continue to leverage new and innovative products from Bosch, Lufkin, Spider, Metabo HPT and Cobalt to provide customers with an outstanding line-up of tool options. As Marvin mentioned, in appliances, despite performance below our expectations in November, we drove comps above the company average in the quarter, leveraging our position as the leading appliance retailer in the U.S. with our best-in-class appliance offerings along with great values and special buys.", "We also delivered comps above the company average in lawn and garden with double-digit comps in live goods, fertilizer and landscape products, benefiting from an improved in-stock position in warmer than average temperatures. And lastly, we posted comps above the company average in lumber and building materials, supported by strong Pro comps and warmer weather. Looking ahead, we are very excited about our plans and enter the year with a strong foundation in our stores.", "Our Merchandising Service Teams or MSTs have improved our merchandising reset execution in day-to-day bay and end cap maintenance at the store level, delivering a better shopping experience for our customer and taking time-consuming tasks off the shoulders of our red vest associates. We plan to build on this strength by adding approximately 7,000 additional vendor-funded MSTs to our stores in the first half of 2020.", "We'll also leverage our field merchandising team to drive customize assortments at the store level and improve our space productivity. In Q4, we made improvements to our store environment, optimizing our layered on a critically important seasonal pad at the front of our stores. This reset activity opens up additional square footage of selling space, which we will use for additional seasonal selling areas and flex space in this strategic location to improve our sales velocity.", "Our upcoming spring sets will ensure that products typically used together to complete a project are now located in the same aisle to make it easier for the customer to efficiently shop their whole project. Also in the first half of the year, we will complete the rollout of our new signage and way finding package. This will provide all of our stores with an updated signage and way finding for the first time in over 15 years. In our pilot stores, customer survey showed that this new package improved the customer experience, make it easier and faster for customers to locate products.", "We have a number of exciting brand introductions in 2020. We are one of the first retailers to introduce the new Weber SmokeFire Pellet Grill. Weber's pellet grill is their initial entry into this fast growing category and is built to let grill users discover what's possible with pellet grilling. And we are proud to partner with Weber to introduce this exciting new product.", "Within our seasonal and outdoor living business, we are excited to build on our strength in outdoor power equipment with the introduction of Honda outdoor power products. After many years, we are extremely excited to be able to offer this brand as part of the Lowe's outdoor power equipment assortment. The categories will be available both in-store and on Lowe's.com and will include walk behind lawn mowers, generators, snow blowers, tillers, pumps and trimmers for both residential and commercial projects. In addition to adding Honda, we will also be adding the Aaron's brand of zero-turn mowers to our outdoor power line-up, which currently includes John Deere, Husqvarna and Craftsman. These two new brands further strengthened Lowe's position as the number one destination for outdoor power equipment in the U.S.", "We are also excited to continue our national home center rollout of Yeti, a leader in coolers, equipment and drinkware. Our expanded product offering highlights our commitment to providing our customers with relevant, innovative, best-in-class products. I look forward to sharing additional brand introduction news with you throughout the year. And in closing, we are very pleased with the progress we've made against our strategic objective of delivering merchandising excellence. We entered 2020 in a position superior last year and we're excited to take our positive momentum into the all important spring season.", "Thank you. And I'll now turn the call over to Joe." ] }, { "name": "Joseph M. McFarland", "speech": [ "Thanks, Bill, and good morning, everyone. In 2019, we focused on improving our customer service, investing in our in-stock position, driving efficiency in our store operations and advancing our Pro service model. Our strategic initiatives not only drove top-line growth, but also positioned us for success in 2020 and beyond.", "We are pleased that this quarter marked our fourth straight quarter of improved customer service scores combined with payroll leverage. This is evidence of our strong commitment to operational efficiency and focus on the customer. We continue to be pleased with our associate engagement as we undertake changes to better serve customers. For example, our annual employee engagement survey showed strength versus retail benchmarks in multiple key engagement measures. As a result of the improved internal and external brand reputation of the company, we have also been very pleased with our ability to recruit seasonal employees for spring. We are ahead of our target and recruiting efforts, which is a testament to our position as a preferred employer.", "In the third quarter of 2019, we completed the national rollout of our new customer-centric scheduling system. Our new labor scheduling system allows us to provide better department coverage and customer service, while ensuring that we're using our payroll efficiently. We have also layered on scheduling effectiveness tools that measure schedule efficiency, all the way down to the store department level. These advancements allow us to align our payroll hours with peak customer traffic and customize that allocation at the store and department level. For example, under previous system, a DIY heavy store in Dayton, Ohio had the same payroll scheduling framework as a Pro heavy store in Brooklyn.", "Our customer-centric scheduling system now allocates more associate hours to the weekend in the Dayton, Ohio store, while allocating more hours to Pro-centric departments on weekdays in Brooklyn, allowing us to provide better customer service while driving payroll efficiency. As a reminder, in early 2019, we deployed new mobile devices to our store associates called smartphones. Throughout the year, we added applications to the devices such as standardized performance scorecards store walk applications and most recently a new pricing application. This functionality made our associates more efficient and ultimately allowed them to spend more time interacting with customers.", "Our investments in store process and technology paid off in 2019 driving strong payroll leverage for the fourth quarter and the fiscal year, all while improving our customer service scores by 500 basis points year-to-date. This payroll leverage combined with improved customer service scores demonstrates our ability to reengineer our labor model while advancing the customer experience.", "We began 2019 with 60% of our payroll hours spent on tasking and 40% spent on service. We ended the year with 48% of payroll hours spent on tasking and 52% serving the customer. This represents a significant step forward and putting associate time back in front of the customers. These advancements will continue to deliver benefits in 2020 and we plan to build on these accomplishments to deliver additional improvements in customer service and drive more efficiency in our stores.", "In the first half of 2020, we will deploy a centralized return to vendor process which will further reduce tasking, limit product damage and free-up additional space in our stores. We will also rollout our new point-of-sale system in the first half of the year. Our previous point-of-sale systems were extremely outdated with an old green screen that was very difficult to navigate. Additionally, our associates had to toggle between multiple systems to sell product. For example, if an associate sold an appliance with home delivery and an extended protection plan, they previously had to interact with as many as six systems to complete that transaction. Our new point-of-sale system has a user-friendly touchscreen interface that will bring multiple systems together in one screen. This will greatly simplify the work of our cashiers, driving payroll efficiency by reducing training time and allowing for a much improved customer experience to checkout. In 2020, we plan to reinvest some of those savings from our process and technology efficiency in nearly 2,000 additional leadership roles in our stores. This includes 650 additional Pro supervisors to drive incremental improvements in customer experience.", "Moving to our Pro business. As Marvin indicated, we were very pleased with our Pro performance in Q4 as the pros continues to demonstrate their willingness to shop with Lowe's when we provide them with the right products and great service. In 2019, our Pro strategy was primarily focused on improving retail fundamentals such as job lot quantities, improved service levels, dedicated loaders, Pro department supervisors and consistent volume pricing. In Q4, we continued this progress with the addition of dedicated point-of-sale terminals and our Pro desks to allow for more convenient fast service.", "Our commitment to retail basics drove strong Pro comps and significant improvement in customer service scores in Q4. Although those. Although, we're pleased with our Pro performance in 2019. We are now transitioning from retail basics to more strategic initiatives for the Pro. In the first half of 2020, we will launch our Pro loyalty program nationally, integrated with the CRM program, which will allow us to deploy more surgical strategic marketing to the Pro and expand our share of wallet through suggestive selling and improved account management.", "We are confident that our partnership with Salesforce.com will allow us to build a best-in-class platform to better serve our pros. All of these Pro-centric initiatives reinforce the importance of the pro customer to Lowe's. We are encouraged by our 2019 successes and once again plot associates commitment to our mission. We are excited about our future and focused on the work ahead to capture the opportunity in front of us.", "Thank you. And I will now turn the call over to Dave." ] }, { "name": "David M. Denton", "speech": [ "Thanks, Joe, and good morning, everyone. Before reviewing the underlying operating performance of the business, I'd like to take a moment to discuss the previously announced restructuring of our Canadian operations and the associated fourth quarter financial impacts. During the quarter, we completed 28 store closures with the remaining six planned closures completed earlier this month. Additionally, we completed the inventory rationalization activities in our remaining Canadian locations in support of our banner simplification strategies. As a result of the Canadian restructuring activities and the final closure of our remaining business in Mexico, we incurred pre-tax operating costs and charges of $5 million in the fourth quarter.", "I'll now turn to review of our operating performance, beginning with our strong capital allocation program. In fiscal 2019, we returned over $5.9 billion to our shareholders through a combination of both, dividends and share repurchases. In the fourth quarter alone, we paid $423 million in dividends and our dividend payout ratio currently stands at 36% over the trailing four quarters. We also repurchased approximately 5.7 million shares for $670 million through the open market, which brings us to nearly $4.3 billion in share repurchases for the year. We have approximately $9.7 billion remaining on our share repurchase authorization. And importantly, we continue to invest in our core business with capital expenditures of approximately $557 million in the fourth quarter and almost $1.5 billion for the full year. In 2019, we generated over $2.8 billion in free cash flow.", "Now turning to the income statement. In Q4, we generated GAAP diluted earnings per share of $0.66. Now my comments from this point forward will include certain non-GAAP comparisons where applicable. In Q4, we delivered adjusted diluted earnings per share of $0.94, an increase of 17.5% compared to adjusted diluted earnings per share of last year. The strong performance exceeded expectations due in large part to improving gross margin trends and solid expense management.", "Sales for the fourth quarter increased 2.4% on a GAAP basis to over $16 billion. Consolidated comp sales were 2.5%, driven by an average ticket increase of 3%, partially offset by a transaction decrease of 0.5%. The decline in comp transactions was isolated to smaller ticket purchases as warmer weather exerted pressure on small ticket seasonal items such as ice melt and pellet fuel. The comparison to our accelerated holiday clearance activity in the prior year also pressured transactions. When normalizing for these items, comp transactions were flat for the fourth quarter.", "U.S. comp sales growth was 2.6% for Q4. During the quarter, the net effect of cycling previous hurricanes was a drag of approximately 80 basis points on comp sales, while weather in the quarter provided a modest 20 basis points of benefit. We saw less impact from commodity deflation this quarter with a negative impact of approximately 15 basis points on comp sales.", "Adjusted gross margin for the fourth quarter was 31.9% of sales, an increase of 40 basis points from Q4 of last year. We are very pleased with the compounding benefits from the actions we've taken to improve our gross margin performance including the implementation of a more dynamic and strategic pricing program, a pivot to more strategic and targeted promotions, greater vendor partnership for key promotional activities and continued aggressive product cost management.", "This quarter we experienced approximately 55 basis points of total rate improvement, offset by 15 basis points of pressure from product mix. Our rate improvement was driven by actions to improve gross margin, which drove approximately 105 basis points of benefit, which was partially offset by 25 basis points of pressure from supply chain cost and 25 basis points of pressure from inventory shrink.", "Adjusted SG&A for Q4 was 22.7% of sales, which levered 27 basis points, driven primarily by payroll leverage, which was partially offset by strategic investments in the business. Adjusted operating income increased 70 basis points to 7.2% of sales. The adjusted effective tax rate was 24.7% compared to 24.3% last year. At $13.2 billion, inventory increased $618 million or 4.9% versus the fourth quarter of LY, but decreased more than $1.8 billion versus Q1. The year-over-year increase was driven by strategic investments in the first half of the year to drive sales, such as Craftsman resets, increased presentation minimums and investments in job lot quantities for the Pro. In the second half of the year, we invested in inventory to support an earlier spring load-in for the southern markets and capture early seasonal demand for 2020.", "Looking ahead, I'd like to discuss our 2020 guidance and our business outlook. I'm providing the outlook today on an adjusted basis versus 2019. We expect that we will incur minor pre-tax operating costs and charges related to our Canadian restructuring into 2020. These charges are excluded from our adjusted 2020 business outlook. We expect that a constructive macroeconomic environment in the U.S. will continue to support our healthy growth in 2020. A strong consumer, low interest rates, a healthy housing sector and aging housing stock provides support for continued growth in home improvement spending.", "Turning to our financial guidance in 2020, we expect to drive strong sales through our brick and mortar locations. As we complete the foundational work to improve our e-commerce platform, we are planning for Lowe's.com sales to steadily improve in the second half of the year, reaching high-single-digit growth, which will provide modest contribution to sales growth. For 2020, we expect a total sales increase of approximately 2.5% to 3%, driven by a comp sales increase of 3% to 3.5%.", "When considering the cadence of the year, we expect comp sales for the first half of the year to be slightly lower than the second half based on the anticipated timing of benefits from our strategic initiatives. Consolidated adjusted operating income is expected to increase approximately 8% to 12% in 2020 versus LY with adjusted operating margins increasing approximately 50 basis points to 70 basis points.", "For the year, adjusted depreciation and amortization is expected to deleverage approximately 10 basis points, driven primarily by increased investments in our store facilities and technology. We expect that gross margin and SG&A will provide equal contributions to adjusted operating margin expansion for the year. However, in Q1, we expect gross margin improvement versus the prior year to be elevated as we cycle the first cost pressure we experienced in Q1 of '19. We also expect that adjusted SG&A margin will be essentially flat in Q1 as we cycle over benefits from lease assignments and terminations in the prior year. We anticipate similar levels of adjusted operating margin expansion for the first and second halves of the year.", "Furthermore, we expect that the Lowe's U.S. operations will drive solid operating income performance, while the Canadian business will continue to mute overall operating profit performance throughout 2020. The effective tax rate and adjusted effective tax rate are expected to be approximately 24.5%. Additionally, our guidance assumes approximately $5 billion in share repurchases throughout 2020 and a targeted leverage ratio of 2.75 times.", "Now with solid growth of approximately 8% to 12% in adjusted operating income coupled with our $5 billion share repurchase program, we expect adjusted diluted earnings per share will grow approximately 12% to 16% to $6.45 to $6.65 per share. Strong sales and expanding margins are expected to generate $6.5 billion of cash flow from operations. We expect modest working capital benefits of approximately $300 million. Our plan in 2020 assumes our inventory level will remain elevated as we implemented enhanced tools to drive long-term inventory productivity. In the short-term, we are focused on ensuring we have appropriate in-stock levels to support our Pro and DIY customers.", "We are planning for capital expenditures of approximately $1.6 billion in 2020 and we will continue to look for investment areas to enhance the business over the long-term. We estimate that free cash flow will be approximately $4.9 billion. In closing, we remain excited about the future of our business and its ability to deliver significant shareholder value over the long-term.", "With that, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator Instructions] Our first question comes from the line of Greg Melich with Evercore ISI. Please proceed with your question." ] }, { "name": "Greg Melich", "speech": [ "Great. Thanks a lot. I guess two areas I'd love to learn some more about. One, Dave, if you think about the margin outlook for this year, I want to make sure I got that right, Canada will continue to mute OI all through 2020. Is that on a year-over-year basis or is that on an absolute dollar basis that is sold pressuring profitability?" ] }, { "name": "David M. Denton", "speech": [ "On an absolute basis." ] }, { "name": "Greg Melich", "speech": [ "On an absolute basis. So year-over-year though, it could still help the restructuring actions, could make it better than last year?" ] }, { "name": "David M. Denton", "speech": [ "Yes. It is our expectation that Canada will get a little better next year in 2020." ] }, { "name": "Greg Melich", "speech": [ "For the whole company. Got it. And then maybe a little bit more on the dot-com rollout and sort of the timing and the expected lift from that. Could you give us a little more detail on what you really expect to get from a customer standpoint once we're up to Google Cloud in terms of the number of SKUs it will be on offer or how it will help you run the integrated business with focus? Just a little bit more about what will change once it's up and running in the second quarter to help us understand that acceleration you expect?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Hey, Greg. This is Marvin. So we're excited about the work on Lowe's.com, but as we noted in the prepared comments, a 3% growth underperformed in any large brick and mortar retailer trying to create an omnichannel environment. So as we replatform the entire site to Google Cloud that will happen in Q2 time period. We'll have additional phases and additional initiatives being added throughout the year. So there is no one big brand unveil, there'll be phases of improvements throughout the year. What we're estimating in Q3, we'll start to see benefits and the customers will begin to become aware of the improved margin.", "Now let me give you a perspective of what we're doing over the course of this timeframe. We're going to decouple freight from product cost. Today, we still have a competitive disadvantage that our retailers live artificially inflated because many of them have freight included. We're changing that. We're going to be able to expand our online assortment. Today, it takes in some cases weeks and months to add drop-ship SKUs on our site because it's very manual. And so we're creating a more digital process do that. We'll have that ready in the second half of the year.", "Today, we don't have the ability to shop box selection. As an example, if you're purchasing patio furniture, it's a very cumbersome process where a customer will have to shop on one screen for the table, at the top of another screen for the umbrella, another screen for the chair. It is not very customer-friendly. We'll be able to get that done in this first part of the second half of the year. And believe or not, with our market leading position in appliances, it's still difficult to schedule a delivery date with the precision that most customers are accustomed to. So we'll have that up and going by the second half.", "So those are just fundamental things in addition to one click checkout. In addition to dynamic homepage. In addition to navigation and search functionality that's more modernized. And so the reason why we are optimistic that this platform is going to be accretive starting in the second half is because we can look at the project timeline to see all of these things coming online over the course of the year." ] }, { "name": "Greg Melich", "speech": [ "Got it. That's super helpful. Thanks, and good luck." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Hey guys. Good morning. Thanks for taking the question. I guess just given the most difficult comparison of the year coming up here in the first quarter, how are you thinking about Q1 in the context of that 3%, 3.5% full year guidance? And if you could just help us with some of the drivers that you think will help navigate these difficult compares here in the spring, obviously you're lapping a lot of inventory growth, much better in-stock last year versus the prior year. Just help us think about first quarter? Thanks." ] }, { "name": "David M. Denton", "speech": [ "Yeah. So this is Dave. So maybe I'll kick it off and then Marvin will pick up here. Just as you know, we don't really guide specifically to the quarter, just particularly in the first half of the year given when the weather breaks from a spring perspective. I will say if you look at first half versus second half, I would expect that the first half from a comp perspective to be slightly lower than the second half of the year as our strategic initiatives begin to take hold through the balance of the year and really start to pay off in the second half of 2020." ] }, { "name": "Marvin R. Ellison", "speech": [ "So Seth, relative to what will be our sales drivers, we have a very robust list of merchandising and Pro initiatives that will be incremental and we have initiatives that we will get full year benefit for things like the merchandised service teams and field merchants. So I'm going to hand it over to Bill to highlight some of the key merchandising initiatives that we believe will drive incremental sales in Q1. Then I'll let Joe touch on some of the additional initiatives in Pro. So Bill?" ] }, { "name": "William P. Boltz", "speech": [ "Yeah. I think in addition to the MST team and the field merchant team, we also have the first full year of our merchants speed and seat, which is a big deal for us. And then as I said in my prepared remarks, we're very excited about introducing Honda outdoor power, bringing in the Aaron's line of zero-turn. We've got the first full year of Craftsman. If you think about that, we didn't finish the Craftsman rollout until mid-year of 2019. We've got a bunch of new products that we're introducing in our private brands in Cobalt and Allen & Roth, touched on the new Pro stuff coming out of Dewalt, the new products from Weber, Yeti, we've got new faster brands with facet master in GRK, we've got Miracle-Gro, live goods product that we're introducing in our live goods program. And then you think about all the changes that we've made in store in 2019 that we could have in place for full year.", "Our end cap strategy completely changed in 2019, as did our off-shelf strategy. We implemented a cross-merchandising program that rolled out in the fourth quarter of last year. We finished phase one of our refresh work. And we've just tackled some really valuable retail space up in the front of the store that we'll be able to execute and use for the spring season. And as Marvin touched on, with Lowe's.com, albeit early and a lot of things going on, we now have the ability to ship battery-powered products. We have the ability to ship oversized products. We have easier checkout navigation experience. We've got a more enhanced homepage. So there is a ton of things that are in front of us that we've got that layout what's going to happen in 2020." ] }, { "name": "Joseph M. McFarland", "speech": [ "And look, we're also really excited about 2020 in our Pro business. If you think about, Marvin mentioned in the prepared remarks, as well as I did, 2019 was all about fundamentals. It was on staffing, it was on services as we move into 2020. We're not going to lap the investments that we made in 2019. As we made these investments to Pro customers, it took them some time to start to catch on. And as we continue to see the Pro business get better and better, but that was all on fundamentals in '19.", "We have been testing our new Pro loyalty platform. The Pro customers are overwhelming excitement about the benefits they're going to have from there. As we think about personalized offers, as we think about being able to attract spending, as we think about business management tools for the Pro, none of that was ever available, the -- our support program exclusive for Pros. So really excited about all the things we're rolling out from a Pro standpoint in 2020 and we'll continue to capture market share and gain traction." ] }, { "name": "Marvin R. Ellison", "speech": [ "So Seth, just in conclusion on Q1, we have a lot of confidence in the growth of the business based on the specific initiatives that we have in place and how we built our business plans from the bottom up for really the first time based on the expectations of these initiatives. We just have to go out and execute. And that's the expectation going into 2020." ] }, { "name": "Seth Sigman", "speech": [ "Okay, thanks. I'll leave it there. Thanks. I appreciate it." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Scot Ciccarelli with RBC Capital Markets. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. Scot Ciccarelli. So system upgrades only sounds like a great idea and provide a lot more speed and flexibility. However, making the changes themselves are often cumbersome and filled with risk. So especially given, let's call it, some of the issues you guys faced in the first quarter of 2019. How do you make sure you guys don't kind of step you tail as you implement all these different system upgrades?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Okay. That's a fair question. And the thing we try not to do is set aggressive financial targets based on the implementation or delivery of a system. And so if you think about the list of things that you just heard from Joe and Bill on where we believe we're going to gain ourselves benefit in Q1, in the first half of the year, there was no system dependencies listed.", "We have some big system things coming, and I can give you a list of those. But other than what we are expecting from e-commerce, there is really no big dependency on systems. And look, this is a big business it's a complicated business, but we are just very pleased that we have a group of leaders that have been in their roles for a full calendar year, to Bill's point, and that creates more continuity than we've had here in a while. So always a risk, but we think the risk is muted because we don't have high dependencies." ] }, { "name": "David M. Denton", "speech": [ "And Scot, this is Dave. I'll just add a couple of things. One is we're rolling out these systems in waves. So we're putting them in -- not in a big bang, but over time, number one. And number two, we have a very robust highlighting and testing program such that we're out in the field either here in the corporate office or out in the stores, running them in a certain market or location to make sure that the functionality is adequate before we roll it out completely to the store environment." ] }, { "name": "Scot Ciccarelli", "speech": [ "That's really helpful. And then just a quick, hopefully a quick follow-up here. Payables inventory has been down a little bit for the last couple of quarters here. Does that start to stabilize as we roll into 2020, Dave?" ] }, { "name": "David M. Denton", "speech": [ "Yeah. I would expect that our inventories are going to stabilize through 2020. We do think over time we have the opportunity to reduce inventories in a major way. However, we're still building the systems and processes to be able to do that in a very systemic fashion. So think about 2020 as a point in time where we will be stable, making sure that we have the right inventory in the stores to support job lot quantities for the Pro and support our in-stock environment, but not at the year in which will yield performance from an inventory reduction perspective." ] }, { "name": "Scot Ciccarelli", "speech": [ "Okay, great. Thanks guys." ] }, { "name": "David M. Denton", "speech": [ "You got it." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. So there was an execution mishap in the first quarter of last year. There is an execution mishap in the fourth quarter. Marvin, you've been involved in some very sizable retailers. Is Lowe's just more prone to these types of execution issues? And at what point in the transformation can we expect to see more consistent and sustainable execution? And then I have a follow-up. Thank you." ] }, { "name": "Marvin R. Ellison", "speech": [ "Mike, I think it's a fair question. And look, in any large business, you're going to have execution risk, but for us, coming out of Q4, it's really more about understanding the competitive marketplace and having the agility to react to it. And when you have limited system capabilities, it really creates agility limitations. And what I mean by that is when we came to the conclusion for marketing spend that we were not where we needed to be relative to the quarter, we just didn't have the sophistication or the agility to pivot as quickly as we needed to. That is more related to internal capabilities than execution issues. And there are always going to be execution issues no matter how good you are as a business.", "What I can tell you is, one year into this multiyear transformation, I feel great about this thing, I feel great about what we've accomplished, I feel great about 2019 and we have a significant amount of confidence going into 2020. But yeah, there will always be execution risk, we'll always hold ourselves to a high standard, but I feel really good about how we execute throughout the quarter even though it wasn't perfection." ] }, { "name": "Michael Lasser", "speech": [ "That's very helpful. And part of the question comes from the fact that you will be lapping some big inventory build up in the first quarter which could create some noise as you have to lap that. So the view is that execution will improve, is that fair?" ] }, { "name": "Marvin R. Ellison", "speech": [ "No, it's absolutely fair. And look, I'll go back to a couple of comments that's already been stated. First, the value of having leaders in their position before your every seasonal cycle is critically important. In merchandising, in store operations, in finance and in supply chain, so -- and we have that. And clarity of what we're trying to get accomplished and having just better tools and resources available. So we feel really good about our execution.", "If you think about for a second, we're able to rollout an entire new scheduling and labor management system, we're able to leverage expenses, improve service improve, improve our margin rate coming off of a tough Q1 throughout the year. So we think our execution really picked up significantly throughout the year and we think we'll carry that momentum into 2020." ] }, { "name": "Michael Lasser", "speech": [ "And a quick follow-up for Dave. It looks like your gross margin guidance for 2020 is pointing to a 32 spot, 3% gross margin at the midpoint, which would suggest you won't recoup everything that you lost in the first half of 2019. Why wouldn't you get it all back, particularly in light of what seems to be some steady gross margin progress in the fourth quarter?" ] }, { "name": "David M. Denton", "speech": [ "Yeah. Really excellent question. As I said in my prepared remarks, we expect a 50 basis point to 70 basis point expansion in OI in 2020 with an equal contribution both from gross margin and SG&A leverage. And if you look at that, we expect that during 2020, we will achieve rate neutrality versus our baseline level on a like-for-like product gross margin level. We will then incur some additional pressure from both supply chain and shrink. So those are the -- that's what's kind of dragging us down a little bit as we cycle into 2020 and we're working to offset those longer term. But I feel really good about the progress we're making in 2020 and we'll get it back to that neutrality level, now we're trying to cycle over those investment areas." ] }, { "name": "Michael Lasser", "speech": [ "That's very helpful. And good luck in the spring. Thank you." ] }, { "name": "David M. Denton", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Charles Grom", "speech": [ "Thanks. Good morning. A lot of good things going on with Pro. Just wondering if you could just update where you are penetration at this point in time and where you think it could go over the next couple of years?" ] }, { "name": "Marvin R. Ellison", "speech": [ "So Chuck, this is Marvin. Our penetration hasn't materially changed from what we called out earlier in '19 and we'll call it between 20% and 25%. We have intentionally not set a penetration target because we believe it's like an artificial target could lead us to be focused on something other than what's in the best interest of the customer. What we're trying to do is be a very customer-centric organization and how we think.", "Now Joe outlined in his prepared comments some key things that we're doing relative Pro loyalty and CRM. Do we have an expectation that we're going to see our Pro penetration pick up in 2020? Absolutely. We haven't set a target, but we do have expectations on what we're going to be able to generate from new customers, average ticket growth, frequency of visits because we're going to know this customer intimately based on having real data and not based on intuition.", "So that's a long-winded way of saying penetration is about the same and we are not setting target, but we have an expectation we're going to grow the business in 2020." ] }, { "name": "Joseph M. McFarland", "speech": [ "And it's important to just realize in 2019 we focused on all of the kind of basics. And so as we roll into 2020, as I mentioned for loyalty and we have also focused on our Pro outside sales and strategic partnerships. We have the MSH business that has been under construction that we're pleased with what's happening there. And so I think you'll get a much cleaner picture as we roll forward in 2020 on what an actual penetration is." ] }, { "name": "Charles Grom", "speech": [ "Okay. That's great. And then on the merchandise service teams that you've installed in 2019, is there any metric you could provide about the productivity that you -- the productivity improvement that you've seen when you layer in those MSTs? And I think just to clarify, I think you said you're adding 7,000 in the first half of '20. Just perspective of how many you have in place today would be great? Thanks." ] }, { "name": "William P. Boltz", "speech": [ "Yeah, Chuck. This is Bill. So the big role for our MST team is to improve the level of service inside of our stores. And so in addition to that, they also assist with project work. With the additional folks that we're adding in 2020, it's really about improving our service level and then being able to also tackle a number of the projects that we have to do. So we're excited about being able to grow this team. And we continue to thank our vendor partners for their participation. And it allows us to provide better level of service to be more ready. So we're already excited about where that's going." ] }, { "name": "Charles Grom", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Eric Bosshard with Cleveland Research Company. Please proceed with your question." ] }, { "name": "Eric Bosshard", "speech": [ "Good morning. Two things or a question and a follow-up. The 2.5 brick and mortar comp in 4Q, you've invested in the last four or five quarters in improving the in-store experience. When you look at that number relative to your peer, curious how you characterize it? It seems a bit underwhelming. Then I guess the core question is, what is limiting the core brick and mortar growth of the business? And what do you do in '20 to materially improve it or is this is as good as it counts?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Eric, this is Marvin. Candidly, we're not spending the time looking at anything other than the customer and our internal execution. So for us, when we look at year-over-year improvement and we look at improvement in our store execution, we believe we're making progress. So if you think about it for a second, a lot of home improvement transactions begin online. They may not consummate online, but they begin online. So on one hand, it is a true omnichannel environment where research and also product education happens online and then it drives traffic to the store. If you have limitations online, not only does it hurt your dot-com sales, it actually hurts your brick and mortar sales because it limits the amount of traffic where people will show up after having quality efficient research and decide to buy.", "So we think it's part and parcel that Lowe's.com has to improve and when that improves, it lifts the entire company from an e-commerce standpoint, from an omnichannel standpoint and from a brick and mortar perspective. But if you think about the things that Bill talked about with the fact that we just changed out our entire income strategy, we just created entire off-shelf program, we just cleared up seasonal space upfront for the first time that's going to be consistent. In every store we can actually set spring, we can set events, we can set holiday gift centers. So all of these things are about creating space productivity in the stores. In addition to that, I'll just let Bill walk through some of the other key drivers of spraying and some of the things we invest in that we think will continue to create better brick and mortar sales." ] }, { "name": "William P. Boltz", "speech": [ "Yeah. The other -- I think another big part that we've invested in is around the training for our associates in the store. And so between Joe and myself, we've put together just a lot of product knowledge training for our teams supported by our vendors, but really wanted to make sure that we can raise the level inside the aisle, inside the store. I touched on in my earlier comments about all of the different product launches that are coming. All of the different capabilities that are coming from Lowe's.com and a couple of them that came on board in the fall of last year.", "I touched on the cross-merchandising program. We didn't have one until late last year. And so that's going to get a full year of that rollout. And then we've got field merchants on the ground, inside of our regions to help us refine these assortments as we continue to work on improving our productivity. And then as I just touched on with the MST team being able to expand those folks allows us to speed up how we service the base inside the store and how we get more things done. So we're excited." ] }, { "name": "Marvin R. Ellison", "speech": [ "And Eric, it really is a fair question. And the only other comment I'll make is the importance of the Pro business. In home improvement, if you don't have a healthy Pro business, you really become the victim of weather patterns, you become the victim of a lot of different things that drive yield normal retail traffic patterns. But irrespective of the weather outside, pros have to work. And so a really robust Pro business creates store base productivity that continues to really benefit you throughout different weather patterns in times of the year.", "And so one of the reasons why we've been so vested in Pro, it goes directly to your question, so we can create a better productivity in our brick and mortar stores and have more sustained growth in our productivity. So work in progress. We're one year into this multiyear transformation. I'm very pleased with where we are." ] }, { "name": "Eric Bosshard", "speech": [ "And then a follow-up. Two important categories, just quickly love some perspective on the relative trend performance versus 3Q or the first three quarters of the year. In flooring, I know that you've invested and gone through reset activity, curious if you've seen comp improvement as a result of that? And then also appliances, did that take a notable step down in growth relative to where the prior trend had been based on how things shook out in 4Q?" ] }, { "name": "William P. Boltz", "speech": [ "So Eric, it's Bill. So on the appliance side, we continue to outpace the store, we're continuing to leverage our number one position, pleased with our appliance performance that it had demonstrated all year long. And then when you look at flooring, we've made a lot of investments in flooring. We're seeing continued growth in luxury vital plank. We're starting to see lines -- signs of growth now in our soft flooring business, which had lagged for years. We're seeing growth in new products. So anything that was new was introduced, like in decorative wall tile, laminate, anything that's water-resistant, all of those trending very well. And then we'll continue to refine that category. It's important for us to be able to get back, chopper in them into our store and drive that portion of our business. So we're going to continue to tweak." ] }, { "name": "Eric Bosshard", "speech": [ "Okay. Thank you." ] }, { "name": "Marvin R. Ellison", "speech": [ "We'll take one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Hey, good morning. I'll make it quick. Are you -- can you quantify or you're trying to quantify some of these holiday marketing in appliances, some of the lapping of the PSI to get back to what you think you would have comped, I realize it's in precise and it sounds like, Marvin, you still weren't pleased with the outcome, but wanted to clarify that?" ] }, { "name": "Marvin R. Ellison", "speech": [ "Simeon, what we know is we had an internal forecast as all businesses will have going through any season where we had an internal plan. And Bill's point about appliances, although we are pleased with the comp in appliance relative to the company comps underperformed our internal forecast. And when you look at the data that all came out of early November because as you know, there are a couple of big event periods during the year in appliances in November happens to be one of the largest and decompressed holiday season and how the customer shop, we just didn't have the agility in our marketing strategy to take advantage of it.", "So we know what we left on the table. We're not stating that externally. But what we can say is, if we would have met expectations in the CAGR which we laid out, we would have been at or above what we had forecasted from a top-line standpoint. And so we can definitely see how and why we did not hit the internal number. But even with that, we were pleased with the fact that we're able to leverage expenses and SG&A and we were able to manage the business much better. I remember not too far in the distant past Lowe's didn't beat the top-line, there was no way they're going to hit the bottom-line performance and we did all of that and still leverage customer service across Pro and DIY. So we did it the right way." ] }, { "name": "Simeon Gutman", "speech": [ "And the short follow-up is, inventories, you've worked them down since the spike in the beginning of the year as you've told us you would. Now we're in a better position, but let me just paint the other side of it. Hey, do you have the right inventory, the right level of purchasing, newness where you want to be for the spring?" ] }, { "name": "David M. Denton", "speech": [ "Yeah. I think from a spring perspective, very much so. I think as we think about the full year, we will continue to invest in strategic categories to enhance our business primarily in the Pro space. At the same time, keeping our inventory levels relatively constant throughout 2020." ] }, { "name": "Simeon Gutman", "speech": [ "Okay, great. Thanks. Good luck next year." ] }, { "name": "Marvin R. Ellison", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. [Operator Closing Remarks]" ] } ]
LOW	2023-08-22	[ { "description": "Vice President, Investor Relations and Treasurer", "name": "Kate Pearlman", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Marvin Ellison", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Bill Boltz", "position": "Executive" }, { "description": "Executive Vice President, Stores", "name": "Joe McFarland", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "Brandon Sink", "position": "Executive" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Cleveland Research Company -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steve Zaccone", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, everyone, and welcome to Lowe's Companies second-quarter 2023 earnings conference call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I'll now turn the call over to Kate Pearlman, vice president of investor relations and treasurer." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you, and good morning. Here with me today are Marvin Ellison, chairman and chief executive officer; Bill Boltz, our executive vice president, merchandising; Joe McFarland, our executive vice president, stores; and Brandon Sink, our executive vice president and chief financial officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's investor relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2023.", "Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A, and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in the quarterly earnings section of our investor relations website.", "Now, I'll turn the call over to Marvin." ] }, { "name": "Marvin Ellison", "speech": [ "Thank you, Kate, and good morning, everyone. For the second quarter, comparable sales declined 1.6%. Our results were driven by a strong spring recovery, combined with continued growth in Pro and online, which helped to offset softer DIY discretionary spending and 160 basis points of pressure from lumber deflation. Q2 also reflected the importance of our ongoing investments in our Total Home strategy.", "And despite an uncertain macro, these investments are paying off with positive comps in Pro and 6.9% comparable sales growth online as we continue to improve our omnichannel experience. We're pleased that our core Pro customer to small and midsized Pro remains resilient and continues to respond to our expanded national brands, MVP's Pro Rewards program, and enhanced online tools. In our most recent survey, nearly 75% of Pro's reported healthy project backlogs and lead volumes remain consistent with recent quarters. This quarter, we launched a new same-day delivery option on lowes.com and our mobile app, powered by OneRail, enabling us to tap into their network of 12 million drivers to deliver directly to Pro job site and consumer homes in a matter of hours.", "This new capability allows us to leverage our 1,700-plus store footprint to make those much needed last-minute deliveries to Pro job sites, saving them both time and money. Our expanded same-day delivery capability is the latest of many examples of how we are meeting our customers where they are in making home improvement shopping faster and more convenient for both Pro and DIY customers. We're also making strides in the rollout of our market delivery model for big and bulky products with 13 geographic regions now supporting more than 1,200 stores, and we are on track to complete the initial rollout by the end of the year. As we invest in what will drive our future growth, we remain disciplined in improving productivity through our perpetual productivity improvement initiatives or PPI.", "In the second quarter, operating margin expanded 18 basis points, leading to dilutedearnings per shareof $4.56. A common misperception we hear is that our productivity journey must be close to us in as we've driven significant operating margin leverage since beginning our transformation 5 years ago. But the reality is we still have a lot of opportunity ahead. We're in the final phases of sunsetting our 30-year operating system.", "In addition to the productivity benefits of using intuitive touchscreens instead of hard-to-navigate green screens, this conversion gives us the modern foundation needed to quickly build and scale new omnichannel capabilities for the future. And we also continue to leverage our penetration of rural stores to drive sales productivity. We run these stores with a lower expense base than the rest of our portfolio, and our ability to generate outsized operating margin leverage on sales growth is unique. Specifically, the expansion of our rural product assortment, combined with the implementation of our PPI initiatives, make our rural and remote stores a competitive advantage for our company.", "Beyond the productivity initiatives underway in stores, our leaders across all functional areas are executing against dozens of PPI work streams to deliver sustained operating margin improvement. One example of this is in our supply chain where we are driving greater throughput with new mobile applications combined with automation and robotics to improve productivity, maximize speed, and minimize damages. And we're piloting a new break pack process, which leverages automation to break down cases five times faster, making it far more efficient to replenish stores. And as we drive productivity, we also continue to focus on sustainability as the two often go hand in hand.", "And we recently published our 20th corporate responsibility report, spotlighting our path to net-zero emissions along with our investments in our associates and communities. As we speak with investors, many of your questions have centered on the macro environment. And as a reminder, the two strongest demand drivers of our business are real disposable personal income and home price appreciation, and they are most supportive of demand when they pull in tandem. Home price appreciation has slowed, but it's still up 35% versus pre-pandemic, while rural disposable income has been pressured by persistent inflation and elevated interest rates.", "But on a positive note, over the past quarter, growth in real disposable income started to improve and realign with long-term trends with growing wages surpassing inflation for the first time in two years. Consumer sentiment has also improved slightly but remains below pre-pandemic baselines, and inflation concerns linger. However, improvements in sentiment typically must be sustained for a period of time before that translates to consumer spending. As a result, home improvement shoppers remain cautious with their spend, especially big-ticket discretionary purchases, and are more focused on smaller repair and maintenance projects.", "These trends are consistent with our expectations and reinforced our outlook for our relevant market to be down mid-single digits in the second half of the year with our sales continuing to outpace the market by 100 to 200 basis points. Looking ahead, it's encouraging to consider that home improvement projects are typically postponed rather than canceled. And home improvement span as a percentage of home equity is below the historical average, a positive indicator for medium-term demand as consumer sentiment improves. The aging housing stock will also drive remodel and repairs, combined with other favorable trends like millennial household formation, aging in place, and persistent remote work.", "All of these factors continue to make us bullish on the mid- to long-term outlook for our industry. In closing, we remain a customer-centric company focused on our daily execution while also ensuring we continue to make the right investments to take share in any macro environment. Our Total Home strategy is resonating with our Pro and DIY customers alike, and we are confident in our ability to deliver in the short and long term. As I'm out visiting stores each week, I continue to be impressed by our hard-working frontline associates, and I'd like to thank each of them for their commitment to Lowe's and their communities.", "And with that, I will turn the call over to Bill." ] }, { "name": "Bill Boltz", "speech": [ "Thanks, Marvin, and good morning, everyone. Our second-quarter comparable sales were down 1.6%, slightly above expectations. We successfully recovered 300 million of delayed seasonal sales from Q1 due to the late start to spring, 50 million more than anticipated. We saw growth in rough plumbing, building materials, paint, seasonal and outdoor living, lawn and garden, and hardware as we capture the spring sales and continue to see solid, broad-based pro demand.", "These factors partly offset 160 basis points of lumber deflation as well as continued pressure on big-ticket DIY discretionary demand that Marvin mentioned earlier. In hardlines, we drove broad-based sales growth driven by our stronger-than-expected spring recovery. Lawn and garden was a standout category, achieved in partnership with our live good vendors who helped us effectively respond to changing weather patterns and stretch spring into the summer months. We saw an increase in smaller instant-gratification projects that improve outdoor spaces at an affordable price, like landscaping projects and preplotted plants.", "Seasonal and outdoor living also benefited from the weather recovery where we saw momentum in outdoor power equipment, specifically in riders with the strength of our exciting products from John Deere and Ariens, along with the battery-powered equipment from the strength of EGO, Kobalt, and Craftsman. And we are pleased with our strong seasonal sell-through putting us in a better inventory position than last year as we move into the second half. Hardware was another top-performing category this quarter as our associates drove attachments alongside the higher lumber units and leaned into fastening with key brands like Specs, GRK, Power Pro 1 and Facia Master. In tools, we started the rollout of Klein Tools, the No.", "1 tool brand for electricians and HVAC professionals. We are excited about the launch of this brand, which is returning to Lowe's after nearly 15 years. As part of this launch, we will offer the largest assortment of client tools anywhere in the home improvement retail channel, featuring hand tools, storage, safety and electrical products in-store and online, positioning us as the go-to retailer for these brand-loyal customers. Within home decor, paint delivered the strongest comp performance this quarter as we gained traction with the pros who paint.", "These pros are increasingly taking advantage of our MVP's paint rewards program, paint job site delivery, and our new spec right paint designed specifically for Pros. Turning to appliances. We continue to outperform the market. We've seen a return to pre-pandemic levels of vendor-funded promotions that are pressuring average tickets across the industry.", "But I'm excited about the traction that we're gaining as the leading appliance retailer in the U.S., reflected in our unit sales growth, market share gains, and the momentum with our Pro customers once again this quarter. One encouraging trend was the increase in bundled appliance purchases. This was fueled by focused Red Vest associate selling, auto applied supplier rebates, faster fulfillment through our market delivery model, and our improved online customer experience. Now, shifting gears to building products.", "We continue to see strength in key Pro categories, helping offset the pressure from year-over-year lumber deflation. While lumber deflation pressured our top line by 160 basis points and our Pro comps by 315 basis points, the category once again delivered the highest unit comp in the company this quarter. reflecting strong Pro demand. Our continued growth in building materials and rough plumbing is another positive indicator of the resilience of the small to midsized Pros supported by the healthy backlogs Marvin mentioned earlier.", "In rough plumbing, we expanded our assortment of PEX products and added our first battery-powered Kobalt drain auger. This is one of several new Kobalt launches this year as we celebrate this private brand's 25th anniversary. Our private brands are speced out and quality tested to ensure that they are equal to or better quality than comparable national brands, and we continue to see our customers respond to their great quality and value. Our increasing private brand penetration is nicely balanced with a strong lineup of trusted national brands like Bosch, DEWALT, Rubbermaid, and Scotts.", "Shifting to localization. We completed our rural expansion to roughly 300 stores ahead of schedule this quarter. This includes scaling our store within a store concept with Petco designed to provide a dedicated space for all things pet. While it's still early, we're encouraged to see an increasing basket size in these stores, and customers are saying that they appreciate the convenience and the ability to reduce the number of stops they need to make.", "As Marvin mentioned, our work to optimize our rural stores is one piece of our broader localization strategy designed to drive market share gains, increased productivity, and margins. Another highlight this quarter is the growth we've driven online as we continue to improve the digital shopping experience and increase conversion. Our launch of same-day delivery nationwide on lowes.com, and our mobile app is resonating well with our customers. We also introduced a new digital will-this-fit capability that helps customers determine if a refrigerator will fit into their space and a refined search experience with better recommendations, filters, and featured categories.", "And our Halloween and holiday sets are already available online, positioning us nicely for customers who want to get a jump start on decorating. We are also encouraged to see better-than-expected performance for our Lowe's One Roof media network, which is driving increased traffic to Lowes.com and generating results that are exceeding the industry average for our suppliers. Our media network is one of many merchandising PPI initiatives underway at Lowe's. The team is constantly working with our suppliers to find ways to take cost out as commodity prices and transportation costs have come down, and we continue to enhance our technology and processes to optimize pricing.", "We have also expanded our merchandising services team, or MST, to over 30,000 associates across our stores and garden centers, which frees up our Red Vest associates to spend more time serving customers. New this year, we are adding MST assistant store managers. This role will be focused on providing dedicated store leadership for the critical work that this team does. Through their improved service, the team is squarely centered on driving sales per square foot productivity in our stores while creating a better shopping experience for our customers.", "As I close, I'd like to once again extend my appreciation to our vendors and merchants for their hard work and partnership. Thank you, and I'll now turn the call over to Joe." ] }, { "name": "Joe McFarland", "speech": [ "Thank you, Bill, and good morning, everyone. I'm really pleased to begin by announcing that we are awarding over $100 million in bonuses for our frontline hourly associates in recognition of their hard work and dedication during the second quarter. Our investments in our associates are paying off as we continue to elevate the customer experience with a 200 basis point improvement in both our DIY and Pro customer service scores this quarter as compared to last year. And we are seeing strong staffing levels and improved associate engagement as we continue to invest in associate wages and ongoing development through Lowe's University.", "As Marvin mentioned, our online comp sales grew 6.9% in the quarter, and roughly half of those orders are picked up in a store. We continue to unlock productivity through one of our many PPI initiatives by reducing the time to pick these orders by approximately 70% as our associates leverage our omnichannel investments, which include mobile devices and order picking carts with mobile printers to streamline the process. And we've enhanced our workforce management tools to better align staffing levels with customer demand. These enhancements are allowing our customers to get in, get what they need, and get back to their projects faster.", "Looking ahead, we are further enhancing our BOPIS experience as we transform the front-end of our stores. This includes an expanded staging area, a dedicated pickup desk with improved signage, and new technology that expedites the process. Now, shifting to Pro. We continue to deliver positive comps this quarter despite lumber deflation and under the leadership of our new Executive Vice President Quonta Vance, we will continue to expand our online business tools for pros that allow them to easily generate quotes and track orders as part of the MVP Pro Rewards program.", "As we continue to find ways to save pros' time, this month, we launched our newest online tool purchase authorization. Until now, when pros send a crew member to the store to pick up an order, the designated buyer would need to call their team from the checkout line to confirm the order and have it authorized by the store. This could be a time-consuming process, taking the pros' time away from their job site and the associate's time away from serving other customers. Now, runners can simply scan a QR code that's pre-authorized up to a specified amount and check out without having to wait in line at the Pro desk.", "This solution addresses a pain point for many Pro customers and our Pro desk associates and leapfrogs the competition. And we're encouraged to see that our suite of online tools is resonated with pros and adoption is already exceeding our expectations. Now, I'd like to spend a moment discussing how we are managing shrink, which is a big responsibility for any retailer, especially in this environment. As expected, shrink was in line with last year's results despite industrywide challenges, driven by our proactive customer service, tech-driven solutions, industry-leading asset protection program, and our penetration of rural stores.", "We're developing radio frequency identification or RFID technology embedded in power tools to prevent theft. This solution will be largely invisible to customers, but it makes a tool inoperable until it is scanned and purchased. Turning to PPI or perpetual productivity improvement. In-store operations, we have a series of exciting initiatives on our road map that will continue to deliver productivity for the company.", "In addition to the omnichannel enhancements that I mentioned earlier, we also upgraded freight flow process for shipments from our distribution centers into our stores and on to the selling floor. Through improved technology, we now have better visibility into how freight is flowing into our stores. This enables us to better match staffing levels with the type of inbound freight, getting the product onto the shelves faster. These PPI initiatives, combined with our continued investments in our associates, have helped us to control our expenses and improve our customer service scores in a down sales environment.", "Before I close, I'd like to extend my appreciation to our frontline associates in Kentucky, New York, and Vermont, who supported flood relief in their communities and to our teams in Hawaii, who are responding to the devastating wildfires. To support the recovery efforts in Maui, we are donating $1 million to provide food, emergency shelter, and relief supplies to those affected and are grateful for our frontline associates for going above and beyond to help those on the island with recovery and cleanup. With that, I'll turn it over to Brandon." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Joe. Let me begin with our Q2 results. We generated diluted earnings per share of $4.56. Q2 sales were 25 billion.", "As a reminder, prior year sales included 1.7 billion generated in our Canadian retail business. Results also reflect a $335 million sales headwind and due to the shift in our fiscal calendar as we cycle over a 53-week year. As Marvin mentioned, comparable sales were down 1.6%, which includes approximately 160 basis points of lumber deflation. This pressure was partly offset by a 125-basis-point benefit or $300 million of seasonal sales delayed from Q1 due to a late start to spring.", "Although the calendar shift pressured total sales growth in Q2, it had no impact on comparable sales as comps are calculated based on weeks 15 to 27 in fiscal 2022. Comparable average ticket was up 0.3% to prior year. Ticket increases in the majority of our merchandise categories were offset by lumber deflation and more normalized appliance promotions. Comp transactions declined 1.9% driven by continued pressure in DIY discretionary purchases, partly offset by our seasonal recovery.", "Our monthly comps were down 1.2% in May, 1.6% in June, and 2% in July as the seasonal recovery was concentrated in the first half of the quarter. Gross margin was 33.7% of sales in the second quarter, up 42 basis points from last year. Gross margin benefited from our ongoing PPI initiatives, favorable product mix, and lower transportation costs. These benefits were somewhat offset by costs associated with the expansion of our supply chain network and as expected, shrink was in line with prior year.", "SG&A of 16.4% of sales delevered 16 basis points, largely due to lower sales related to the shift in our fiscal calendar. Please note that it also includes the benefit of a one-time legal settlement. We continue to tightly manage expenses, adjusting spend appropriately to align with demand, all while still improving our customer service. Also, as you heard from Marvin, Bill, and Joe, we are pleased with the ongoing momentum we are experiencing across our portfolio of PPI initiatives, which continue to create significant value for the organization and helped offset the impact from lower sales.", "Operating margin rate of 15.6% of sales levered 18 basis points, consistent with the expectations we outlined on our last call. The effective tax rate was 24.6%, in line with the prior year. Inventory ended the quarter at 17.4 billion, 1.9 billion lower than the prior-year quarter. U.S.", "inventory units were down 3% compared to last year as we continue to manage replenishment in line with sales trends. Now, let me turn to capital allocation. In Q2, we generated 3.5 billion in free cash flow and returned 2.8 billion to our shareholders through a combination of dividends and share repurchases. During the quarter, we repurchased 10.1 million shares for $2.2 billion.", "In addition, we paid $624 million in dividends at $1.05 per share, and we announced a 5% increase to $1.10 per share for the dividend paid on August 9th. Capital expenditures totaled $385 million as we continue to focus on high-return projects that support our growth objectives. Our balance sheet remains healthy, adjusted debt-to-EBITDAR stands at 2.69 times as we move toward our stated target of 2.75 times, in line with our BBB+ credit rating. Additionally, we delivered return on invested capital of 27.8%, inclusive of a 750-basis-point impact related to transaction costs associated with the sale of our Canadian retail business and the discrete gain we reported in Q1.", "Now, turning to our 2023 financial outlook. As Marvin mentioned, we continue to expect our relevant market to decline mid-single digits this year and to outperform the market by 100 to 200 basis points. As such, this morning, we reaffirmed our full-year 2023 financial outlook. We continue to expect 2023 sales in a range of 87 billion to 89 billion for the year, representing comparable sales of down 2% to down 4%.", "This includes a 150-basis-point impact from lumber deflation for the full year. This outlook reflects continued strength in Pro and online, offset by ongoing pressure from DIY discretionary purchases. Specific to our Q3 expectations, we will be cycling over the toughest comparison of the year as we delivered plus-3% comparable sales in the U.S. last year.", "Given these difficult comps, we are expecting Q3 sales toward the lower end of our full-year guide. We continue to expect full-year adjusted operating margin in a range of 13.4% to 13.6%, with disciplined expense management and ongoing PPI initiatives, partly offsetting the impact of lower sales volumes. And we are reaffirming our outlook for adjusted diluted earnings per share of $13.20 to $13.60. As a reminder, our full-year outlook for operating margin and diluted EPS excludes adjustments associated with the sale of our Canadian retail business.", "And finally, we continue to expect capital expenditures of up to 2 billion this year. In closing, I remain confident that the investments we are making in our Total Home strategy are positioning us to grow our market share regardless of the macro environment while continuing to deliver meaningful long-term shareholder value. And with that, we will open it up for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We are now ready for questions. [Operator instructions] In order to allow questions for as many individuals as possible, please limit yourself to one question and one follow-up. Our first question comes from Chris Horvers with JPMorgan.", "Please proceed with your questions. Mr. Horvers, please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning. So, my first question is on the top line. What drove the difficult comparisons in the third quarter that you're not expecting this year? And then as you think about those bigger-ticket DIY discretionary categories, how do you see the rate of change in those businesses? Are we starting to get to a baseline level that we can grow from, or is that spending pattern still deteriorating?" ] }, { "name": "Marvin Ellison", "speech": [ "Hey, Chris. This is Marvin. And I'll take the first part, and I'll let Brandon take the second part. When you look at last year, it's two different years, two different macro environments, two different sets of consumer sentiments, two different sets of expectations for DIY and Pro customers.", "I think the key point is that we feel good about the steps we're taking to grow market share. Regardless of the macro environment, we have a plan to outperform the home recruitment mark by 100 to 200 basis points, and that's what we're focused on. So, I'll let Brandon answer the second part of your question." ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Chris. This is Brandon. Let me get into a little detail on Q3 and second half. First, before I do that, let me take care of one quick housekeeping item as it relates to Q2 exit rate.", "There's some noise that we saw in the comp spreads across Q2 given the calendar shift that we experienced. And after adjusting those spreads to compare to last year, Q2 comps are down roughly 1% in July. Also, when we look at July and August, they're traditionally lighter volume weeks until we hit the Labor Day fall seasonal period. So, looking ahead at Q3 specifically, we are cycling our toughest comparable of the quarter, plus 3% last year in August, the toughest across that quarter, plus 4%.", "And then your question on sort of puts and takes different from Q2. As we get into Q3, we won't see the same level of seasonal benefit. Going forward, we called out 300 million there that we experienced in Q2. More modest lumber deflationary pressure in Q3, which sized at about 75 basis points and then continuing to expect pressure in the DIY discretionary spend.", "And then on the flip side, continued growth and momentum from the Pro business as we expect to outpace DIY. So, those are just to give you some insights as we look at Q2 and how we transition in Q3." ] }, { "name": "Chris Horvers", "speech": [ "Got it. Makes sense. And then on the gross margin line, I know you had some price cost issues in the first half of this year. As you look ahead, given -- is that behind you? And as you think about how freight is going to start to roll through the inventory, should gross margin performance improve in the back half relative to the first half? Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Yes, sure, Chris. So, gross margin bounced back as we expected. From Q1, we had easier product margin comparables due to prior-year timing. The benefits, as you mentioned, the transportation cost relief is now flowing through margin as expected.", "We also benefited from product mix, and we continue to see great momentum with our PPI benefits across the merchandising portfolio. Those benefits are offset by continued investment in supply chain and the expansion specifically on market delivery. We called out shrink being neutral, as Joe mentioned, continuing to drive tech solutions to manage some of the industrywide challenges there. And all in, as we look at the full year, we still expect roughly gross margins flat across the year.", "So, puts and takes there, just like Q2, supply chain expansion, continued pressure from some of the Pro growth initiatives, and then we expect continued benefits across the back half of the year from private brand penetration, supplier clawbacks, lower transportation costs, and initiatives that we're seeing across the pricing portfolio." ] }, { "name": "Chris Horvers", "speech": [ "Thank you." ] }, { "name": "Brandon Sink", "speech": [ "Thank you, Chris." ] }, { "name": "Operator", "speech": [ "The next question is from the line of Simeon Gutman with Morgan Stanley. Please proceed with your questions." ] }, { "name": "Simeon Gutman", "speech": [ "Good morning, everyone. We're at the halfway point of the year. I was hoping to take stock or diagnose the macro housing, Marvin, you mentioned that. And then also the consumer.", "Curious how it's playing out versus your expectation. It feels status quo, but wanted to hear the puts and takes on both sides." ] }, { "name": "Marvin Ellison", "speech": [ "Yes, Simeon. Look, I think you summed it up well. For us, when we look at consumer sentiment, I mean, we know that we're seeing a pullback in DIY discretionary spend. And that's really for us the kind of the overall theme of how we see the second half of the year.", "I think the good news for us is we remain really bullish on the mid- to long-term view of the home improvement market, and we think it's still very healthy. I mean, I can just give you the traditional data points that really matter, and we think that they're going to matter not only for home improvement in the mid to long term, but we think this is one of the best retail sectors to be in. You look at home demand, you had 2 million fewer homes than what's available for sale, the age of homes, 90% of homeowners have fixed mortgage rates in an environment where rates, as you know, are going up. And when we look at all the things that we're doing relative to Pro to DIY, we feel really, really comfortable that irrespective of the macro environment for home improvement that we're going to outperform the marketplace by 100 to 200 basis points.", "And key examples of why we believe that is when we take a brand like Klein Tools that we have had absent from Lowe's for almost 15 years, and we can bring back the number 1 brand for electrical and HVAC Pros and be the largest home improvement retail outlet for that brand, that gives us a lot of confidence that our strategy is working, and we're going to continue to grow market share across Pro and DIY. But the DIY discretionary pullback on big ticket drives our overall modest concerns about the back half. But even with that, we think we can outperform about 100 to 200 basis points." ] }, { "name": "Simeon Gutman", "speech": [ "That's helpful. The second question is more on margin, and this is maybe irrespective of what happens to sales. So, both on SG&A per foot and even GM, you have the PPI as a good guy and then just in general spending levels. Can you talk about where PPI is? Is it performing better than you thought, and then is there any areas where you in hindsight should be spending more in or less for that matter just as we think about the margin progression going forward?" ] }, { "name": "Marvin Ellison", "speech": [ "So, I'll take the first part and I'll let Brandon add any additional context. What's interesting is that PPI started in store operations. I mean, typically, you think about expense, it always begins in the store because of the amount of payroll we spend, how we execute in our 1,700-plus store environment. But then the philosophy started to permeate around the entire company, merchandising, supply chain, and across all those functional areas.", "And so, because of that, we built a road map that Brandon and I could look at over a multiyear time frame, and we can understand the tech investments we're making and the expense reduction and the productivity that will be driven based on those investments. In addition to that, I don't want to understate the importance of our role in remote stores, as I mentioned in my prepared comments and Bill mentioned in his. We simply believe as we continue to identify ways to localize this a little bit in addition to putting in technology and implementing PPI, we think it's going to give us a disproportionate benefit over the long term in driving operating margin improvement. And again, PPI is a big part of that.", "Brandon." ] }, { "name": "Brandon Sink", "speech": [ "Yes, sure. Simeon, the good news too, when we look more in the short term around the back half of 2023, we actually are expecting PPI to get more momentum in the second half than what we saw in the first half. A couple of really good efforts that are going on with new store tech architecture as we continue to build the modern foundation, enabling new capabilities in the store like omnichannel selling. We're transforming the front end of the stores with improved self-checkout, revamped BOPIS experience.", "And then across the other areas, within merchandising, I mentioned earlier, pricing, private brand expansion and claw back and then also within the supply chain efforts as we continue to improve process and implement automation there. So, all in, really pleased with the progress. We have those benefits factored in. They're going to continue to accelerate as we move across the second half of the year, and those are captured in our expectations." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Elizabeth Suzuki with Bank of America. Please proceed with your questions." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you. Just a couple of questions about the assumptions of the guidance. So, for the second half, you're assuming at the high end comps down about 1%, but on the low end, down about 5%.", "So, I'm just curious what economic scenarios you're contemplating for both the high end and the low end? And then if trends you're seeing today continue, do you think you would end up on the higher end or on the lower end?" ] }, { "name": "Brandon Sink", "speech": [ "Yeah, Liz. This is Brandon. I think as we think about our range for the full year, we believe the range is practical and it reflects a measured approach given the various potential scenarios and outcomes. We still as we look at the back half, still significant macro uncertainty, inflation, interest rates, a more cautious consumer especially on the discretionary side.", "There's also variables such as the student loans and the uncertainty there with the moratorium. So, the team continues to be focused on executing the Total Home strategy. We believe home improvement is going to be down mid-single digits, and we'll outpace that 100 to 200 basis points. We expect second half the softness with DIY discretionary to continue, and we expect to continue to see momentum from Pro and dot com.", "So, those -- that's what's reflected overall in our second half." ] }, { "name": "Marvin Ellison", "speech": [ "So, Liz, this is Marvin. And this is a point I want to continue to reinforce. I mean, obviously, we're looking at the data that we have available, and we're looking at historical trends and how that data correlates to historical trends. But what we're saying is we're going to outperform the market by 100 to 200 basis points.", "So, if we're being too pessimistic in the second half, that's great because we're going to outperform that by 100 to 200 basis points. And so, for us, we're really focused on controlling what we control, executing our Total Home strategy, and just maintaining our organizational alignment and agility around whatever the macro throws our way. But we're just really confident as a team and a company that we have the agility to make sure that we continue to take market share irrespective of what the home improvement environment will be in the second half of the year." ] }, { "name": "Liz Suzuki", "speech": [ "Great, thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Zach Fadem with Wells Fargo. Please proceed with your questions." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. So, your average ticket slipped back slightly positive. We know lumber played a role, but considering this line is still 30% above 2019, can you talk us through the moving parts here in a little more detail, and if you think it's fair to say that the average ticket has normalized or if there's still risk that you revert back closer to those '19 levels?" ] }, { "name": "Brandon Sink", "speech": [ "Zach, this is Brandon. Let me take sort of the ticket transaction narrative here. So, on the ticket side, as we look at inflation, the benefits we expect to continue to normalize as we cycle a number of the price increases from 2022. As we look at new cost increases that are currently in our pipeline or inbound from our suppliers, that's effectively minimal at this point.", "There is some positive improvement in the average ticket and the expansion there that's not necessarily inflation driven as we continue to see healthy growth from our Pro customers and Pro penetration. But punchline as we look across the second half, we're not anticipating meaningful deflationary pressure. We're going to see year-over-year lumber pricing is going to be much more normal across the second half. Bill mentioned, we're going to begin to cycle more normal appliance pricing, specifically as we get into Q4 and then the ongoing expectation with DIY discretionary is going to continue to put some pressure on ticket.", "So, taking all that into account, our outlook assumes more pressure overall on transactions, and we look at ticket and expect that to really hold over the back half of the year." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And just over the past two years, your cost controls and operating margins have been able to show really nice progress even on a negative comp. And considering all the PPI commentary and host of structural changes, can you talk through what kind of margin progression we should anticipate as comps slip back to positive eventually? And if you think the expansion today could, in any way, preclude more meaningful expansion and recovery?" ] }, { "name": "Brandon Sink", "speech": [ "Yes, Zach. This is Brandon. I think, look, right now, we're really focused on delivering our expectations for 2023. We've laid that out in the guidance.", "I'll reference back just as we your question around slipping positive comp. We laid out various scenarios back in December. We still, as we sit here today, confident in our path to continue to expand comps, top line through deployment of our total home strategy. We feel like we have a nice path going forward to expand operating margins.", "We've talked already at length around where we are from a perpetual productivity initiative standpoint, we're going to continue to make progress there. I'm confident, again, that we have the road map in front of us and all those building blocks are in place when we look beyond 2023." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Thanks for the time." ] }, { "name": "Brandon Sink", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Scott Ciccarelli with Truist Securities. Please proceed with your questions." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. Can you please talk about any regional differences you are seeing both in different parts of the country but also differentiation here between, call it, the rural locations you guys continue to reference as well as heavier urban locations? Thanks." ] }, { "name": "Marvin Ellison", "speech": [ "Yes. So, Scott, I'll take the first part there. Look, I'd say regional differences, there's nothing material to speak to. I mean, we know that housing and home prices ramped up pretty aggressively during the pandemic time frame in a couple of markets.", "But when we look at the overall geographic spread, I mean there are no real material differences between locales that have had dramatically increase in housing costs and some of those costs are starting to moderate because you still have markets around the company -- country rather where home price is still going up. So, we look at it, obviously, because it's one of those key internal macro indicators that we factor into our assessments, but there's nothing material to speak to. Relative to urban and rural, we have spent a lot of time talking about the importance of localization. And to say that Lowe's was a company that was not very localized five years ago would be an understatement.", "And as much progress as we have made, I think Bill will tell you that we still are excited because there's still lots of opportunity for us to be even more specific in how we localize from a rule and from an urban standpoint. I'm going to let Bill talk a little bit about our rule initiative and kind of what we're seeing. It's early days, but the early signs are positive. And I'll let him share just some general thoughts around those initiatives and kind of what we hope we'll continue to see." ] }, { "name": "Bill Boltz", "speech": [ "Yes. Thanks, Marvin. And Scott, as I said in my prepared remarks, we got roughly 300 stores completed in the second quarter. Excited about what we're hearing from our consumers as they're giving us credit for the products that we're putting in there.", "We've been able to do some stuff around pet with our partnership with Petco, which we're excited about. We've also continued to learn and continued to listen to our customers. And so, there's opportunities with different things related to that rural customer, whether that's utility vehicles, livestock feed, apparel, different types of products that they'll use every single day in and around their home. And so, we're going to continue to learn.", "We're going to continue to adjust as we go, as Marvin said, kind of in the early innings of our localization opportunities. And on the urban side, we continue to adjust there as well, making sure that we're right for those urban markets, whether that's the types of products that they need for security and safety, whether that's areas in and around building codes and making sure that we can meet the Pro's needs in those markets. We're going to continue to tweak and adjust as we go forward. So, excited about what we're doing on the localization front and what we're doing with rural." ] }, { "name": "Scot Ciccarelli", "speech": [ "Bill, just a clarification, if I can. On the rural side, like is it outperforming the urban areas now or that's the expectation as you wind up localizing more?" ] }, { "name": "Bill Boltz", "speech": [ "It's performing at what we expected it to perform." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your questions." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. It's not the fairest metric, and there's a lot of noise in it but if we simply look at Lowe's performance relative to its largest competitor, over the last couple of quarters, Lowe's has been outcomping that player. Presumably, this quarter, it's in part due to Pro doing a little bit better, online sales doing well, and maybe more seasonal catch-up as a result of leading higher -- harder into that category.", "So, A, is that the right interpretation? And then, B, how sustainable do you think that this measure of Lowe's performance is?" ] }, { "name": "Marvin Ellison", "speech": [ "So, Michael, I'll take that. This is Marvin. And I'll just be really honest with you. We spent a lot of time talking about the importance of being customer-centric.", "We don't pay a ton of attention to what's happening at our competitor because we believe if we take care of the customer, the customer takes care of everything else. So, we're going to continue to stay focused on our total home strategy. We think if we do that well, then our results will be sustainable. And that means that we're going to be very localized, it means that we're going to be intentional around the small to medium-sized Pro that we're going to make our 1,700 stores connected to our customers via omnichannel, and we're going to continue to be intentional around what we do to give our associates a great place to work.", "Those things are most important. And I think our results this quarter, although in a difficult market, reflect that our Total Home strategy is working, and we're continuing to invest the appropriate amount of capital to ensure that irrespective of the macro environment, we're not going to slow down on our investments in supply chain IT infrastructure, omnichannel, and our Pro initiative. So, for us, it's all about taking care of the customer, and that allows us to outperform our closest competitor, then that's just a benefit that we'll be more than willing to accept." ] }, { "name": "Michael Lasser", "speech": [ "Understood. My follow-up question is on your view of the sales environment for the back half, understanding that you're still taking a prudently cautious stance given what's happening with macroeconomic indicators. Now, with that being said, are you seeing any signs that those discretionary big-ticket purchases that had been weak, such as patio furniture, grills, other big ticket purchases are starting to stabilize or do you have line of sight that they might start to stabilize as you move into next year?" ] }, { "name": "Brandon Sink", "speech": [ "Yes, Michael. This is Brandon. Just a reminder, again, as we look out at the second half, we're cycling up plus 3% in Q3 of last year and a positive 0.7% in Q4. So, that's been factored into our expectations.", "To your question specifically on DIY discretionary, we definitely saw the smaller ticket discretionary projects that were fueled by lawn and garden. We saw that benefit in Q2 as we get into second half, that seasonal benefit is going to subside. So, some of the bigger, I'll call it, interior DIY discretionary areas, I would say, we're seeing very much performance here early on through August, similar performance with what we've seen over the first half. And that baseline performance is essentially what's reflected in our expectations for second half." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much, and good luck." ] }, { "name": "Brandon Sink", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "The next question is from the line of Eric Bosshard with Cleveland Research. Please proceed with your questions." ] }, { "name": "Eric Bosshard", "speech": [ "Thanks. Two things, if I could. First of all, I guess probably for Bill, as you think about managing inventory and mix and promotions in this environment, how are you trying to position the business, are you leaning in to try to drive traffic, are you responding and perhaps a little bit more defensively, just how are you trying to position inventory mix and promotions?" ] }, { "name": "Bill Boltz", "speech": [ "Yes, Eric. First of all, thanks for the question. We're focused on trying to provide value to the customer every single day. And so that comes through lots of different things, making sure that from the Pro side that we continue to do things like we're doing right now as we roll out client tools in our stores, excited about that launch.", "We think that offers a nice opportunity for us as we'll have the largest assortment of client in the home improvement channel. So, right now, we've got roughly 150 SKUs in the stores today. We'll have all of our stores set by the end of this week. So, that's just one way of being able to provide value to that Pro customer.", "And then from an inventory side, we came out of Q2 in better position with our seasonal inventories than we did a year ago. So, that helps us. It allows us to invest as we go into Labor Day and fall planning and fall harvest, Halloween holiday, those types of things so that we can continue to provide value that way to the consumer with those holiday sets and Halloween sets provide a transition in the stores, as you know, and gives the customer some excitement. And then we've got a lot of new stuff that we've talked about.", "We've got Coca-Cola that will finish rolling out in our stores, being able to have access to that entire portfolio of product we're excited about. We'll roll out Carhart to 250 stores in Q3. So, we're excited about getting that out there for both the DIY and the Pro. And then we'll have some new stuff in that spooky area for Halloween for the Halloween enthusiasts.", "So, all of that try to provide value to our customers in lots of different ways. And then offer them those promotional offers in appliances like you have to provide because over 100,000 appliances break every single day, and we want to make sure that we're relevant out there, and try to manage all of it in a portfolio approach. So, we've got a lot of stuff going. We're excited about it, and we think will give us a nice way to position ourselves to drive value for our customers through the back half of the year and into next year." ] }, { "name": "Eric Bosshard", "speech": [ "OK. And then second question, if I could. As you -- Brandon did a good job of explaining that you've kind of cycled through the price increases, and there's minimal from here. The math of the past couple of years has been price up more than volume has been down.", "I'm just curious how you all think about as price no longer goes up, the path for volume turning from a negative to a positive, I'm just curious how you think about that, and what makes that happen and perhaps when?" ] }, { "name": "Brandon Sink", "speech": [ "Yes, Eric. This is Brandon. I think again, focus right now on 2023. As I mentioned earlier, we have kind of broken down transactions in ticket.", "We do expect pressure on transactions as we move across the balance of the year ticket to hold. I do think when we get on the backside of this, I'm not going to put a time frame on it, obviously, as there's a bunch of variables, a lot of uncertainty. It's too early for us to call what 2024 is going to look like. But I do think we are expecting a convergence in a better balance of transactions and ticket probably similar to pre-COVID levels as we start to look ahead across the long term." ] }, { "name": "Marvin Ellison", "speech": [ "This is Marvin. The only thing I'll add to that is we still are in the early innings of making what I would call best-in-class business operations in our omnichannel area, in localization, and in just the overall technology infrastructure. I've mentioned that we're retiring a 30-year-old operating system. And not only will that make our stores a lot easier to operate from a technology standpoint, but what it does, it gives us incredible agility to build on top of that modern platform for more omnichannel capabilities.", "There's a lot of things we're doing today, the hard way. And so, I get excited because I can get out of bed every day, and I can see a long list of initiatives that we have yet to get to that's going to drive operating margin improvement, drive space productivity, and hopefully will drive top line as consumer sentiment continues to improve. So, we're confident that we've not even reached a point of peak performance relative to the investment cycle that we have because we've been other places, we know what world class looks like, and we know that we're on a journey to get there, but there are still areas of our business: Pro, online, fulfillment capabilities, space productivity that we know that we're still in the early innings. And so, that's exciting, and we just have to do the work to make sure that we can achieve the expectations we have.", "And Rob, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. That final question will be from Steven Zaccone with Citi. Please proceed with your questions." ] }, { "name": "Steve Zaccone", "speech": [ "Good morning. Thanks very much for squeezing me in. I wanted to circle back to your commentary about the appliance promotions. Could you elaborate on that a bit more? It sounds new.", "What are your expectations for that side of the business in the second half of the year? And then just a follow-up on the promotions question earlier, it seems like the industry has not needed to be promotional, how long do you think this can last if big-ticket discretionary weakness continues?" ] }, { "name": "Bill Boltz", "speech": [ "Yes. So, Steve, this is Bill. So, just on the appliance side, specifically, what we've seen with appliances is that really, the industry has returned to kind of a more normalized go-to-market promotional offering, similar to what you saw prior to the pandemic. And so this normalization, as I said in my remarks, has put pressure on average ticket and average selling price across the industry.", "Everybody, I think, is feeling that impact. But essentially, we cycle this as we get into Q4, and we get into more of an apples-to-apples comparison when we get to Q4. But we're excited about the strength that we've seen with our appliance business. First quarter track line data would indicate that we took share in the first quarter.", "So, we're driving units and trying to make sure that we can meet the needs of our consumers is, like I said, in Eric's question, 100,000 appliances break every single day, we've got to be there for our consumer. But it's not a radical shift to heavy promotions. It's more of a normalized promotion." ] }, { "name": "Steve Zaccone", "speech": [ "Got it. And then just question on the back half margins for you, Brandon. Given the commentary about same-store sales in the third quarter, is there anything to be mindful of in terms of gross margin or SG&A cadence in the third quarter versus the fourth quarter?" ] }, { "name": "Brandon Sink", "speech": [ "No. I would say, Steve, still expect 40 to 60 basis points of expansion. The one thing that I would call out, I mentioned we expect the PPI benefits to build over the second half. And then the second thing I'll mention is we are cycling over $400 million of associate discretionary bonuses that were paid out last year that we're not expecting to recur.", "So, those are the big items that I would call out as we move through the second half." ] }, { "name": "Marvin Ellison", "speech": [ "And, Steve, I would be remiss if I didn't just talk a little bit about our performance and shrink and the most difficult retail environment for shrink in my 35 years in this space. I want to let Joe just talk a little bit about the successes that we're seeing and how we hope that continues to support our gross margin forecast for the back half of the year." ] }, { "name": "Joe McFarland", "speech": [ "Thanks, Marvin. And let me give you just a quick shout out to the store operations team and really our asset protection team. I believe they are best in class. And as you look across the actions that we've taken, whether it's in supply chain, whether it's on the front end with our new proprietary self-checkouts replacing the MCRs, we have a best-in-class awareness platform that's got a 92% voluntary participation rate.", "And that we have a line of sight for front-end transformations as we move into next year. The 100% execution of our high-strength program, where we've identified the stores. And so, I feel really confident and just a great job by the team." ] }, { "name": "Kate Pearlman", "speech": [ "Thank you all for joining us today. We look forward to speaking with you on our third quarter earnings call in November." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
LOW	2017-11-21	[ { "description": "Chief Executive Officer, President and Chairman", "name": "Robert Niblock", "position": "Executive" }, { "description": "Chief Operating Officer", "name": "Rick Damron", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Marshall Croom", "position": "Executive" }, { "description": "Robert W. Baird -- Analyst", "name": "Peter Benedict", "position": "Analyst" }, { "description": "Oppenheimer -- Analyst", "name": "David Bellinger", "position": "Analyst" }, { "description": "Citigroup -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "Chief Customer Officer", "name": "Mike McDermott", "position": "Executive" }, { "description": "JPMorgan Chase -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Chief Development Officer and President, International", "name": "Richard Maltsbarger", "position": "Executive" }, { "description": "Gordon Haskett -- Analyst", "name": "Andrew Minora", "position": "Analyst" }, { "description": "Michael Lasser -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" }, { "description": "Consumer Edge -- Analyst", "name": "David Schick", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning everyone, and welcome to Lowe's companies Q3 2017 earnings conference call. This call is being recorded. Please note, if you pressed * 1 to enter the question queue prior to the start of today's call, your signal did not register. You will need to press * 1 again to enter the queue. All supplemental reference slides are available on Lowe's Investors Relation website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document to the following call. During this call management will be using certain non-GAAP financial measures. The supplemental reference slides include information about these measures and a reconciliation of the most directly comparable GAAP financial measures. Statements made during this call will include forward-looking statements as defined in the Private Security Litigation Reform Act of 1995. Management's expectations and opinions reflected in those statements are subject to risks and the company can give no assurance that they will prove to be correct. Those risks are described in the company's earning release and in its filings with Security and Exchange Commission. Hosting today's conference will be Mr. Robert Niblock, Chairman, President, and Chief Executive Officer; Mr. Rick Damron, Chief Operating Officer; and Mr. Marshall Croom, Chief Financial Officer. Joining during the Q&A session will be Mr. Richard Maltsbarger, Chief Development Officer and President, International; and Mike McDermott, Chief Customer Officer.", "I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir." ] }, { "name": "Robert Niblock", "speech": [ "Good morning and thanks for your interest in Lowe's. This quarter our teams were tested by the largest natural disaster response we've ever mounted, and I'm extremely proud of the way they met the challenge. Our merchants, vendor, logistics, and storm teams worked together seamlessly to ensure customers had the right products to protect and repair their homes. Following the storms, our operations team worked tirelessly to get out stores up and running quickly and over 3,000 employees generously volunteered to serve on employee-relief teams providing additional support to customers in their time of need and giving employees impacted by the hurricanes a chance to focus on their own recovery efforts. Lowe's has also provided financial support, committing over $2.5 million in disaster relief through cash and card donations, and we continue to work closely with our nonprofit partners to provide both immediate and long-term support to impacted areas. I'd like to take a moment to thank our employees for their remarkable efforts to serve their communities, help customers, and support their colleagues in the face of numerous natural disasters.", "Turning now to our third-quarter results. We delivered comparable sales growth of 5.7%, driven by a 4.8% increase in comp average ticket and transaction growth of 0.9%. Hurricane-related sales contributed 140 basis points to comp growth. Our US home improvement comp was 5.1%, with positive comps in all regions and all the product categories. Lumber building materials led product category growth with double-digit comps, driven by pro demand, hurricane prep and cleanup, and inflation. Appliances also posted double-digit comps, supported by our best-in-class omnichannel offering and we achieved above-average comps in rough plumbing and electrical. We're pleased with the progress we've made to enhance our product and service offerings for the pro customer, delivering another quarter of comps above the company average. Our integration of Maintenance Supply Headquarters and Central Wholesalers remains on track and we continue to be excited about opportunities these acquisitions provide to further expand our products and services to serve the multifamily housing industry. During the quarter, we also advanced the customer experience through omnichannel assets, driving 33% online comp growth. We're seeing positive customer response to our evolving omnichannel capabilities, continuing to meet customers at every critical moment, whenever, wherever, and however they choose to engage with us. In fact, we were recently recognized by Forbes magazine as one of the top 10 most-engaged companies. This distinction highlights our commitment to engage customers with a purpose, offer consistent experiences, and put the customer at the center of everything we do.", "Internationally, we delivered strong performance including half-single-digit comps in Canada and double-digit comp growth in Mexico in local currency. We made further progress with the integration of Rona, continuing our rollout of appliances, converting our second Rona big-box store to a Lowe's-branded store, and continuing to drive growth with our e-commerce platform. We're excited with the momentum in the business and believe we are well-positioned for continued success in Canada. We continue to focus on improving our profitability while investing in key capabilities to drive sales growth. For the quarter, we drove diluted earnings per share up $1.5, a 19.3% increase over last year's adjusted diluted earnings per share and in line with our expectation. Delivering on our committed to return excess cash to shareholders in the quarter, we repurchased $500 million of stock under our repurchase program and paid $344 million in dividends.", "Turning to the economic landscape, the home improvement industry remains poised to see solid growth, with job and income gains supporting consumer spending. We believe that revolving credit usage will continue to supplement the spending power generated by stronger incomes. Housing is also expected to remain a bright spot. Household-formation improvement this year is encouraging, and home-price appreciation should continue as housing demand outpaces supply, encouraging homeowners to engage in discretionary projects in addition to ongoing maintenance and repair spending. And, as we survey consumers, we continue to see favorable trends. Our third-quarter consumer sentiment survey highlighted that consumers have an increasingly positive view of the national economy and continue to view their personal financial situations favorably. Given that over half of homeowners believe their home values are increasing, intent to engage in discretionary home improvement projects remains strong.", "Reflecting our third-quarter results, we were pleased with our continued traffic growth, driven by optimized marketing messaging and the benefits provided by strategic investments in our integrated omnichannel experience. We look to further build upon our strong foundation by developing capabilities to anticipate and support customers' evolving needs and improve our operating discipline and execution, making productivity a core strength for Lowe's. We remain committed to balancing our promotional strategy with our price-optimization efforts to improve profitability, and we will further leverage our new store leadership model, which provides better management and accountability while optimizing our investments in customer-facing associate hours to fully capitalize on strong traffic trends and deliver an improved customer experience. Once again, I would like to thank our employees for their unwavering commitment to serving customers and their communities. The team faced challenging circumstances this quarter and they delivered, demonstrating our purpose-driven mission to serve the communities in which we live and work.", "And finally, before I turn the call over to Rick, I want to take a moment to thank him for his innumerable contributions to Lowe's. As you know, we announced this morning that Rick will be retiring after 36 years at our company, the last five as our Chief Operating Officer. Rick has worked across every aspect of our operations and he has positively impacted Lowe's customers and employees. We wish him all the best in his retirement. Richard Maltsbarger, who currently serves as our Chief Development Officer and President, International, will succeed Rick upon his retirement in February. Richard is a proven leader with a keen understanding of our business and industry. He has been instrumental in the development and implementation of our strategy. Rick and Richard have a great working relationship and I expect the transition will be seamless.", "And with that, I'd like to turn the call over to Rick." ] }, { "name": "Rick Damron", "speech": [ "Thanks, Robert. It's been an honor to our work besides you and our incredible Lowe's organization and management team through the various phases of my career. I'm thrilled that Richard will be stepping into this role and I'm confident that he will further propel the company's operations and customer experience to new levels of growth and success. I look forward to working closely with Richard over the next few months to ensure a seamless transition and will be cheering Lowe's on from the sidelines of my retirement.", "During the quarter, we drove increased traffic in-store and online with compelling messaging and integrated omnichannel experiences, capitalizing on a supportive macroeconomic backdrop and customers' continued desire to invest in their homes. We delivered a 5.7% comp, achieving positive comps in all regions and all product categories. We drove double-digit comps in appliances, posting our best appliance comp in seven quarters, leveraging our investment in customer experience both in-store and online, our service advantages of same or next-day delivery and haul away, and facilitation of repairs and maintenance, our best-in-class selection of leading brands, and our strongest strategic relationships with partners such as Whirlpool, who we proudly announced as one of our 2017 vendor partners of the year. We also achieved double-digit comps in lumber and building materials and above-average comps in plumbing and electrical. Lumber and building materials benefited from robust pro-growth inflation and strong hurricane-related demand for plywood, pressure-treated lumber, [Inaudible], shingles, drywall, and insulation. And as hurricanes Harvey and Irma drove demand, our team sent over 11,000 truckloads of products to impacted areas, supporting both pro and DIY customers as they prepared for the storms and worked to repair their properties afterward. For the pro customer, we also added Account Executive ProServices, or AEPs, to the Texas and Florida markets to support incremental demand. Historically, most storms have four distinct phases. First, preparation, in advance of the storm. Second, impact, when the storm actually causes damage. Third, cleanup. And fourth, recovery, when repairs are made and damaged items are replaced.", "In the third quarter, we experienced preparation, impact, and some initial cleanup from hurricanes Harvey and Irma. We expect hurricane recovery to begin in fourth quarter and extend into 2018. Given that Harvey was more of a water event and Irma was more of a wind event, we expect that the magnitude of the benefit and the recovery period for Houston will surpass that of Florida. Rough plumbing and electrical performance this quarter is evidence of the power of destination brands as our evolving brand portfolio continued to capture pro sales and drive above-average comps in the category. Our pro business continues to thrive, with comps above the company average, driven by a favorable macro backdrop as well as our continued efforts to optimize our product and service offering to better serve the pro customer. In addition to our outstanding portfolio of brands, we're also expanding our relationship with the pro customer across all categories with our strong value proposition including our \"Five ways to save,\" as well as advancing our capabilities to connect with the pro seamlessly across channels through Lowesandpros.com and growing pro services team.", "The addition of Maintenance Supply Headquarters and Central Wholesalers further expands our capabilities to serve multifamily property-management customers throughout the country with enhanced product and service offerings while strengthening our platform for future growth with this important customer. In fact, we are pleased with the early results of the MSH and Central integration efforts. The teams are leveraging best practices to build a new product catalog with an expanded offering for the maintenance, repair, and operations professional, which will roll out this spring, and we're working with our suppliers to improve terms and price. Finally, our pro services teams are collaborating to serve customer needs, including serving multifamily property managers in the hurricane-impacted areas. We continue to build pro awareness with targeting marketing as well as pro exclusive offers to grow our share of wallet with existing pros while also expanding our base of pro customers. We continue to execute on our strategic priorities, including leveraging our omnichannel capabilities to help customers achieve great project results. Customers can engage with our associates in store for expert advice, our content on Lowes.com for inspiration, our contact centers for ongoing support, and our project specialists, who work with them within the homes to design, plan, and manage their home-improvement projects. We are leveraging our investments in Lowes.com, providing an upgraded online shopping experience with enhanced functionality and display for touch-screen devices to deliver an optimized mobile experience, improved product, and content recommendations, refined search algorithms, optimized assortments informed by digital [Inaudible] and expanded views, including video content. Along with our flexible fulfillment options of \"Buy Online, Pick Up in Store\" and \"Buy Online, Deliver from Store\" and our enhanced digital marketing, our efforts combined to drive online comp growth of 33%. We will continue to advance our online platform, adding more functionality, such as inventory and order-status visibility, to improve the customer experience.", "Our interior and exterior project specialists are another important element of our omnichannel strategy and a differentiated capability in capturing and serving project demand for the DIY customer who needs a bit more help navigating their project. We're making it even easier for customers to engage with our in-home project specialists and request services from Lowes.com and we're working to centralize our process for providing installation quotes, allowing for greater efficiency and more consistent customer experiences. We're rolling out this capability in the flooring category for the remainder of the year, with all US markets expected to be online by Q1 2018 and expanding to other categories throughout 2018. We're also driving brand loyalty through our MyLowe's platform. Our simplified military-recognition program allows active-duty personnel and veterans to register through MyLowe's and receive 10% off their purchases every day. We're also offering free parcel shipping exclusively for MyLowe's members. We've seen great response, with 1.5 million new memberships since we offered the expanded benefits in Q1. And we've seen those customers increase their spend by 15% after registering for MyLowe's. We continue to focus on driving productivity and profitability and drove 27 basis points on leverage, in-store payroll in the quarter. This leverage was primarily the result of our new store leadership model, which streamlined management hours to provide better oversight and accountability. As we discuss our second-quarter call, to more fully capitalize on our strong traffic trends and ensure we're delivering an excellent customer experience, we began adding incremental associate hours this quarter and continue to provide the necessary training and resources to all associates. We worked through the quarter to increase hours, and we'll continue to optimize our labor allocation to ensure resources are utilized in the areas of greatest need in order to improve traffic conversion. We also made progress in centralizing indirect spend, leveraging our scale to drive efficiencies in procurement. We have now centralized 60% of indirect spend compared to 30% at the end of 2016.", "Our supply chain is another productivity focus area, offering opportunities to streamline cost even as we improve the [Inaudible] options for customers. For example, we are working to consolidate freight shipments from both in port and domestic freight to drive greater efficiency and optimize the flow of inventory, significantly reducing the number of trucks arriving at our distribution centers and stores, allowing us to reinvest labor in others areas. As we look forward to the fourth quarter, we're enthusiastic about our plans for an integrated omnichannel holiday experience, including the exciting Black Friday and Cyber Monday events. We'll continue to highlight our project expertise and our best-in-class kitchen and appliance offers. And we'll leverage our in-store and online assets to create unique holiday decor experiences, capitalizing on the nostalgia of the holiday season and providing cohesive decorating solutions as well as compelling gift ideas across all of our assortments. We are excited to announce the introduction of Craftsman products in-store and online in the second half of 2018. We're committed to offering a wide selection of brands DIY and pro customers trust, and Craftsman strengthens our ability to deliver on customer expectations across many product categories. The partnership between Stanley Black and Decker and Lowe's will bring some the most innovative products into our omnichannel home improvement shopping experience, allowing both DIY and pro customers even greater access to high-quality, value-oriented product offerings for their next home-improvement project. We are proud to be the partner of choice in the Home Center channel for the Craftsmans brand and look forward to sharing additional information with you in 2018. Thank you for interest in Lowe's and I will not turn the call over to Marshall." ] }, { "name": "Marshall Croom", "speech": [ "Thanks, Rick, and good morning, everyone. Sales for the third quarter increased 6.5% to $16.8 billion, supported by total customer transaction growth of 0.7%, the total average ticket growth of 5.8% to $72.63. The acquisitions of MSH and Central contributed 70 basis points of the growth in the quarter, while new stores contributed 50 basis points. The calendar shift from the 53rd week in Fiscal 2016 had no impact on comp sales, but it did decrease third-quarter total sales growth by approximately $60 million or 40 basis points. Comp sales were 5.7%, driven by an average ticket increase of 4.8% and transaction growth 0.9%. Looking at monthly trends, comps were 3.9% in August, 8.2% in September, and 4.5% in October. As Rick indicated, we drove traffic in-store and online with optimized messaging and our strategic investments in integrated omnichannel experiences, capitalizing on customers' continued desire to invest in their homes.", "Our teams also responded to the demand generated by hurricanes Harvey and Irma this quarter, and we estimate that the storm positively impacted comp sales by approximately 140 basis points. Gross margin for the third quarter was 34.07% of sales, a decrease of 28 basis points from the third quarter of last year. As we've grown our market share in appliances, gross margin has been impacted from both a mix and rate perspective. Additionally, there was a mix impact from hurricane-related demand. And lastly, we continued to take competitive actions which were partially offset by benefits from [Inaudible] improvement well as early results from pricing optimization efforts. SG&A for the quarter was 22.71% of sales, which leveraged 323 basis points. In last year's third quarter, we recorded $462 million in non-cash charges, which drove 293 basis points of the leverage for this year. Please refer to Page 14 of our supplemental slides for a summary of those charges. The main driver of the remaining 30 basis point of leverage was 27 basis points of payroll leverage, primarily the result of our new store leadership model. Depreciation and amortization for the quarter was $358 million, which leveraged 31 basis points. Operating income increased 326 basis points to 9.23% of sales. Prior year non-cash charges accounted for 293 basis points of the increase in operating income. Interest expense for the quarter was $160 million which leveraged 8 basis points. The effective tax rate for the quarter was 37.1% compared to 51.2% in third quarter of Fiscal 2016. The higher rate last year was driven by the joint venture non-cash charge, which was a long-term capital loss. And earnings per share was a $1.05 for the third quarter, a 19.3% increase over last year's adjusted earnings per share of $0.88. This is in line with our expectation.", "Now turning to the balance sheet. Cash and cash equivalents at the end of the quarter was $743 million. Inventory at $12.4 billion, increased 1.4 billion, or 12.8%, versus the third quarter last year. This was primarily driven by investments in key categories, such as appliances and tools, as well investments across pro categories. Part of the increase is also attributable to the addition and acquisitions of MSH and Central. Inventory turnover was 3.94, an increase of 5 basis points over the third quarter of last year. Asset turnover increased 12 basis points to 1.91. Accounts payable of $8.9 billion represented $1.1 billion, or a 13.6% increase over the third quarter of last year due to the timing of purchases and terms improvement. At the end of third quarter, lease-adjusted debt to EBITDAR was 2.16 times and return on invested capital was 19.5%.", "Now, looking at the statement of cash flows. We generated strong operating and free cash flow in the quarter of $5.4 billion and $4.6 billion respectively. Our capital allocation strategy first focuses on investments that align with our strategic priorities to expand our home improvement reach, develop capabilities to anticipate and support customer needs, and generate profitable growth and substantial returns. For example, our acquisition of Maintenance Supply Headquarters is a strategic investment to further grow our pro business by expanding our ability to serve the multifamily housing industry. The transaction is expected to be slightly accretive to earnings this year. And after strategic investments, we looked to return excess cash to shareholders. In the quarter we paid $344 million in dividends. In August we entered into a $25 million accelerated share repurchase agreement, which settled in the quarter for approximately 3.2 million shares. We also repurchased approximately 3.2 million shares for $250 million through the open market. In total, we repurchased $500 million of stock in the quarter. We have approximately 2.1 billion remaining on our share-repurchase authorization.", "Looking ahead, I'd like to address several of the items detailed in Lowe's business outlook. We are reaffirming our guidance for the year. While we expect incremental hurricane-related sales in the fourth quarter, we continue to optimize our investments in customer-facing associate hours to fully capitalize on the strong traffic trends generated by our enhanced marketing efforts. We are also facing a tough prior-year comparison and, as you know, weather in the fourth quarter is unpredictable. Also, earnings per share of $1.05 in the third quarter was again in line with our expectations. With that backdrop, for the year we expect the total sales increase of approximately 5%, driven by a number of factors. First, we're forecasting comp sales increase of approximately 3.5%. Second, the Rona acquisition is expected to drive about 2% growth due to a full-year of Rona results versus roughly seven months from 2016. Also, we expect new stores and acquisitions of MSH and Central to add approximately 1%. Also, keep in mind total sales growth will be reduced by roughly 1.5% related to the comparison of 52 weeks in 2017 to 53 weeks in 2016. On a GAAP basis, we are anticipating an operating margin increase of 80 to 100 basis points. Remember, a full year of Rona results versus roughly seven months last year will pressure operating margin by an estimated 15 to 20 basis points for 2017. Effective tax rate is expected to be approximately 37% for 2017. For the year, on a GAAP basis, we expect earnings per share of $4.20 to $4.30. Again, please refer to Page 14 in our supplemental slides for the summary of adjustments as you compare 2017 to 2016. We are forecasting cash flows from operations to be approximately $5.4 billion and capital expenditures of approximately $1.2 billion.This results in an estimated free-cash flow of approximately $4.2 billion for 2017. Our guidance assumes approximately $3.5 billion in share repurchases for 2017.", "Christie, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "To ask a question, press * 1 on your telephone keypad. To withdraw your question, press the pound key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one follow-up.", "Your first question comes from Peter Benedict with Baird. Please go ahead." ] }, { "name": "Peter Benedict", "speech": [ "Hey guys, thanks for taking the question. First is around the efforts to drive better conversion. Can you maybe help us with the key actions you're taking here in that area? How did the third quarter do relative to your expectations there? That's my first question." ] }, { "name": "Marshall Croom", "speech": [ "Sure, Peter. There are several actions that we're taking as we think about conversion. As you know, we have been able to begin tracking our traffic inside the stores. So it's the first time we've got real solid data on year-over-year comparison which allows us to really understand what's happening inside the stores. We're working through the optimization of hours. As we talked about in Q3, or Q2, we invested incremental hours to really be able to maximize the opportunity to convert our traffic that we're seeing from the marketing-spend investment and the traffic that it's generating. During Q3, we worked to fully deploy those hours and were able to achieve that by the end of the quarter as we added the incremental hours throughout the quarter. And now we continue to work on better utilization of those hours and deploying those during peak traffic times when we see the opportunity to increase our conversion more holistically. And, as always, we continue to work on the training and development of our employees to meet the demands of our customers. So if I'm looking at it from that perspective, we've done a solid job in adding the hours that we committed to. Now we're working to continue to optimize those hours to customer traffic and continue to work on training and development of all of our employees to meet the needs of the customer." ] }, { "name": "Robert Niblock", "speech": [ "Peter, this is Robert. The only other thing I would add is, as highlighted in my comments, the progress that Rick took you through that we're making on this effort was somewhat impacted by our need to redeploy resources into the hurricane-affected areas as we spoke about. So, kind of got that behind us. And so, we made progress and continue to be focused on it throughout the fourth quarter." ] }, { "name": "Peter Benedict", "speech": [ "OK, that's helpful. Thanks. And then just shifting over to some your omnichannel stuff. Maybe talk about your delivery capabilities today, where they stand, where you think you need to take these, and also [Inaudible] just updated commentary around \"Buy Online, Pickup in Store\" and \"Deliver from Store,\" where you sit with those and where you see those going. Thank you." ] }, { "name": "Marshall Croom", "speech": [ "Peter, I'll start with \"Buy Online, Pick Up\" and \"Delivery From Store.\" Those two aspects of omnichannel delivery have been part of our Lowes.com platform since its original launch in 1999. So it's something that we're very familiar with. From an execution standpoint, 60% of our dot-com sales are currently picked up in store, with 40% of those customers buying incremental products when they arrive to pick up their items. Another 10% to 15% is delivered from store with the remaining 25% to 30% being parceled. So, for us, that tells a great story of the role of the store and the omnichannel environment and how our customers continue to utilize our stores for fulfillment options in their omnichannel strategy. As it relates to delivery, holistically, as you know, we operate both in-house deliveries and a third-party model in order to continue to drive the capacity that we want to be able to be nimble enough to meet the changing needs of our customers. We're very pleased with our delivery programs and how our teams continue to execute against those offerings which is evidenced by, I think, our growth in appliances, as we highlighted, which is a strong delivered category and our teams are able to continue to meet the demands of that business and be able to drive those sales. So we're comfortable with where we are. We continue to look at options for fulfillment. If you look at parcel, we'll be opening our first direct fulfillment center in Q3 of this year, in 2018, in Nashville, and we continue to ship parcels from our stores from a fulfillment perspective." ] }, { "name": "Peter Benedict", "speech": [ "That's great. And how about delivery to the pros? How are we thinking about that?" ] }, { "name": "Marshall Croom", "speech": [ "Sure. Delivery from pros has been part of our ongoing programs since we've been executing against the pro initiatives. We feel very comfortable with our ability to meet the needs of the pros through various different fulfillment options. We are able to narrow delivery windows to a two-hour timeframe for our pros when we run through the process and the programs. So we feel confident that we're able to meet their needs on an ongoing basis both within our in-house and our third-party models. Mike Tummillo and the pro team continue to work on options to continue to improve that from a fulfillment perspective. So we feel good about our existing ability to execute versus the pro as well as our ongoing strategic options that we're building out to continue to meet their needs in a dynamic marketplace." ] }, { "name": "Peter Benedict", "speech": [ "OK, that's helpful. Thanks very much, guys." ] }, { "name": "Robert Niblock", "speech": [ "Thanks, Peter." ] }, { "name": "Operator", "speech": [ "Your next question comes from Brian Nagel with Oppenheimer. Please go ahead." ] }, { "name": "David Bellinger", "speech": [ "Good morning. This is David Bellinger on for Brian. So a couple of questions from us. First one on the progression of comps throughout the quarter. You were coming off a strong 7.9 gain in July and that slowed to 3.9 in August. Can give us more detail on what drove that and was it more traffic versus ticket and also what led to the improvements in September and October. Was there some type of internal change made in addition to the $200 million lift from the hurricanes?" ] }, { "name": "Marshall Croom", "speech": [ "I'll take the first part. We were actually pleased with what we were seeing from in-store and online traffic in August and, as Rick mentioned, we were working on investing in increasing our associate hours for customer-facing in the areas where we needed the most [Inaudible] help us drive better conversion. So as that played out in the quarter, we began to see that pick up in September but a little bit soft in August." ] }, { "name": "David Bellinger", "speech": [ "OK. And then just looking at the comp guidance for the year and sticking with the 3.5%, it looks like comps year to date are up about 4% and that implies Q4 slowing to something below 2%? Should we read anything into that or is that simply conservatism in your forecast? Can you comment on early trends into November and how that compares to what's implied in your outlook?" ] }, { "name": "Marshall Croom", "speech": [ "OK. Certainly, we think that our guidance for the quarter for the year is appropriate and balanced as we look to invest in running the business and continue to invest in our ongoing capabilities. We are confident in our ability to drive traffic in Q4. We do expect some benefit from the hurricanes as we move into Q4 and into 2018 but one of the things again, we've been optimizing our selling hours in the stores and still tweaking that, like where we are today but, again, recognize in Q4 we have tough comparisons to last year. As we mentioned weather to be a kind of wild card in the fourth quarter, so, just keep those in mind as we head into Q4. As far as where we are, quarter to date, we're just slightly ahead of our expectations for the quarter." ] }, { "name": "Robert Niblock", "speech": [ "David, this is Robert. I would layer on this. Marshall talks about tough comparisons to the prior year. Keep in mind that we're also cycling the fourth quarter of last year [Inaudible] the benefit of Hurrican Matthew and the Louisiana flooding, so we've tried to take all that into our guidance and just to reiterate, we're saying approximately 3.5% comps per year is what we're looking at." ] }, { "name": "David Bellinger", "speech": [ "Got it. Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from Kate McShane with Citi. Please go ahead." ] }, { "name": "Kate McShane", "speech": [ "Thank you. Good morning. Thanks for taking my question. My question is centered around the multifamily acquisitions that you made. It's helpful for you to break out the contribution of that business going forward but I wondered if you could walk through how the integration is going and how much of a lift do you expect in your stores once it rolls out to all the Lowe's stores?" ] }, { "name": "Marshall Croom", "speech": [ "Sure, Kate. The integration as [Inaudible] in my opening comments is going extremely well. The organizational aspects of the design have been implemented as we continue to work to integrate the two companies, and we're seeing some strong leverage from our initial business case through working to continue to harmonize our pricing and our terms with our merchants and working with Mike's organization to make sure that we're able to leverage that and continue to move forward. Our existing focus currently is to continue to work on the integration of both companies into one operating model. As I highlighted, the teams are building out a new product catalog, which will effectively improve the customer experience across both verticals. And then as we continue to move forward, we will continue to work for the in-store integration, but that is further out in the current integration plans than today. Currently, it's really focused heavily on the integration of the two." ] }, { "name": "Kate McShane", "speech": [ "OK, great. Thank you. And my second question was just on the growth that you saw for ticket above $500. Was the majority of that driven by appliances or can you help us break down from the bigger categories that drove that growth?" ] }, { "name": "Mike McDermott", "speech": [ "Sure, Kate. This is Mike McDermott. We continue to see great progress in the appliance business, obviously leveraging our No. 1 share position and the great brand portfolio and values that we're communicating to our customers. We also continue to see pro outpace the company average and pro certainly is also driving significant growth in big ticket. So, our project specialists, interior and exterior, continue to drive, remodel, and refresh business across a number of different categories and we continue to see momentum really across the business in regard to tickets above $500." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Christopher Horvers with JP Morgan. Please go ahead." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks and good morning. Can you talk about the comp trends in Canada and Mexico? It seems like they did improve from the last quarter. Did Rona contribute to that comp? I think it was only in the quarter for a partial period. And can you talk about how much the FX lifted the reported total comps as well?" ] }, { "name": "Richard Maltsbarger", "speech": [ "Yes, Chris. This is Richard. We had a very strong quarter up in Canada. As Robert noted in his comments, we had high-single-digit comp within Canada and there's a very strong contribution to that across all the different banners. Just a small point. We actually had Rona in our comp for the entire quarter this quarter. So this will be the first quarter where all of their sales are rolled into our comp comparison. And, as Robert said, we're very strong, we're very pleased with the progress that we're making there. We have brought our first two big-box evolutions live from the Rona brand into the Lowe's brand out in western Canada. We're underway with several more now. We have expanded our appliance mix to more than 70 stores on track and above our plan in terms of rollout given the opportunity for share in the appliance market in Canada, and we're seeing really good strong pro results in our business in Canada given our higher mix of the pro across our different banners including those specifically focused on the pro in both Quebec and out west. Similarly, very strong, as Robert noted, double-digit comps in Mexico. Very proud of the team there. The team has also, to the plan that we laid out last year, had begun down the path of expansion again, having recently opened two new stores in the Monterrey, Mexico market and putting us well on the path to our goal to double that business across three years." ] }, { "name": "Christopher Horvers", "speech": [ "And then the FX contribution and then I had a follow-up." ] }, { "name": "Marshall Croom", "speech": [ "That was fairly minor for the quarter. It was largely driven by operational results from Canada and Mexico." ] }, { "name": "Christopher Horvers", "speech": [ "OK, understood. And then I was curious how you thought about the market-growth rate in the US and the census categories show about a 7%-ish type growth year to date. You're running year to date about 5 and in 3Q, that gap persisted. Do you think the census is a fair estimation of the market growth rate? Do you have insights into certain market share trends in the key categories because one of the questions that we get from investors is, not per se the comp gap, but just trying to understand how your share is playing out in the United States relative to the census benchmark?" ] }, { "name": "Richard Maltsbarger", "speech": [ "Chris, certainly, I mean, it's the indicator of the health of the overall market. It's not a perfect match. When we look more specifically at the leading indicators from housing, from home improvement, we feel really good about that. We think the leading indicators certainly remain supportive [Inaudible] job and income gains driving strong growth but [Inaudible] and consumer spending, revolving credit usage continuing to be favorable as we mentioned here, and then probably most important, home-price appreciation, which is driving increased housing wealth. So as we look at that, we feel good about the macro environment, we feel good about housing, we feel good about looking at things like our consumer sentiment survey, homeowners' willingness and intention to engage in projects around the home driven by 1. their views of the overall housing market as well as views of the increasing values of their homes. So overall, we feel good about it and, like I said, when we look at our trajectory of comp growth, if we look at the quarterly progression that we've had through the year in focus the team has put behind improving our execution, we're pleased with our performance and excited about the opportunity ahead of us." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from Charles Grom with Gordon Haskett. Please go ahead." ] }, { "name": "Andrew Minora", "speech": [ "Hi. Good morning. This is Andrew Minora on for Chuck. I have one question on hurricane impact. Can you guys quantify the impact on gross profit margin and SG&A from hurricanes? Then I have one follow-up." ] }, { "name": "Richard Maltsbarger", "speech": [ "Ultimately, the gross margin impact actually hurt our mix. This is a below-average company rate on the gross margin. So that certainly had an impact. We did have incremental SG&A expenses but all told, net-net, while it was slightly positive, it wasn't a driver to our earnings for the quarter." ] }, { "name": "Andrew Minora", "speech": [ "OK, thank you. That's helpful. And then just on the pro comments, it's a little bit nit-picky, but you guys went from saying the growth was well above the company average to above the company average for the last two quarters. Is that more of a function of the overall comp doing better in the last two quarters or are you seeing any slowdown in the pro business? Any color there would be helpful. Thank you." ] }, { "name": "Mike McDermott", "speech": [ "Yeah, this is Mike. What I'd highlight is we continue to see positive strength in our DIY business which maybe tightens the balance between pro performance and DIY. I still feel very good about our pro performance teams doing a great job engaging the customer in a variety of different segments across that marketplace. Pro represents about 30% of our business and we continue to see expanded penetration." ] }, { "name": "Andrew Minora", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from Michael Lasser with UBS. Please go ahead." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. Can you give us some quantification of how far along you are into the competitive pricing actions you've been taking? Are you close to being done?" ] }, { "name": "Mike McDermott", "speech": [ "Michael, this Mike McDermott again. Obviously, we're going to continue to react to the competitive intensity of the marketplace. I feel good about the actions we took coming out of the first quarter, when we recognized an opportunity to improve our value perception. Teams have done a great job on both base price stock and SOS as well as our promotional pricing strategy to make sure that we are delivering those great values in the market to our customers. I also feel good about the actions the team is taking around leveraging new pricing and analytics tools and refine our pricing strategy across categories to make sure we're optimizing our effectiveness. And recognize that in the May timeframe we also drove two loyalty actions which are having a positive impact. The first was our simplified approach to military recognition offering, both active and veteran military personnel, the ability to enjoy 10% discount every day. And on top of that, we launched free parcel delivery for MyLowe's members. So we're seeing both customer growth and loyalty from those actions but they will have some impact as to our gross margin performance." ] }, { "name": "Michael Lasser", "speech": [ "And are you seeing competitors respond as you take price action?" ] }, { "name": "Mike McDermott", "speech": [ "Yeah. I think the marketplace remains competitive and what I would tell you as I look at third quarter versus second quarter, it's consistent with our expectations and as we go into the fourth quarter, again, I think consistent with where we were in 3Q." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from Simeon Gutman with Morgan Stanley. Please go ahead. Your line is open." ] }, { "name": "Simeon Gutman", "speech": [ "Hello. Can you hear me?" ] }, { "name": "Richard Maltsbarger", "speech": [ "We hear you now." ] }, { "name": "Simeon Gutman", "speech": [ "Sorry. OK, I was on the different line. A follow-up to Michael's question. It's around gross margin and in this quarter in the slide deck, the gross margin headwinds, one of them, was described as competitive actions. If in the first quarter you called that pricing investment, in the second quarter you called it promotional activity, can we discuss what these descriptions? Are they just different ways to say the same thing? And then, Mike, just a follow-up on that, can you describe what's going on in the marketplace broadly?" ] }, { "name": "Mike McDermott", "speech": [ "Yes, Simeon, what I would tell you is that you should translate both of those descriptions as the same. When we think about promotional activity, actually we think about advertising and promoting value with the customer as well as some of the actions I highlight around loyalty. So, that would be in the same bucket. And as it relates to the competitive environment, it's consistent with our expectations." ] }, { "name": "Simeon Gutman", "speech": [ "OK. And then regarding execution, we've talked over the past 12 months there's been some management change. We talked about some inconsistency between merchants and some of the marketing, and then you've added some labor hours back to stores. If you think about how you performed in Q3 and going forward, are the bumps more or less ironed out and can you talk about where you could be or you should still be getting better?" ] }, { "name": "Robert Niblock", "speech": [ "I'll start and let the others jump in. Certainly, yeah, we made a lot of changes to set us up for the future. Like I said, we're pleased with our new store leadership model and what we're seeing out of that. I'm pleased with the work that's being done to try and add hours back into the stores. As Rick indicated, we will continue to focus on getting those hours in the right kind of day part if we wanted to focus on the high-traffic times to better match the customer demand. There was certainly a little bit of an impact as we had to redeploy people to the hurricane-affected areas in the quarter. In addition to that, as we indicated earlier, we made some changes to the organizational structure here at our corporate office to kind of flatten the organizational structure and improve our spending control and we're pleased with the way the team has responded and working together to focus on driving the business forward." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Eric Bosshard with Cleveland Research. Please go ahead." ] }, { "name": "Eric Bosshard", "speech": [ "Good morning. Two things for you. First of all, the step-up in online growth the past two quarters. I know a component that is easier compares to some changes you were making a year ago but just curious if you could give us a little bit more color of what's driving that and also if there are categories that are leading that improvement. Some insight on that would be helpful." ] }, { "name": "Richard Maltsbarger", "speech": [ "Yeah, Eric, I'll take that. We continue to see great progress as it relates to our digital performance with the 33% comp you saw for the quarter, continue to optimize our online platform, continue to add and invest in additional functionality, improving everything from content to our checkout process, adding visibility for the customer around inventory and order status and essentially driving more of a simple and seamless approach online. When I think about the categories that continue to perform well, appliances, fashion fixtures, and seasonal outdoor living led the way as it relates to our online performance. So team's doing a great job bringing that experience to life and connecting it to our overall omnichannel platform and driving additional traffic into our stores." ] }, { "name": "Eric Bosshard", "speech": [ "Secondly, it was roughly a year ago that you all started to talk about productivity and I'm curious now coming up on a year later within this, what the emphasis is within this now. It seems like it started with a little bit more focus on profitability. It feels like you're trying to shift to a little bit more balanced or focused on sales but I'm just curious how you're thinking about the productivity initiatives, especially with the 2% comp in 4Q and the 3.5% in a year where the market feels like it's stronger. Which way are you leaning and focusing on with the productivity and this initiative?" ] }, { "name": "Marshall Croom", "speech": [ "Eric, this is Marshall. And actually yes and yes, we want both. Sales productivity and SG&A productivity cost out. So those will continue to be focus areas. So if you think about some of the investments we're making from the omnichannel capabilities, we want those to be sales drivers. If you think about processes within the stores from just customer experience to services, again, trying to eliminate employee and customer pain points but we've got a good line of sight into actions, one that we took this year. Rick highlighted a couple of those with indirect spend, moving the needle on how much we centralized indirect spend, along with some of the changes we've made to the payroll set model and the leadership changes that we made earlier in the year along with things that we're doing from supply chain efforts to drive better productivity, reduce burden for the distribution center and stores. So all of that wrapped up into the amount of investments we've made in 2017 to be able to drive a flat operating margin on an adjusted basis for 2017 and knowing that we've got future opportunity to keep getting after from a productivity standpoint to move into 2018 and 2019 and beyond." ] }, { "name": "Eric Bosshard", "speech": [ "Great. Thank you." ] }, { "name": "Robert Niblock", "speech": [ "I think we have time for one more question." ] }, { "name": "Operator", "speech": [ "Your next question comes from David Schick with Consumer Edge Research. Please go ahead." ] }, { "name": "David Schick", "speech": [ "Hi. Good morning. Thanks for taking the question. You talked about Craftsman and I know there's been work on merchandising around pro. Is there any metric you can give to the amount of skewer category newness that you're introducing now versus in the past?" ] }, { "name": "Mike McDermott", "speech": [ "Dave, we don't really look at it that way as it relates to new assortment but what I can tell you is the merchants continue to work with our strategic partners across every category to make sure that we refine our assortments and expand value. Obviously, we're very excited to welcome the Craftsman brand to the Lowe's portfolio, iconic brand that customers know with innovation and high quality at a value. So if you think about all brand work that we've done over the last four years, adding more than 25 brands back to the portfolio, brands that DIY and pro customers know and trust, I really think Craftsman, when it launches in 2018, will continue to propel us forward with customers in both of those segments." ] }, { "name": "David Schick", "speech": [ "Great. Thanks. And then any comment on how you're thinking about the potential wage pressures on your business just that we're observing in the economy whether nationally orregionally would be helpful." ] }, { "name": "Mike McDermott", "speech": [ "Again, as we think about that, obviously, there's been some wage pressure. Just one of the things that our productivity efforts are designed to help offset, along with continuing to challenge are we rightsizing staffing in the stores in the [Inaudible] in corporate offices and always looking to balance, again, how we're getting better productivity in our processes throughout the supply chain and then the appropriate mix of hours in the stores from selling and non-selling to make sure that we're appropriately flowing freight, taking care of our customers, and providing best experience that we can." ] }, { "name": "Richard Maltsbarger", "speech": [ "And, David, I would just add based on the model and the experiences we try to create and product knowledge required of our associates, we pay a higher average hourly rate already than the marketplace. So, that helps us also mitigate that, just understanding the fact that because of the model itself, we do have a higher rate than the industry as well." ] }, { "name": "Mike McDermott", "speech": [ "And we take a look at it not only [Inaudible] on the base rate but all-in, from incentives and benefits to be competitive in the marketplace." ] }, { "name": "David Schick", "speech": [ "OK. Thank you." ] }, { "name": "Robert Niblock", "speech": [ "Thanks and, as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our fourth-quarter results on Wednesday, February 28. Have a great day." ] }, { "name": "Operator", "speech": [ "This concludes today's conference call. You may now disconnect." ] } ]
MA	2021-04-29	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "Sanford C. Bernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "Chris Donat", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Tsin Wang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Trevor Williams", "position": "Analyst" }, { "description": "Autonoumous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by. And welcome to the Q1 2021 Mastercard, Inc. earnings conference call. [Operator instructions] I would now like to turn the call over to Warren Kneeshaw, head of investor relations.", "Thank you. Please go ahead." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Denise and good morning, everyone, and thank you for joining us for our first-quarter 2021 earnings call. We hope you're all safe and sound. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the investor relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted. With the release and the slide deck both include reconciliations of non-GAAP measures to GAAP reported amounts.", "Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days.", "With that, I will now turn the call over to our chief executive officer, Mike Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren and good morning, everyone. So here are the headlines. We started the year with good momentum, delivering positive net revenue growth this quarter. We're encouraged by the return of domestic spending levels to pre-pandemic trends.", "We continue to execute against our strategic objectives as we signed notable new deals, advanced our multi-rail strategy by closing our transaction with Nets and extended our digital identity capabilities with the planned acquisition of Ekata. So let's dive in, looking at the broader economy first. Domestic spending levels showed continued improvement with very strong e-commerce sales. According to our quarter 1 spending pulse report, which is based on all tender types, U.S.", "retail sales were up 11.8% versus a year-ago ex auto, ex gas. This reflects the impact of fiscal stimulus and the lapping of the start of the pandemic. Spending costs also indicated that overall European retail sales got close to flat in quarter 1 versus a year ago. The vaccine rollout has become scaled in the U.S., U.K.", "and several other countries. And broadening this critical effort is under way, but will take time. Let's start with our business, specifically, and the four phases framework we established for managing through the COVID environment. At this time last year, markets were going through the containment and stabilization phases.", "We now believe many markets are transitioning from the normalization phase to the growth phase domestically. crossborder travel spending continues to be in the stabilization phase, where spending is restricted due to closed borders Looking at Mastercard spending trends, volumes continued to improve quarter over quarter with strength across products. We saw particular strength in debit, primarily driven by fiscal stimulus and share gains. In terms of how people are spending, e-commerce continues to be strong and we're seeing improvements in card-present spending.", "On the travel front, we've seen some recent improvements in domestic travel, primarily personal travel. crossborder travel remains limited as border restrictions remain in place for most markets. crossborder card-not-present spending, excluding online travel spend, continues to hold up well. As we have observed in many markets, progress is not always linear.", "And we believe there's significant pent-up demand for travel, as we've just seen in domestic travel. We expect domestic travel to improve progressively throughout the year in countries with strong vaccination programs. International travel should start to open on a select basis in the second half of the year between countries, the strong vaccination programs and/or low case rates. In the meantime, we remain focused on building on our already strong position in travel, engaging travelers early through our loyalty programs and expanding relationships with our partners in travel.", "As a result, we are well positioned to capitalize on this opportunity when it occurs. As we look forward and see positive momentum in the drivers that impact our top-line growth, we will increase the investment we put toward our strategic priorities: one, for payments; two, deploying a broader set of services; three, enabling digital solutions; and four, providing choice with multi-rail capabilities. As always, we will do this with an eye toward driving top and bottom-line growth over the long term, along with expense discipline. Let me illustrate how we're executing against each of these strategic priorities.", "I will begin by sharing how we're driving growth in the core, always supported by differentiated services capabilities. Here are a few key examples. Building on our strength in U.S. retail cobrands, we're excited that Mastercard was chosen as the exclusive network for Gap Inc.'s cobranded credit cards across the Old Navy, Gap, Banana Republic and Athleta brands.", "This partnership will include a reimagined rewards program to drive increased customer engagements, with the migration of existing card members planned for 2022. We've had a long-term services relationship with Gap, which led to additional opportunities to support both their cobrand programs and their broader business. We're also leveraging our differentiated service to expand relationships with key global partners like Santander. This quarter, we signed a new deal with Santander Brazil and executed a long-term exclusive partnership with Superdigital, Santanders fintech arm, to provide digital prepaid accounts across seven Latin American markets.", "Also, we're happy to announce that the financial arm of one of the largest retailers in Europe, El Corte Ingles, is migrating its entire closed-loop consumer credit portfolio to Mastercard exclusively for 10 years. This strategic partnership includes our processing capabilities and will contribute to growing Mastercard's overall credit share in the region. Talking about share. I'd also like to point out that the migration of Santander U.K.", "debit portfolio is progressing well, and we're preparing for the other conversions to be previously announced. Finally, we secured several strategic renewals and expansions. As many of you know, Huntington Bank announced its anticipated acquisition of TCF at the end of last year, which will make them a top 10 U.S. regional bank.", "I'm happy that they have decided to both renew their existing business with us and convert the TCF business to Mastercard. This brings significant new debit volume to our brands. We've also expanded our relationship with Synchrony Bank, as the exclusive partner for their general purpose consumer credit portfolio. Turning to the next strategic priority.", "We continue to enable digital solutions to drive the secular shift to electronic payments. A great example of this can be seen through the partnerships we have established with several leading mobile telecom providers across Africa and other regions. In Africa, there are more mobile money accounts than bank accounts and consumers increasingly expect digital financial services to be provided through their mobile phones. Now we signed a multiyear partnership with the MTN group to enable millions of their MTN mobile money wallet customers with a Mastercard virtual payment solution.", "We've also expanded our partnership with the Airtel group to equip their Airtel money customers with virtual cards and QR solutions. And we've extended our partnership with the Airtel Payments Bank in India along with the recent investment in Airtel Mobile Commerce. While our digital capabilities are enabling us to penetrate new geographies, our multi-rail strategy is allowing us to provide greater choice and capture new payment flows. We're happy that we have now completed the acquisition of the majority of the Corporate Services division of Nets, which reinforces our leadership position in providing realtime payments, infrastructure and applications.", "This transaction significantly enhances our application capabilities, inclusive of a robust set of bill payment solutions, which are operating at scale across several markets. Furthermore, this is an integral component of our regional strategy in Europe, enabling us to operate as a local partner. We see significant opportunity to expand these capabilities into additional markets around the world. Speaking of Bill Pay, in the U.S., we continue to scale our Bill Pay Exchange solution through new billers and bank partners.", "We're excited to announce that Verizon will connect as the most recent national biller on the platform. Turning to crossborder applications. We have now fully integrated our acquisition of Transfast and can now provide unsurpassed reach via a single point of access that allows banks and digital partners to send and receive money through bank accounts, mobile wallets, cards and cash payouts to over 90% of the world's population in more than 100 countries. We're expanding our relationships with the United Nations Federal Credit Union, Saudi British Bank to expand their reach into additional markets.", "And both Bancorp and IDT payment services will now leverage our capabilities for crossborder advantages. And in addition, we have extended our partnership with Western Union, who will be using our capabilities to allow customers in 18 European countries to transfer funds directly to debit cards in near real time. Our multi-rail capabilities are critically important to our efforts in open banking as well. They enable us to provide our customers across banks and fintechs with greater flexibility in how they manage both payment and data flows.", "We're off to a strong start at Finicity as we've integrated our sales teams and already signed several new connectivity partners and application users. For example, we're live with our state-of-the-art API-based data access in several large banks, including U.S. Bank, as well as with the leading payroll processor, representing millions of employees. Finicity was also selected by companies like Upgrade, SWBC, MoCaFi, MoneyLion and TomoCredit to provide permission-based access to financial data to support a variety of use cases, including mortgage, lending and, of course, payments.", "We're expanding our open banking capabilities in Europe as well as we're now live with our open banking connect solution with Lloyds Bank in the U.K. for consumers to make payments to their credit cards. We continue to see a great deal of interest and activity in digital currencies, and we're innovating in this space through new crypto and CBDC partnerships, enabling digital currencies on our network, and continuing our investments and underlying blockchain technology as part of our multi-rail strategy. We have several new crypto partnerships approved for launch this quarter, including a partnership with Gemini, a leading crypto platform here in the U.S., to launch a first of its kind cryptocurrency rewards credit card that allows consumers to receive crypto rewards on everyday purchases.", "And over in Spain, Crypton, a crypto exchange launching a Mastercard Crypto Card. On central bank digital currencies, we continue to engage with central banks around the world, and our virtual testing platform is helping them design features, similar issuance and evaluate interoperability with existing payment systems. In partnership with the Central Bank of Bahamas and Island Pay, we launched the world's first CBDC-linked payment card, enabling people to pay for goods and services using fiat currency anywhere Mastercard is accepted. Digital identity.", "Digital identity is critically important as the shift to a digital economy continues. It is a foundational component of our multilayered approach to security and have allowed us to help consumers and businesses safely and easily prove their identity while enabling them to main control over their information. Last week, we announced the planned acquisition of Ekata, which advances the digital identity efforts we have under way. Ekata has access to validated identity information on a global basis and leverages artificial intelligence to produce highly accurate identity scores.", "Ekata's insights support multiple payment and nonpayment use cases, including new account openings, instant issuance and transaction risk checks to be used by a broad range of customers, including leading digital merchants, financial institutions, travel companies and digital currency platforms. This is an example of how we are entering into adjacent areas and innovating beyond the core payment transaction. And now back to the bigger picture. We're leveraging our business to have a broader impact on society by executing our commitment to bring 1 billion people into the digital economy by 2025.", "Specifically on the environmental front, we have pledged to achieve net 0 emissions by 2050 and issued a sustainability bond in the last quarter to support these efforts. Furthermore, our Mastercard carbon calculator developed in collaboration with Doconomy, is enabled on our network to provide consumers with a snapshot of carbon emissions generated by their purchases. We've worked with customers to issue over 10 million cards using sustainable materials. If we tie all of this together, we are now linking executive comp to Mastercard's sustainability priorities.", "With all of that in mind, I continue to be excited about the opportunity ahead, and I'm happy with the progress we're making against our objectives. And with that, Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael and good morning, everybody. So turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis and excluding special items and the impact of gains and losses on the company's equity investments. Net revenue was up 2%, returning to positive growth for the first time since the peak of the pandemic in Q2 2020 and includes a 1 ppt benefit from acquisitions. Operating expenses increased 7%, which includes a full ppt increase from acquisitions.", "Operating income was down 1%, and net income was down 6%, both of which include a 1 ppt decrease related to acquisitions. EPS was down 5% year over year to $1.74, which includes $0.02 of dilution related to our recent acquisitions, offset by a $0.02 contribution from share repurchases. During the quarter, we repurchased about $1.4 billion worth of stock and an additional $418 million through April 26, 2021. So let's turn to Page 4, where you can see the operational metrics for the first quarter.", "Worldwide gross dollar volume, or GDV, increased by 8% year over year on a local currency basis. We are seeing sequential improvement in both debit and credit as vaccination progress takes hold and mobility increases. In addition, debit growth is being further strengthened by fiscal stimulus and share gains. U.S.", "GDV increased by 14% with debit growth of 26% and a decline in credit of 1%. Outside of the U.S., volume increased 5%, with debit growth of 12% and a decline in credit of 2%. crossborder volume was down 17% globally for the quarter with intra-Europe volumes down 11% and other crossborder volumes down 23%. Turning to Page 5.", "Switched transactions grew 9% in the first quarter globally. Card-not-present growth rates have accelerated during the past year and continue at those elevated levels, while card-present transactions are now growing above 2019 levels for the first time since the peak of the pandemic. In addition, card growth was 6%. Globally, there are $2.8 billion Mastercard and Maestro-branded cards issued.", "Now let's turn to Page 6 for highlights on a few of the revenue line items, again described on a currency-neutral basis, unless otherwise noted. The increase in net revenue of 2% was primarily driven by domestic transaction and volume growth as well as strong growth in services, partially offset by lower crossborder volume fees and higher rebates and incentives. As previously mentioned, acquisitions contributed approximately 1 ppt to net revenue growth. Looking at the individual revenue line items.", "Domestic assessments were up 8%, in line with worldwide GDV growth of 8%. crossborder volume fees decreased 26%, while crossborder volumes decreased 17%. The 9 ppt difference is primarily due to an adverse crossborder mix, mainly driven by lower-yielding intra-Europe crossborder volumes being less impacted than higher-yielding other cross border volumes. Transaction processing fees were up 4%, while switch transactions were up 9%.", "The 5 ppt difference is primarily driven by adverse mix. Other revenues were up 27%, including a 3 ppt contribution from acquisitions. The remaining growth was mostly driven by our Cyber & Intelligence and Data & Services solutions. Finally, rebates and incentives were up 4%.", "Moving on to Page 7. You can see that on a currency-neutral basis, total operating expenses increased 7%. This includes a 4 ppt increase from acquisitions and a 3 ppt increase related to the lapping of a favorable hedging gain from a year ago. Excluding these items, expenses were flat as we continue to invest in our strategic priorities while keeping an eye on top-line growth.", "Turning now to Page 8. Let's discuss the specific metrics for the first 3 weeks of April. We are seeing significant improvements in the growth rates across our operating metrics versus 2020, primarily due to the lapping effects related to the pandemic that began mostly in March of last year. Hence, to provide you better visibility into current spending levels, we thought it would be useful to present the 2021 volumes and transactions as a percentage of the 2019 amounts when we were not experiencing the impact of the pandemic.", "So if you look at the spending levels as a percentage of 2019. For switched volumes, they have shown steady sequential improvement, continuing along the same trend line we saw in Q1. This is driven primarily by the U.S., which has benefited from the recent fiscal stimulus. We have seen improvements in discretionary categories like clothing, furniture and sporting goods.", "And we have also seen some recent strength in personal domestic travel in the U.S. and the U.K., which we are making strong progress in vaccinations. For instance, we have seen U.S. airline spend essentially doubled over the last four weeks relative to where it was earlier in Q1.", "Trends in switched transactions remain steady and are generally tracking the trends we are seeing in switched volumes. In terms of cross border, spending levels as a percentage of 2019 remained mostly unchanged through the start of April. We continue to see very strong growth in card-not-present crossborder volumes, excluding online travel-related spend. However, border restrictions remain widespread and to crossborder travel, which is card-present and travel-related card-not-present volumes continues to be impacted.", "As you can see from the numbers, there's a significant opportunity for improvement in crossborder travel. In fact, where borders are open, such as Mexico, certain Latin American countries and the UAE, we have seen travel improve. Turning to Page 9. I wanted to share our current thoughts looking forward.", "First off, we continue to make strong progress against our strategic objectives and feel we are very well positioned to grow with the new and renewed deals we have signed over the last several quarters. We have positioned ourselves for the return of travel, with travel-oriented portfolios and have built a strong set of services capabilities, which continue to grow at a healthy rate and has helped diversify our revenue base. In terms of the macro environment, domestic spending levels have continued to improve, entering the growth phase this quarter, supported in part by fiscal stimulus and the rollout of effective vaccines. The pace of vaccinations has been uneven, however.", "And as a result, we expect the pace of recovery to vary from country to country. As Michael said, we do believe there is significant pent-up demand for travel and are already seeing domestic travel improve. In terms of crossborder, we believe that in the second half of the year, we will see additional borders open, particularly between those countries with low infection rates and/or advanced vaccination programs. Turning to the second quarter.", "If spending levels continue on their current trajectory, we would expect Q2 net revenues to grow around a low- to mid-20s growth rate year over year on a currency-neutral basis, excluding acquisitions. It is important to point out that this is just one potential scenario, which could be impacted by factors such as more restrictive measures being put in place because of rising infections, or the opening or closing of borders. In terms of operating expenses, we continue our disciplined expense management approach while furthering our strategic imperatives and keeping an eye on top-line growth. As we progress through the growth phase of the pandemic domestically, we will look to increase our investments in key areas such as digital, cybersecurity, data analytics, B2B and our multi-rail solutions, as well as begin to increase our advertising and marketing-related spend.", "For Q2, we expect operating expenses to grow at a rate in the low 20s versus a year ago on a currency-neutral basis, excluding acquisitions. As a reminder, we are now beginning to lap the spending actions we took last year as the pandemic hit. With respect to acquisitions, we are pleased to have announced the planned acquisition of Ekata and have now closed on the transaction with Nets, and expect acquisitions will contribute about 2 to 3 ppt to revenue in Q2 and for the year. Similarly, acquisitions will contribute approximately 9 to 10 ppt to operating expense growth in the second quarter, and 8 to 9 ppt for the year.", "As a reminder, we discretely disclosed the impact of acquisitions for the year in which they close and the subsequent year, after which time, we do not split them up. Other items to keep in mind. Foreign exchange is expected to be a 2 to 3 ppt tailwind to net revenues and a 3 to 4 ppt headwind to operating expenses in Q2. On the other income and expense line, we are at an expense run rate of approximately $115 million per quarter given the prevailing interest rate environment.", "This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics. And finally, we expect a tax rate of approximately 18% to 19% for the year based on the current geographic mix of our business. And with that, I will turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Sachin. Denise, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Your first question comes from Harshita Rawat with Bernstein. Your line is open." ] }, { "name": "Harshita Rawat", "speech": [ "Hi. Good morning. Thank you for taking my question. Michael, can you elaborate on Ekata acquisition and your broader digital identity efforts? Digital identity has so many problems today, streaming for solutions and is something you've been looking at for quite a while.", "So can this be a long-term adjacency for your business? And how does it fit in with what you're doing with open banking at Finicity? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Yes. Hi, Harshita. Thanks for the question. So we're excited about Ekata.", "And it is a continuation of what we have been doing in digital identity. So clearly, it's a non-sustainable path forward in a more digital economy to have even more passwords, so that's pretty clear. So identify is one pillar in our overall security strategy. So we needed to strengthen up here.", "The -- we started that activity with a pilot that we launched in Australia about a year ago, that is now going live in partnership with the Australian telecom, Optus, where we are introducing a reusable digital identity. What Ekata does is it accelerates our efforts, and accelerates our efforts because Ekata has access to verifiable data points that allow to establish an identity. As I said earlier, they can, in near realtime, produce very accurate identity scores. And it comes along with a set of -- established set of global customers, digital merchants, cryptocurrency chains, financial institutions and so forth.", "So we were on the track. Ekata is accelerating our efforts. It sits right into our existing set of cyber solutions. It's at the start of the transaction.", "It's at the end of the transaction. And in between, we have our decision intelligence, our various other transaction-focused solutions. So it's a full package. It sets us apart.", "And as you can appreciate, you linked this back to open banking, as you asked the question, we are going beyond the payment transaction and such. And you need identity solutions for data transaction just as much as you do for digital identity use cases." ] }, { "name": "Harshita Rawat", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Jason Kupferberg with Bank of America. Your line is open." ] }, { "name": "Jason Kupferberg", "speech": [ "Two quick ones for me. First off, just anything you can tell us in terms of second-quarter expectations on rebates, whether it's relative to last quarter or last year? I know you had given us a little bit of help on that for the first quarter. So I'd love to hear your thoughts on Q2. And then just wondering if we can get a quick comment on opex.", "I mean I know that on an organic constant currency basis, the second-quarter opex is growing about in line with net revenue. So is that kind of the right general model to think about in the second half as well if the recovery progresses in line with your base case? Or does the second quarter have more catch-up opex spend in it?" ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Jason. So let me take your rebates and incentives question first. Look, I mean rebates and incentives is really dependent on the timing of deals and how the volume and mix plays out. Having said that, we expect rebates and incentives as a percentage of growth to be up sequentially as domestic spending recovers and new and renewed deals come online.", "I think you're aware about the fact that our domestic volumes are more indexed -- our rebates and incentives are more indexed to domestic volumes. There are less indexed to crossborder. So depending on how that volume mix plays out, things might move around. But generally speaking, we expect rebates and incentives as a percentage of growth to be up from current levels, pretty much the remainder of the year as volumes recover.", "On your second question around opex, look, as we look forward, we see positive momentum in the drivers that impact our top-line growth, and we will increase the investment we put forward toward our strategic priorities. And these are essentially the ones we've talked about growing our share of core payments, ensuring that digital experience for our customers, driving a broader set of services capabilities, executing on our digital strategy as well as our B2B strategy. As we do this, we will keep an eye on both the top line as well as the bottom line. And we will basically be very focused on making sure that we are making investments to drive the long-term growth of our business.", "And that's kind of the essential thing I'd like to leave you with, which is we will continue to stay disciplined from an expense management standpoint. We see domestic spending is transitioning toward the growth phase, which gives us confidence, and vaccines are effective and they're being deployed at scale. So we will keep an eye on all of those metrics, we will keep an eye on the top line, and we will look to invest in the business to drive that long-term growth objective that we're talking about." ] }, { "name": "Jason Kupferberg", "speech": [ "OK, thank you." ] }, { "name": "Operator", "speech": [ "Your Next question comes from Darrin Peller with Wolfe. Your line is open." ] }, { "name": "Darrin Peller", "speech": [ "Thanks, guys. When we look at the structural improvements that are impacting the business coming out of the pandemic, it does look like you have what could be several hundred basis points of incremental earnings power long-term from all the variables you guys talked about and what you're -- including your investments. Do you also think though -- so first of all, I guess, if you can comment on that in terms of what are the most of the areas you're most excited about in terms of incrementally having changed now, more spending in certain areas than maybe pre-pandemic. But would you also comment on whether your spend -- the investment levels you're at now on a percentage of revenue basis, or on an overall dollar amount, is something we can see some more operating leverage off of if we get that uplift from better structural terms.", "Thanks, guys." ] }, { "name": "Michael Miebach", "speech": [ "All right. Darrin, let me start off with the structural changes. I mean, that's the key question here. What makes a trend? What will stick? We have, over the last 14 months, on a monthly basis, helped consumers around the world, small businesses around the world.", "And the input that we're getting from this research remains unchanged. And that is fundamentally starting with increasing consumer confidence, spending is going up. And then when you look at the way how people spend, what we're hearing is when the pandemic subsides, 70% of people are saying, I'm going to continue to use more online commerce than I have before the pandemic. Almost 70% is saying the same thing for digital -- for digital banking.", "Almost the same number says more for contactless. And then you look at the other side of the coin, and that is about 60% of people are saying, I will actually use less cash. So we believe that these trends of elevated -- anything elevated online will prevail, maybe not at the same levels, but they will be elevated. At the same time, we're already seeing that in countries where strong vaccination programs are there and social distancing measures are reduced, that the spend in store is coming back.", "So people do want to go and spend at the local restaurant or support the local shop in their local main street. So the good thing is we're ready for both with our solutions. So that is around consumer behavior, the changing consumer as we turn out of this nightmare. And then you look at what else is going on.", "And what else are we seeing is with this push toward a more digital economy, we're seeing there's more data around. And the thirst for data analytics is increasing. Our services teams can't be running fast enough to satisfy that thirst. If you look at more data, you look at an increasing cyber footprint.", "So our cyber solutions, that is going to be -- it's going to be a continuing trend. Earlier, we talked a little bit about our multi-rail strategy and what we're doing there. I talked about Europe and being the local partner. Government is interested in -- payments government is interested in realtime payments and crypto central bank digital currency.", "So this whole trend of government leaning in, I think, is important. So our focus on our government vertical is going to help us there. And finally, just came across the news over the last couple of days, is the dependence on international supply chains is showing up. It shows up in the context of vaccine distributions lately, but it has been showing up across many different industries.", "So there is a real push to digitize supply chains, make them more flexible. And of course, that comes to payments as well and comes to associated data flows. So B2B should also be seeing quite a push out of -- as we turn out of the pandemic. So it's a shifting picture.", "And Darrin, I agree with you that there's a lot of things to feel positive about in terms of our strategy is on point for all these drivers. That's why we're increasing the investment behind these. And the second half of the question, I'll turn over to Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "So Darrin, just the one thing I'd kind of point out to you is, and you can see this in the slide deck, which we shared with you. You can see how let's take something like crossborder, and crossborders card-not-present, excluding travel, right? That, as been indexed back to 2019, is showing pretty healthy growth rates. Now as we come out of the pandemic, we expect a large part of that to stick. On the flip side, when you look what crossborder travel-related indexation looks like, in other words, 2021, current spend levels relative to 2019, they're running at about 40%.", "So if you believe that travel comes back, and we do believe that travel comes back, we see structurally the opportunity for upside growth coming from that as well. Just kind of bringing the whole picture together just to add to what Michael was saying. And kind of lends directly into your operating leverage question as well." ] }, { "name": "Darrin Peller", "speech": [ "OK. All right. That's helpful. Thanks guys." ] }, { "name": "Operator", "speech": [ "Your next question comes from Lisa Ellis with MoffettNathanson. Your line is open." ] }, { "name": "Lisa Ellis", "speech": [ "Hi, good morning and thanks for taking my question. I had a question on crypto, specifically related to stablecoins and CBDC. Michael, you called out in the prepared remarks that many governments are using Mastercard's virtual testing platform for their CBDC experiments. Can you describe just what you're seeing in terms of if governments are looking at implementing stablecoins or CBDCs, what type of public-private partnerships are they considering? Meaning what type of role or roles could you envision Mastercard playing? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Lisa, it's a great question. Let's take a look at CBDCs. I mean across the whole crypto space, I mean where we want to play a role in CBDCs, we want to play a role in private stablecoins, we want to facilitate the buying and selling of crypto assets. So it's a broader space.", "Specifically in CBDCs, I would describe it as relatively early days. So the engagement that we have, and that's where we see our role to start with, is to answer the question that you just asked, in partnership with governments, is what is the right construct? What is the role of the private sector? And where we came out, and fortunately, as of late, there's been a few thought leadership pieces involving some of the leading central banks around the world, including the ECB and the Bank of England and so forth is, ideally, there's a 2-tier system where the government takes the role of mining the currency, so to say, as they do in fiat, and the private sector takes the role of distributing it. And the private sector, this comes to your question about the specific role that players could have, including us, is innovating around that. Innovating the true power of blockchain, what else could it do other than facilitating a payment.", "So I think there is -- there's a direction that we like where this is going. So concepts of interoperability are also very important because the utility for a consumer or business will only come when you can do something with the central bank digital currency. I think this example out of Bahamas is actually a very striking one. So here is a Mastercard partner program that allows you to spend on a CBDC unit that you have received at any place Mastercard is accepted.", "That's solving the last mile issue. Imagine how we could be doing this in so many countries. So is that engagement on model? Is that engagement on policy? Now as you try to do something like the Bahamas did, you've got to test it and try it. And for now that we see our second role, in actually facilitating a real-life test bed, where you can iterate around the design and see how does this work.", "And that's not only for governments. Governments like that, Sandbox, they engage, but it's also to pull in the commercial banks because it needs to go in conjunction if you have a two-tier system. So I see all of that, and then I'll come to assume a scenario where this is in play, and it exists in a given country. We just talked about the Bahamas.", "There's this last mile issue. But there's also been the questions of what other applications can ride on this infrastructure. And you've heard us talk about in the context of realtime payments, our go-to-market is always underlying infrastructure, application services, and we intend to do the same thing here. And that is what is an application that could ride on top of this? It could be a smart trade contract.", "So a smart contract technology is what we're investing in, when I made the reference earlier, reinvesting in further blockchain technology. And then, of course, there are services. Everybody right now is asking us what should our blockchain strategy, and our advisors team is all over that. And there will be cyber questions.", "Governments are raising the question, when a blockchain comes along, is that a backdoor for hackers? So our whole cyber solution space is also geared up to engage. So I think there's a role to play for the private sector and there's a role to play very specifically for us to help the private sector and government." ] }, { "name": "Lisa Ellis", "speech": [ "Perfect. Thank you. Very excited." ] }, { "name": "Michael Miebach", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Chris Donat with Piper Sandler. Your line is open. Your line is open." ] }, { "name": "Chris Donat", "speech": [ "Hi, good morning. Thanks for taking my question. Just trying to get a little more specific on the benefits of vaccines and lower case loads for crossborder travel. As we think about the European union taking steps to allow vaccinated U.S.", "tourists into Europe, when we think about that corridor of the U.S. Traveling to Europe, is that -- I imagine it's big enough to move a needle for crossborder, but can you help us understand how meaningful like some key corridors would be if they reopen in strong ways for you? Or is it a highly dispersed set of corridors that you've got around the world that will take a lot of them coming back online." ] }, { "name": "Sachin Mehra", "speech": [ "Yes, Chris, I can give you a little bit of color on that. So when you think about, first, the high-level answer to your question is the corridors are pretty widely dispersed across the globe. You could see, generally speaking, intra-Europe constitutes a fairly significant portion of our crossborder volumes. And you can see that from the metrics, which we've been sharing with you.", "And so that will depend upon how travel opens up within the intra-Europe border, as kind of point one. Now but we recognize also that intra-Europe is lower-yielding than the other crossborder volume. So and as you think about it, you should think about it in that context. Secondly, what I'd tell you is U.S.", "is an important outbound corridor, there's no question about that. But there are several corridors well beyond that. When I think about the Middle East and Africa, when I think about what's going on in Asia Pacific, these are all important corridors. Take U.S.", "to Canada, another important corridor. U.S. to Latin America and Mexico these are all important corridors. I think the operative thing here is at least what we are spending a lot of time thinking about is not only about the rollout of vaccines, but what are governments doing to establish travel bubbles.", "So you've heard about Australia and New Zealand. You're hearing about Hong Kong, Singapore. You're hearing about China establishing some sort of bubble. So there's a lot of work which is currently under way in terms of seeing, is there a level of comfort to open up borders and to make it less onerous for people to travel.", "So it's kind of a 3-prong thing as far as I'm concerned: it's vaccines; it's the opening up and establishing of border kind of protocol; and then the third is, have you made it less onerous for people travel. And you've got to look at all those three as you think about how crossborder travel comes back. Now, the proof points we've got so far are in corridors like U.S., Latin America, things have worked out pretty nicely. It's not that onerous.", "People are traveling. You've seen decent crossborder spend. Similarly, in the UAE, you've seen decent crossborder spend. A lot of this -- and one more reminder, a quick one I've got for you is, a lot of our crossborder travel volume is personal travel, and we do expect personal travel will come back.", "And the leading indicator for that is we've seen it come back in the domestic environment pretty robustly. Now that you've taken away these quarantine requirements in the context with the U.S. and several other countries. So that's the kind of color I just wanted to share with you as you think about how this will play out going forward." ] }, { "name": "Chris Donat", "speech": [ "OK, thanks very much, Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "Your next question comes from Bryan Keane with Deutsche Bank. Your line is open." ] }, { "name": "Bryan Keane", "speech": [ "Hi, guys. Good morning. Just thinking about modeling, going forward, looking at the two year. In particular, thinking about the lapping of stimulus versus the economic recovery.", "Sachin, I don't know if you could give us some help on how you guys thought about the impact of those two factors. And particularly, I'm just curious on how much stimulus had an impact? Do you think it's having an impact? And then secondly, on services, I noticed the strength there. Just curious if that strength is expected to continue as we move forward through this year. Thanks so much." ] }, { "name": "Michael Miebach", "speech": [ "Modeling was a queue here. This is clearly for Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "So I guess what I'd tell you, I'd tell you, our experience based on what we've seen from the stimulus is, this round of stimulus has actually come into the flow from a spending standpoint, a lot more rapidly than the last round of stimulus had come through. What we've also experienced is that the dollar spent are not kind of once and done. So said differently, people are saving. And then there is the trickle effect, which comes to over a period of time.", "So it's our expectation that the impact of the stimulus will continue to be felt but at a declining pace as time goes along because we've started to see a lot of that come through in the early part right now. As I kind of just mentioned, you can see that in the strength in the numbers we've got. And then on your question on services, solid quarter on services again. Look, services continues to do really well.", "It does well from a revenue-generating capability. It also powers the core very effectively. You can see that in the way we're winning share. And I'm seeing a very strong pipeline in terms of what we're seeing from a services standpoint, going forward.", "So I feel pretty good. And the way, again, I think about this is you have a set of existing capabilities. How do you deepen your penetration with your customer base, existing and new customers, and then you keep building on your services capabilities. For example, the acquisitions we've recently done and how did we contribute to growth on a going-forward basis.", "So I think when you add all of that up, I feel pretty good about our services growth trajectory going forward." ] }, { "name": "Michael Miebach", "speech": [ "I just want to add one point here. So there's the deepening part into our existing customer set. As Sachin just said, you extend your capabilities. There's another vector here, and that is extending in new segments.", "So as we're -- throughout the last couple of years in the front of a number of acquisitions like SessionM or APT, we're finding that there's other adjacent segments that are needing these kinds of services. And as we go into these new segments, that's also an opportunity for us to also then, so to say, cross-sell our payment solutions. So it works in different ways. And then the last thing to add obviously when it comes to our multi-rail strategy, there's a growth dimension of extending our services across all new flows." ] }, { "name": "Bryan Keane", "speech": [ "Got it. Thanks for the help guys." ] }, { "name": "Operator", "speech": [ "Your our next question comes from Tien-Tsin Wang with J.P. Morgan. Your line is open." ] }, { "name": "Tien-Tsin Wang", "speech": [ "Thank you. Good morning. I want to ask about Nets. Now that you've had it for a couple of months, it was, I guess, a little different than what you originally agreed to buy.", "So given that, what are the priorities here, Michael, both short term and long term? It sounds like Europe is clearly part of it. But can you just catch us up on your to-do items right now?" ] }, { "name": "Michael Miebach", "speech": [ "Yes. Yes. So the first thing I would say, it's not entirely different from what we intended to buy. It's certainly different in terms of the expected time line.", "So it should have been a little faster than it was. Now but that aside, we were excited in August 2019, and we're excited on March 3 when we had Legal Day One, and we welcomed the team in Copenhagen. And I'll tell you why we're excited. So with our existing set of multi-rail capabilities, particularly in the account-to-account space, we're well positioned with Vocalink.", "Vocalink has strong infrastructure capabilities, applications and helped us to build the services business. What Nets does is, Nets gives us additional infrastructure capabilities because here's a significantly customizable high-end solution that Vocalink brings, which works for large established markets that have had some journey in realtime payments. And then there's Nets, which is a more nimble platform that allows us to deal with the smaller markets and take on more in a shorter period of time. So there's complementary assets here and that if you look across that, it makes us the one-stop shop partner when it comes to realtime payments, and that is unsurpassed.", "There's nothing else out there at this point in time. On the application side, I'm even more excited because here, what we're having is -- we're not just getting technological capability with this purchase and we can bolt on to what we've already done in Vocalink. But we're getting scaled businesses that are live in market. There are strong bill payment propositions and volumes with large customer reach in, particularly in the Nordics regions, but other parts of Europe as well.", "So we've identified Bill Pay as a growth opportunity sometime back here in the U.S., and now we're bolting that on. And then we have the choice of taking some of our U.S. capabilities into other parts of the world or do the same with Nets. So that is accelerating our growth in the application space, which I'm particularly focused on.", "I think last but not least, that they have activities in the open banking space and few services around realtime payments. So that just rounds off the picture. And I come back to Legal Day One. We're getting a fantastic team of engineers and experts in this space that is just really rounding off of our capability side.", "Now the aspect on how this might look different. So Tien-Tsin, you made that reference. And I all want to remind us, there was a remedy that we had put on the table in kind of negotiations with the EU commission throughout the approval process. And it basically means we will license the Nets infrastructure technology to a licensee, and the licensee was identified as part of the approval process.", "That allows -- but that is on the infrastructure side, not much of an issue because we have other assets to compete and then we can use it ourselves. So we're not excluded here. The package of having infrastructure application and service altogether, I think, makes such a differentiated proposition that we were quite happy to give that remedy. It made the EU commission happy.", "And it comes back to the point about -- yes, this is particularly important in Europe because in Europe, being seen as a true European partner, we have the commission put a stamp of approval on this transaction, and that works well for us. But we're going to take it elsewhere, for sure. I mean, that's the whole plan." ] }, { "name": "Tien-Tsin Wang", "speech": [ "Yeah. Very complete and clear answer. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from David Togut with Evercore ISI. Your line is open." ] }, { "name": "David Togut", "speech": [ "Thank you. Good morning. Bridging to Tien-Tsin's question, how has the pandemic affected the rollout of account-to-account payments in Europe under PSD2? Account-to-account certainly seems much more akin to debit than credit, and we know debit has certainly accelerated. So any thoughts would be appreciated." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. Dave, that's a great question. Throughout the last quarter calls, we make references to engagements on the government front and, oftentimes, that involve our progress and our engagement with governments on account-to-account. And there are other things, obviously, that we had to dial down throughout the pandemic because there simply was no appetite in the market, but account-to-account wasn't one of them.", "We never missed a single step there and neither did government. This was really driven by a lot of governments trying to get stimulus money into their citizens' hands, and they couldn't do it fast enough, and they couldn't do it in an efficient-enough way. So the focus and the light shed on realtime payment infrastructure was -- certainly helped. So I would see, there is an increasing engagement around account-to-account.", "Throughout the pandemic, if you look at what else was going on, you saw the two factor authentication thing in Europe for -- strong customer authentication, I think, is the actual technical term there. That moved forward throughout the pandemic. So the government, the financial sector players in Europe advanced that, and that was broadly it. And then you look at what we've done with open banking.", "I mentioned it earlier. That's, again, a regulator-driven aspect of payments and the broader financial services here at Tesco. We talked about that last quarter I think in our Lloyd's. So there is momentum.", "I think it's actually literally a shot in the arm rather than anything else. Sachin, do you have anything to add?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. I'll just make one more additional comment. When we think about account-to-account, there's certainly the domestic flows, and then there's the account-to-account crossborder. And I think we've got to kind of think about it in the composite because, candidly, we're seeing some very decent traction take place even in that crossborder space from an account-to-account standpoint.", "Michael mentioned this in his remarks, where he talked about the traction we're having with the integration of Transfast being complete. And it's not only exclusive to Europe, by the way. It's pretty much across the globe. So we think about it holistically, including the crossborder categories." ] }, { "name": "David Togut", "speech": [ "Thanks very much. Appreciate your insights." ] }, { "name": "Sachin Mehra", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Trevor Williams with Jefferies. Your line is open." ] }, { "name": "Trevor Williams", "speech": [ "Hey, good morning. Thanks for taking the question. I wanted to ask on yield within domestic assessments, where they held in pretty well for most of 2020, but just over the last couple of quarters, have been down about 5% or so. And I guess there are a lot of moving pieces with mix shifting around from quarter to quarter, with the pace of recovery varying by region.", "But just any color you could give us on maybe where some of the recent weakness might be coming from and really what needs to happen, whether that's a recovery in certain geographies or anything else you might not be thinking about to get yields in that segment moving back up. Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. So Trevor, I think your question specifically is around domestic assessment yields, correct? Just want to be sure." ] }, { "name": "Trevor Williams", "speech": [ "Correct. Yeah. Yeah." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. Look, I mean, we've seen a little bit of recovery in domestic assessment yields in the first quarter relative to what we saw in the fourth quarter. That number kind of moves around, right? And it moves around -- there's a whole bunch of stuff, which is kind of going on in there. Because remember, in the denominator, when you're doing yield calculations, we talk about GDV.", "I think the natural instinct is to think about GDV only as domestic volumes. It's a composition of domestic and crossborder volumes. Whereas the numerator, which is domestic assessments, is only the revenue we own on our domestic volumes. So depending on how that mix moves around, you're going to see that yield move around as well.", "And then there are other moving parts in domestic assessments, the card fees and those kind of things, which are actually featured in there as well. But by and large, I would tell you, between the fourth quarter of 2019 going into the first quarter of 2021, our yields have held pretty steady if I take those two endpoints. They bounce around a little bit quarter to quarter, but they're now pretty steady." ] }, { "name": "Trevor Williams", "speech": [ "OK. Terrific. Thank you. Appreciate the color." ] }, { "name": "Michael Miebach", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "Your next question comes from Craig Maurer with Autonomous Research. Your line is open." ] }, { "name": "Craig Maurer", "speech": [ "Yeah. Hi, thanks. Wanted to ask about the material debit wins that you've had in Europe and now in the U.S. with TCF.", "You're going to obviously be on-boarding a significant amount of debit volume over the next two years, which begs the question, how do you view the long-term in terms of debit versus credit growth rates? And we've seen insignificant outperformance of debit. During the pandemic, it's the obvious replacement for cash. So do you view the spread between the two versus historical levels as widening significantly over time? Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Hi, Craig. Let me take this and then see if Sachin has anything to add. So throughout the pandemic, as you rightly said, there was clearly a relative rise in debit over credit transactions. The way I look at this is, this is a time of economic uncertainty, frankly, uncertainty general.", "And in those times, people generally prefer to spend money they have and have more control over that. So that is what we've seen in previous crises, so no surprise there, that is crisis-induced. We see debit benefit from stimulus payments because they are attached to a bank account. So we saw that.", "And then you look at how the mix of spending has changed in terms of overweight to everyday spend versus discretionary spend, and that is just -- there's a lot of historical consumer behavior ingrained in that, is that you use debit for more everyday spend. That is what we're seeing in many markets around the world, and that has played out here as well. So now the question is, what of that is going to stick back to what we said earlier in terms of trends? And in the end, that's hard to predict. I do think what we're going to see is that the crisis in use spend is -- the trigger there is going to go away because this nightmare will be over at some point, hopefully, soon.", "And you will also see that the discretionary spend categories are coming back. We're already seeing this in the last three weeks when I look at the first three weeks of April here. So you start to see travel, strong travel programs. And it's very, I think, reasonable to expect that a lot of that is going to drive credit growth back up.", "So we're going to see a bit of a balancing. Now, for us, I think the strategy has to be, we have to have the best solutions across debit and credit, and frankly, beyond cards as well because we just talked about earlier how the overall payment landscape is changing. And that's where the focus is. That's why we lean in on the travel side, but that's also why we lean in on debit.", "And you're right, NatWest, Deutsche, Santander, it's in conversion right now, as I said earlier, and that's going to be good for us, and we try to bring our best solutions forward with consumers. So Sachin, I don't know if you have anything to add." ] }, { "name": "Sachin Mehra", "speech": [ "Yes. I think, Michael, you pretty much covered it. The point I'd make, Craig, in addition is, obviously, the increased secular shift which is taking place. I think you were alluding to the fact that the first point of replacement of cash happens to be debit.", "We're certainly seeing that come through. But like Michael said, there will be some level of reversion to the mean. The one point I'd make is, the way we look at it, even from a product life cycle standpoint, is people tend to start, when you think about financial inclusion and you think about how people come into spending in electronic forms, they start with prepaid, then move to debit, then they start getting their toe into credit. And that's just the natural evolution, which will take place.", "We want to have a balanced portfolio. We want to win across the board, and we want to be ready to actually address those spend as they come across debit and/or credit." ] }, { "name": "Craig Maurer", "speech": [ "Thanks so much." ] }, { "name": "Michael Miebach", "speech": [ "Sure." ] }, { "name": "Warren Kneeshaw", "speech": [ "Great. I see that we've got to the top of the hour. And so maybe I'll just turn it over to Michael to see if you have any final comments as we wrap up." ] }, { "name": "Michael Miebach", "speech": [ "All right. Thanks, Warren. So first of all, thanks for your questions. I'd love to go on for a while, but be mindful of time.", "Just the key takeaways, bring it all together. It's -- we're back in the growth phase domestically, that's fantastic. We're ready for the return of travel. When it comes, it's going to be selective, second half of the year.", "We keep strong focus on our strategic priorities, I don't have to repeat them again. We're excited about Nets, as I just laid out. And we are excited and hopeful that we will close Ekata as soon as possible. So all that is good.", "None of this would happen without our people, and I do just want to recognize that. It's been 14 months, that's a marathon. And our folks are running it hard, and that is a big shout out. I sent a note to the whole team this morning with our results and told them that, that momentum that we were just sharing with you is really entirely their doing.", "With that, I'm going to leave you to it and look forward to speak to you in a quarter from now. Thank you very much and thanks for all your support." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, everyone." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2020-07-30	[ { "description": "Executive Vice President of Investor Relations", "name": "Warren Kneeshaw", "position": "Executive" }, { "description": "Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": "President", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "William Blair -- Analyst", "name": "Bob Napoli", "position": "Analyst" }, { "description": "Tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "SunTrust Robinson Humphrey -- Analyst", "name": "Andrew Jeffrey", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Ashwin Shirvaikar", "position": "Analyst" }, { "description": "General Counsel -- Analyst", "name": "Tim Murphy", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to the Mastercard Q2 2020 earnings conference call. [Operator instructions] I would now like to hand the conference over to your speaker today, Warren Kneeshaw, executive vice president of investor relations. Thank you. Please go ahead, sir." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you Casey, and good morning everyone. Thank you for joining us for our second-quarter 2020 earnings call. We hope you are all safe and sound. With me today are Ajay Banga, our chief executive officer; Michael Miebach, our president; and Sachin Mehra, our chief financial officer.", "Following comments from Ajay, Michael and Sachin, the operator will announce your opportunity to get into the queue in the Q&A session. It's only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the investor relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning.", "Our comments today regarding our financial results will be on a non-GAAP, currency-neutral basis unless otherwise noted. Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements.", "Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days. With that, I will now turn the call over to chief executive officer, Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thank you Warren, and good morning everybody. So over the past several months, the COVID-19 pandemic has impacted every aspect of our society. And we remain focused on supporting our employees, our issuers, merchants, small businesses and government partners to help them navigate through what I think are completely unprecedented times. You may recall that we introduced a four-phasedframework for monitoring spending levels and how we would run our company on our last earnings call: containment, stabilization, normalization and growth.", "Now in the second quarter, we saw a progressive improvement in volume trends over the course of the quarter driven by the opening up of domestic economies. And today, we believe that most markets are in the normalization phase domestically, with people and social distancing and mobility limitations are relaxed and spending begins to gradually recover with some sectors recovering faster than average. We expect that progressing through the normalization phase and ultimately move to the growth phase, essentially bringing us back to pre-COVID days, is very much dependent upon turning the tide on infection which you've seen in Europe, in Asia and the United States Northeast, but also is ultimately tied to the broad availability of a vaccine and proven therapeutics. We expect that the progress through the phases will be nonlinear.", "We have seen that in places like Japan and potentially in the Southern United States, where we are monitoring for the effects of the reintroduction of social distancing restrictions. Meanwhile, the world is becoming more digital. Our services are in strong demand, and we expect that travel will begin to come back as borders reopen, the first signs of which we are beginning to see in Europe. The COVID crisis has driven an acceleration in the use of electronic forms of payment with much greater adoption of digital and contactless solutions.", "Now we believe those will sustain beyond the pandemic, and we believe we are very well positioned to capitalize on those. The pandemic has also highlighted the resiliency of our differentiated business model which is reflected in our financial performance. Our services growth remains strong. It's outpacing the core, and it drives meaningful differentiation and diversification.", "Our digital and multi-rail solutions are enabling us to address key opportunities by providing customer choice and the capabilities required to capture a wide range of payment flows. And we continue to win deals across all our core products. So we are focused on what we can control. We are focused on executing against our strategy.", "We are focused on managing the business for the long term. And we are focused on investing in key strategic priorities, in areas like open banking, real-time payments, cyber and intelligence solutions and B2B payments. Now you're going to hear lots of that from Michael. And before I hand it over to him, I'd like to share a few comments on diversity and inclusion.", "Through the events we've watched unfold in the United States and elsewhere over the last several weeks, our society is facing the difficult truth that there is a long way to go to ensure that the fundamental human rights of all people are equally respected. There is no place for racism or discrimination in our communities, in our company, in our hearts. For years, we here in Mastercard have championed inclusion. We have focused on issues that matter to the black community as well as to others including delivering on our commitment to bring 500 million individuals into the financial system.", "We have extended that pledge, as you know, to 1 billion people by 2025 including 50 million micro and small businesses and 25 million women entrepreneurs. We are long-standing partners of several civil rights organizations, and we have closed the racial pay gap over the years. In 2019, Mastercard employees in the United States who are people of color were paid the same as Caucasian employees. So we are proud of where we are, but we recognize how much more there is still to do.", "And to that end, we have launched a companywide, long-term initiative to drive change for our people, for the market we work in and for society at large including bolstering black recruitment and training, driving financial inclusion and addressing the wealth and opportunity gap faced by black communities. We must and we will capitalize on this opportunity to effect change. So now over to Michael." ] }, { "name": "Michael Miebach", "speech": [ "Thanks Ajay. As Ajay mentioned, the COVID-19 pandemic has triggered a series of significant behavioral changes across consumers, merchants and businesses to having a profound impact on payment preferences, many of which are likely to persist beyond COVID. Key trends include a preference for contactless, the rapid adoption of e-commerce and increased aversion to cash, a merchant requirement to omnichannel acceptance and a need to automate B2B payments. Each of these provide an opportunity for our business to accelerate the secular shift to digital forms of payment.", "Let me give you some examples. So let's start with the consumer. According to our latest COVID-19 consumer impact study, over 70% of consumers plan to continue or increase their online purchasing, and approximately 60% believe they will use less cash even after the pandemic subsides. And we are providing digital-first solutions that leverage our tokenization and other digital technologies to meet these changing needs.", "In addition to the success we've had in the digital space with companies like Apple, we recently announced an expanded partnership with Samsung which includes the digital-first Samsung Money by SoFi product here in the U.S. and the Samsung Pay Card with Curve in the U.K. Southeast Asian super app, Grab, has launched a digital-first Mastercard prepaid card in the Philippines and by partnering with emerging fintechs like C24 in Germany, Doha Mastercard Debit solution and Tide in the U.K. to provide a new commercial prepaid product.", "In addition, Click to Pay, the streamline industrywide guest checkout capability, continues to gain momentum as consumers shift to digital experiences. More than 10,000 merchants have been enabled in the U.S., and preparations for global expansion are under way. We are differentiating our Click to Pay offering through an additional layer of security enabled by new data, AI and machine learning technology and through push provisioning of consumer enrollment through banks like Citi which will help to speed up and ease consumer adoption. Another implication of the shift to e-commerce is the need to support merchants with digital enablement solutions.", "Small- and medium-sized enterprises which represent about 90% of businesses worldwide, have an acute need in this area as they recover from the impact of the pandemic. As part of our $250 million commitment to support small business globally, we have recently launched our digital doors initiative which provides gateway, cybersecurity and other resources for merchants to quickly establish an online presence and start accepting electronic payments. We're also providing a comprehensive suite of installment capabilities through API-based solutions, partnerships and acquisitions, all of which provide greater choice in lending solutions for merchants and consumers, both online and in-store which is particularly important in a credit-challenged, post-COVID environment. Our Mastercard installment solution has been available marketwide for several years.", "Our acquisition of Vyze allowed us to advance our presence with marquee merchants in the U.S. And internationally, we forged partnerships with Pine Labs, Afterpay, Gifiti and Divido to provide tailored regional solutions. In addition, we recently announced a new partnership with Splitit to provide interest-free installments for e-commerce purchases. Now while the pandemic has accelerated consumer adoption of digital payment solutions, the crisis has also driven increased demand for our services offerings including cybersecurity and data analytics capabilities.", "These services allowed to offer differentiated solutions that are valued by a wide variety of customer segments and provide us with a level of revenue diversification. This has become particularly evident in the COVID environment as our services lines grew much faster than the core in the second quarter. Digital commerce continuously requires more advanced cyber solutions. In anticipation of that, we have been scaling our capabilities both organically and inorganically.", "Our RiskRecon acquisition, for instance, helps ecosystem participants assess and approve cybersecurity, and it is being utilized by several governments, healthcare providers and leading tech firms. Our Ethoca solutions are scaling quickly. We continue to have strong partners like Bank of America, and our Ethoca Digital Receipts product has been enabled at more than 80 new merchants over the last few months. NuData which provides behavioral biometrics capabilities, has secured new partnerships with Jack Henry & Associates as well as others.", "In addition to cyber, our customers are leveraging our data and analytics capabilities to assess, plan and react to the pandemic. Our test and learn platform, powered by our acquisition of APT, is helping partners like Citi to supplement their planning processes. In addition, we have engaged with governments in over 100 data analytics, cybersecurity and disbursement programs in over 30 markets around the world since the crisis began. And finally, our services capabilities provided key elements of differentiation to help us win several deals this quarter.", "We renewed key consumer partnerships with Preferred Bank in the U.S., Abu Dhabi Commercial Bank in UAE, Santander in Mexico and a credit renewal with the Bank of China. On the commercial side, we signed a deal with PNC in the U.S. and established a partnership with Virgin Money in the U.K. In addition to our efforts in digital and services, I'd like to touch on a few of our initiatives to address a broader set of payment flows and opportunities.", "Let's begin with open banking. As the shift to a digital economy accelerates, the demand for open banking services will increase further. In Europe, our open banking connect, protect and resolve solutions which we launched last year, continue to gain traction. We've added new fintech players like Modulr, DiPocket and Aion, in addition to the recently announced Tesco win.", "And we are excited about the planned acquisition of Finicity which advances our open banking strategy here in North America and which we will leverage globally. This will enable a new round of innovation and inclusion in financial services and new products for consumers. Finicity brings best-in-class connectivity with thousands of U.S. banks, along with a robust set of applications including credit decisioning and account owner verification capabilities.", "But we're also attracted to Finicity's approach to open banking including their strong commitment to data privacy and transparency, their balanced ecosystem model and their focus on API-based connectivity, all of which are consistent with our principles in the open banking space. We expect the deal to close by the end of the year and believe that the combination of Finicity and our internally developed solutions will provide us with a differentiated set of capabilities. Shifting gears to B2B. Recent research conducted by Kearney indicates that COVID has made the digitization of accounts payables and receivable processes a priority for many corporations.", "We have now commercially launched Mastercard track business payment service. The U.S. launch included 13 distribution partners across the B2B ecosystem including global payments, AvidXchange, boost payment solutions, Fiserv and others. Cross-border payments and international expansion are planned for 2021.", "Talking about cross-border, earlier this week, we announced the partnership with the Bank of Shanghai to allow customers of Mastercard's Cross-Border Services which is inclusive of our acquisition of Transfast and Mastercard Send, to send international B2B payments into China with less friction and more certainty. This is the latest example of how our cross-border services are enabling financial institutions and partners to reach a variety of payment end points in more than 100 markets, whether over card or a counter account infrastructure via a single connection. With that, let me now turn the call over to Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks Michael. So turning to Page 3 which shows our financial performance for the quarter on a currency-neutral basis and excluding both special items and the impact of gains and losses on the company's equity investments. Net revenue was down 17% reflecting the impact of the pandemic and includes a 1 ppt benefit from acquisitions. Operating expenses were down 5% year over year or down 9% if you exclude the full ppt impact of acquisitions.", "Operating income was down 25% and net income was down 27%, both of which include a 1 ppt decrease from acquisitions. EPS was down 26% year over year to $1.36 which includes $0.03 of dilution related to our recent acquisitions, offset by a $0.03 contribution from share repurchases. Although we did not complete any share repurchases in the second quarter, we have recently reinitiated our share repurchase program. And quarter to date through July 27, we have repurchased approximately 3.3 million shares at a cost of $1 billion.", "So let's turn to Page 4 where you can see the operational metrics for the second quarter. Worldwide gross dollar volume or GDV, declined by 10% year over year on a local currency basis reflecting the impact of the pandemic. U.S. GDV declined by 5%, with credit down 23%, partially offset by debit growth of 12%.", "Outside of the U.S., volume declined by 12%. Cross-border volume showed modest improvement progressively through the second quarter and was down 45% for the quarter, recovering off a low of down 55% in mid-April. The decline in cross-border was due to the impact of the pandemic which has limited cross-border travel to a great extent. Turning to Page 5.", "Switched transactions were also impacted by the pandemic. They stabilized around mid-April at down approximately 24% and improved progressively through the quarter, exiting the quarter close to flat versus a year ago resulting in switched transactions being down 10% for the quarter. In addition, card growth was 5%. Globally, there are 2.6 billion Mastercard and Maestro-branded cards issued.", "Now let's turn to Page 6 for highlights on a few of the revenue line items again described on a currency-neutral basis unless otherwise noted. The decrease in net revenue of 17% was primarily driven by a decline in transactions and volumes due to the effects of border restrictions and social distancing measures, partially offset by continued growth in our services offerings which continue to help diversify our revenue base and differentiate our core, as Ajay mentioned. As previously mentioned, acquisitions contributed 1 ppt to growth. Looking quickly at the individual revenue line items.", "Domestic assessments were down 8% due to the decline of 10% in worldwide GDV. The 2 ppt difference is primarily driven by favorable mix. Cross-border volume fees decreased 52%, while cross-border volume decreased 45%. The 7 ppt difference is mainly driven by an increase in the proportionate share of intra-Europe cross-border which is relatively low-yielding compared to other cross-border activity.", "Transaction processing fees were down 6%, while switched transactions were down 10%. The 4 ppt difference is primarily driven by favorable mix. Other revenues were up 14% including a 4 ppt contribution from acquisitions. The remaining growth was primarily driven by our cyber and intelligence and data and services solutions which continue to perform well.", "Finally, rebates and incentives were down 7% reflecting a decrease in volumes, partially offset by recent deal activity and were slightly lower than expectations. Moving on to Page 7. You can see that on a currency-neutral, non-GAAP basis, total operating expenses decreased 5%. This includes a 4 ppt increase related to acquisitions.", "The remaining decrease in operating expenses of 9 ppt primarily reflects lower advertising and marketing, travel and professional fee-related expenses. This is lower than expected primarily due to the delay of certain sponsorship activity which we now expect to occur in the third quarter of 2020. Turning to Page 8. Let's discuss what we've seen through the first three weeks of July, where we continue to see improvement in spending levels relative to June and the second quarter.", "One point to note: while the week ending July 21 shows slightly lower growth metrics relative to the prior week, I would not make too much of it since growth in that week is being impacted by the timing of significant e-com merchant promotional activity from a year ago. In fact, when I look at the early numbers for the 4th week of July, we see a continuation of the growth we saw in the week ending July 14. Starting with switched volumes, we continue to be in the normalization phase in most markets domestically. The U.S.", "continues to show positive year-over-year growth. And Europe has improved with several markets, such as Italy, Russia and Poland, showing positive year-over-year growth and others, such as the U.K., Germany and the Netherlands, showing significant improvement. It appears Europe's economy is recovering faster than others at this stage which could bode well for us given our strong position in Europe. Each of the other regions have also shown improvement.", "When you look at how people are spending, we continue to see improvement in card-present transactions, as you would expect as markets open up. Notably, this includes further recovery in restaurant and hotel spend as well as an increase in healthcare spending, while retail continues to hold up well. Card-not-present spend remains healthy. Trends in switched transactions are similar to what we are seeing in switched volumes as they are impacted by the same factors for the most part.", "One point of note, in the second quarter, contactless penetration represented 37% of in-person purchase transactions, up from 28% a year ago. In terms of cross-border, as expected, intra-Europe has shown the most improvement as border restrictions within Europe have been relaxed. As you can see however cross-border outside of Europe remains in the stabilization phase, with some recent signs of improvement in Asia Pacific and North America which have been offset by declines in Latin America and Middle East and Africa. Turning now to Page 9 for some additional color on the cross-border volume trends.", "You can see that the trends we laid out through the course of the quarter continued. In total, if you look at the gray line, total cross-border has improved modestly, mainly due to continued improvement in intra-Europe travel. If you look at the orange line, card-present spend continues to improve. Since June 21, we have seen a 15 ppt improvement in card-present travel and entertainment volumes in particular primarily related to spend on lodging and restaurants.", "We have also seen increased card-present spend in other discretionary categories such as clothing and home improvement. Card-no-present which is the yellow line on the chart, has been more resilient and has held up well. Looking at the green line, if you exclude online travel, card-not-present spend remains positive and reflects some shift to card-present spend as travel restrictions begin to relax and, as I just mentioned, some difficult prior-year comps related to e-com, merchant promotional activity in the 3rd week of July. We remain confident that cross-border volumes will continue to improve as travel restrictions are relaxed and believe a return to the growth phase is dependent on an improvement in consumer confidence that is in turn related to the availability of effective therapeutics and ultimately vaccines.", "Turning now to Page 10 and our outlook going forward. As we established last quarter, given the ongoing uncertainty, we will not be providing a forward view for net revenues for either the third quarter or the year at this time. We do intend however to continue to provide periodic updates to our operating metrics to help you understand the trends we are seeing. I would like to make a few additional comments to help you with your modeling.", "First, with respect to cross-border, in line with our previous outlook, we expect the recovery in intra-Europe travel will outpace the recovery in other cross-border travel. As a reminder, intra-Europe transactions are low-yielding than other cross-border transactions. Secondly, we expect rebates and incentives as a percentage of gross revenues to increase sequentially reflecting increased deal activity in Q3. Turning to operating expenses.", "I want to reinforce that we are carefully managing through this period to preserve our ability to invest in strategically important initiatives that will deliver on our long-term growth opportunities, digital, cyber, data and analytics, B2B and multi-rail solutions. In the meantime, we will save where as appropriate based on factors such as market readiness and customer demand. And we will continue to monitor the situation closely and adapt quickly as circumstances change. We expect operating expenses to be down low single digits in Q3 versus a year ago on a currency-neutral basis excluding acquisitions.", "This reflects sequentially higher A&M spend primarily due to increased sponsorship activity and digital campaigns. Other items to keep in mind. Foreign exchange is expected to be about a 1 ppt headwind to net revenue for each of the third and fourth quarters and will have a minimal impact to operating expenses over these same time periods. Acquisitions will contribute about 1 ppt to revenue for both Q3 and the year and 6 to 7 ppt to operating expenses for both Q3 and the year, assuming the transaction with Nets closes in Q3 and the Finicity transaction closes by the end of the year.", "On the other income and expenses line, we are at an expense run rate of approximately $100 million per quarter given the debt we have issued and prevailing interest rates. This excludes gains and losses on our equity investments which are excluded from our non-GAAP metrics. With respect to the tax rate for the year, we now expect to be closer to the bottom end of the 17% to 18% range we last provided, assuming the geographic mix of the business does not change significantly. So to sum it up, we are seeing signs of normalization domestically in most markets.", "Our service lines continue to perform very well, and we are in a very strong position to take advantage of the accelerating digital shift and address the significant opportunities that lie ahead. And with that, I will turn the call back over to Warren to begin the Q&A session." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Casey, we're now ready for the Q&A session." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] And your first question here comes from the line of Bryan Keane with Deutsche Bank. Please go ahead. Your line is open." ] }, { "name": "Bryan Keane", "speech": [ "Hi guys. Good morning. I wanted to ask about the margins. They were better than we expected.", "Just interested to know was there -- because expense growth had looked like it was controlled more than you guys anticipated. Were there some onetime events there that got pushed out or is that just better cost control that hopefully can continue? And then kind of part to that I guess secondly, why were incentives lower than expectations? I think that's the comment you made, Sachin. Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. Good morning Bryan. So on your question on margins, you're right, our expenses did come in lower than what our expectations were. And it was, like I said, it was driven primarily by just the timing of when our sponsorship activities and the associated expenses with that occurred.", "So we expected some of that to occur in the second quarter. As we can see, a lot of the events which Mastercard sponsors didn't necessarily come to fruition because of the pandemic in the second quarter. We're now expecting for that to happen in the third quarter. And so like I said, I kind of think about that more in terms of the shift in operating expenses between the second and the third quarter.", "On your question on rebates and incentives, it's really a function of we go into a quarter, we think about what our expectations on rebates and incentives based on what new and renewed deals we might be entering into. And really, I think the lower rebates and incentives, relative to our expectations in the second quarter, is a function of what actually ends up closing in a given quarter relative to what our expectations were. So like I said, we do expect that there will be an uptick in our rebates and incentives as a percentage of gross in the third quarter on account of new deals which we expect to occur in the third quarter." ] }, { "name": "Ajay Banga", "speech": [ "The only thing I'd add to that is, Bryan, this is Ajay, is that underlying what's going on in the expense base of the company is a lot of effort to ensure that we are more thoughtful about what we spend based on the readiness of our markets and our clients to accept the new things we are doing. So you do see an expense-based reduction in totality. But that's -- we are then using that ability to put it back into the investment areas that we want to and taking some of that to the bottom line. And I think that's what's going on inside our expenses.", "The A&M part is moving from a quarter to the other. But really what's underlying our expenses, as Sachin spoke about in his prepared remarks, is that. And Michael and the team are doing a terrific job on that." ] }, { "name": "Bryan Keane", "speech": [ "Got it. Thanks so much. Stay safe." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Darrin Peller with Wolfe Research. Please go ahead. Your line is now open." ] }, { "name": "Darrin Peller", "speech": [ "Thanks guys. If we think about the structural tailwinds you're seeing that are more pronounced and maybe sustainable given the pandemic, you talked about contactless obviously digital being up. But you guys don't mind just honing in on the services pieces obviously the other revenue is up. And there's definitely services flowing into the other transaction lines as well, so card-not-present fraud.", "I guess, how big can this be? Do you think that's sustainable even beyond the pandemic as well? And then can they offset potentially some of the cross-border headwinds we see? That's it." ] }, { "name": "Michael Miebach", "speech": [ "Yes. Darrin, it's Michael here. Let me take that. So as you rightly said, there is this accelerated shift to digital, yes, and we see that right now.", "What does that all -- or what does all of that mean for the business overall? Well, first of all, that accelerates the secular shift to digital payments. So that's all fantastic. But it has a downstream impact into our services, for sure. So more digital transactions versus more cash transactions is more data.", "More data means more desire and more need for data analytics capabilities, but also to protect that data. So our cyber solutions are going to benefit from that in the long run. We've clearly seen that. As long as the underlying trend to digital continues which we believe it will, our services portfolio which it hits right on to these points, should be benefiting." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question please." ] }, { "name": "Operator", "speech": [ "Your next question here comes from the line of Craig Maurer with Autonomous Research. Please go ahead. Your line is now open." ] }, { "name": "Craig Maurer", "speech": [ "Yeah. Good morning. It's Craig Maurer. So I wanted to ask a couple of questions.", "First, can you tell us the -- how your value-add services revenue are distributed among your different lines of revenue? And what value-add services are enabling you to win deals versus competition? And secondly, with the class action lawsuit against Plaid pending in California, I was hoping that you could reiterate for us the differences between Finicity and Plaid that made you more comfortable with the Finicity business." ] }, { "name": "Sachin Mehra", "speech": [ "Hey Craig, it's Sachin. So as it relates to where our services revenue side, they, for the most part, reside between other revenues and our transaction processing fees. Depending on the nature of the service, a, it either comes into other revenues, and there's some amount which comes in transaction processing fees to the extent they're related to the number of transactions which are switched. You kind of asked the question as to what services are helping us differentiate and win at the core.", "I would argue that if you start from what Michael said earlier which is ability to gain access to data, utilizing data to analyze and provide advice to our clients as to how they can optimize their portfolios, how they can end up growing their top line while still managing their expense base, is a key enabler on one side. And then separate from that, a pain point which exists which is around fraud, is another area which -- where our cyber and intelligence capabilities are a key differentiating factor." ] }, { "name": "Ajay Banga", "speech": [ "Hey Craig, it's Ajay. I'd throw one point in, and then pass it over to Michael for the Finicity answer. Just think about when you convert a portfolio during a flip. When you convert a portfolio during a flip, there are dormant cards in that portfolio and the ability for the client to come out in a better place with less dormancy, more active, more engaged customers, that is determined a lot by our ability to use data analytics in a sensible way.", "That's one example. For like that, there are many examples that enable us to put our best foot forward during such an opportunity. So Michael, Finicity." ] }, { "name": "Michael Miebach", "speech": [ "Yes. I just have one point to add to that. As we turn out of the COVID pandemic, I was talking earlier about understanding the crisis, reacting to it and planning for the future. Our test and learn stuff works almost like a hook.", "The crisis got us engaged on test and learn at a much greater scale than before, and that leads into conversations in more in the BAU realm of our business around payments with our customers. So we talked about planning processes on branch opening and what retailers are doing to stocking their shelves and so forth. But that leads into payment opportunities which is again a way for us to differentiate and win in payments. Now on Finicity.", "So I have to say from the first interaction that we had with the Finicity team, with the leadership team, with Steve and Nick over there, the founders, we felt a very strong cultural affinity here. So here is a company that has been the leading voice and setting up the FDX, the Financial Data Exchange approach, transparent business model, a model that works for everybody in open banking, open -- that is for fintechs, it's for banks, it's for consumers. They have been a voice in that for years. And that's pretty much exactly where we are going.", "When you dig a little more into the detail, you see a company that has very strong relationships with U.S. banks. I talked about the connectivity earlier. But they have a series of agreements, data sharing agreements in place with several of the large U.S.", "banks, Chase, Wells and Capital One, for example. So there is a really good reaction that we got once we announced the deal in terms of our banking partners and saying, this is a good partner for you. When it comes to data quality, one of the important things that matters for fintechs and banks alike as well as consumers is that the data quality of what is being shared here is at the highest point. It is cleansed.", "It works at all times. And here, Finicity is clearly a leader. The applications that they bring, specifically around credit decisioning, makes Finicity a leader. This is something that I believe is a very useful use case.", "It's one that will be needed certainly as we come out of the crisis. If you think about their Boost product, here, the company was thinking around financial inclusion for a while, as we have. With the Boost product, it basically helps people improve their credit score so they can get access to credit. So all around, I see clear differentiation of Finicity versus other players that make them, as far as I can see, our best possible partner." ] }, { "name": "Craig Maurer", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Lisa Ellis with MoffettNathanson. Please go ahead. Your line is now open." ] }, { "name": "Lisa Ellis", "speech": [ "Hi. Good morning and thanks for taking my question. Question about fraud and e-com in midst of the pandemic, the higher -- significantly higher rates of fraud and e-com has kind of become a lot more evident. Can you just speak maybe more holistically to Mastercard's initiative to help the broader ecosystem address and rapidly reduce online fraud, specifically things like accelerating deployment of tokens? I mean, are there tools you can use like creating different interchange categories or changing liability rules, etc., to kind of accelerate and help the whole ecosystem move in the direction of rapidly addressing the fraud issues? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Hey Lisa. It's Michael here. So let me take this question. As you rightly said, we talked about it earlier, we see fraud rates increasing, more transaction happening digitally.", "So there's no surprise there. Our broad strategy is along a number of pillars. We want to prevent fraud to start with. As and when transactions occur, we want to ensure that authentication is best as possible.", "We want to help our customers assess their cybersecurity status to start with. So those are the key dimensions of our strategy. But here, you pointed to an important aspect here. The underlying components of the digital economy, like tokenization that we have invested so much effort in over the last couple of years, come to play here.", "And tokens can do many things. But for once, they -- what they do is, because it's a onetime token, this -- a compromise transaction cannot be used by anybody for anything else. So what it does is it makes it safer, but it also drives a great user experience because the approval rates are going to be higher. So that effort is paying off significantly.", "So we keep expanding our capabilities here with RiskRecon. I talked about cybersecurity readiness. That is -- we can't run fast enough right now. There's -- everybody is seeking all those merchants that are coming online these days, trying to establish an online business.", "We see great demand for that. And then of course is once transactions are happening, there might be faulty transactions of some sort, the whole chargeback process comes into site. And here, as an ecosystem leader, as a custodian of the payments ecosystem, we're putting out our solutions that help making chargeback solutions go away even before a chargeback is actually filed. That's what Ethoca does for us.", "So around about, I think we're quite well positioned here. But tokens, as you said, make a real big difference." ] }, { "name": "Ajay Banga", "speech": [ "And Lisa, you can see the effort of both organic and inorganic build that we've been trying to do in that space. The organic build was the tokens and the investment that went into developing the idea and building these capabilities. And the inorganic build includes Ethoca, RiskRecon and other such efforts, and then the organic expenses on those to help them expand their reach. So it's kind of a combination of that that come into our system.", "And that's the discipline we follow on our acquisitions. And for a couple of years, we tell you that this is X acquisition. And then after that, it's in our base because that is how it has to be." ] }, { "name": "Lisa Ellis", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Bob Napoli with William Blair. Please go ahead. Your line is now open." ] }, { "name": "Bob Napoli", "speech": [ "Thank you and good morning. The acquisition in open banking, that area obviously has been getting a lot of attention. I was wondering if you can give a little more color on what Mastercard's strategy is in open banking and how you see that evolving? And then, Michael, you'll be taking over as CEO in the near future. I just wonder, any color on how you feel like you'll stylistically be different than Ajay? Will you be as colorful as Ajay? And then what are you most excited about?" ] }, { "name": "Ajay Banga", "speech": [ "Well, he kind of from here and get it covered but I don't oppose that. He goes between 2 topics and that's way beyond the overview of this call." ] }, { "name": "Michael Miebach", "speech": [ "All right. Let's go open banking first. Meanwhile, I can think about this question in the back of my mind. All right, open banking.", "So open banking is in the end all about putting control into the hands of a consumer to use their data, in this case, the data in their bank accounts to get access to better financial services, just generally benefit from the data. So that's the whole principle. Our strategy is, when you look at the ecosystem that's opening up here, is you got a lot of fintechs out there, third-party providers that are coming in and wanting to provide such financial services, and there's a lot of banks that hold that data. So we believe there's a role for us to be a trusted party in the middle between the fintechs and the banks, and all that based on consumer content to provide seamless transactions and make sure that everybody is a good player and enable the consumer to benefit from their data.", "So that's broadly the strategy. We have built those solutions in Europe. We brought them to market last year, connect, protect, resolve. I talked about it earlier.", "Good progress there. 11 countries, 2,000 banks on, that works really well in Europe. And then here in North America, there's a market that grew up in a different way, not driven by regulatory pushes in Europe, but basically, incumbents are there. They're having slightly different models on providing such services to consumers.", "We looked at Finicity here, as I laid out earlier, a good fit for us. That will be our starting point in North America to assume that trusted role between fintechs and banks. In the end, what I see is us participating in data transactions or in payment transactions. Both will happen in the world of open banking.", "And as we participate in card transaction and build a portfolio of value-add services on top of that, it makes those transactions better and differentiated for Mastercard. We seek to do the same in open banking. So in terms of open banking applications, I'll give you an example. Out of our world of loyalty services, our pay with rewards API, that would be something that we seek to deploy to the fintechs that are participating in the open banking ecosystem.", "There might be a neobank that says, I want to have a pay with rewards capability and here's a premium API from Mastercard. And of course, around all of this is everybody is trying to figure out their open banking strategy. It's a great opportunity for our consulting business for advisors. So infrastructure, application services is the way that we think about to go to market.", "And I think with our organic stuff and Finicity, we have the tools that we need. Now that gave me just two minutes to think about the colorful question. So you know what, we have been, since this whole pandemic started, basically locked up together for the last four and a half months here in purchase. Extended family, I would say.", "And I first found out all the things I don't want to be like. And there's a few..." ] }, { "name": "Ajay Banga", "speech": [ "Here's a guy who's known me for 20 years, and now he made fun of me. So don't give him so many remarks for his ability to be a bright spark." ] }, { "name": "Michael Miebach", "speech": [ "No. But in all seriousness, when you look at our strategy, what we're doing in terms of the accelerated drive to digital economy, we've got to just be on that and maximize that as much as we can. But at the same time, I just do want to make the point that we do see, even in these 4 months, consumer behavior is changing. Yes, people are using more digital services.", "But also, when there is an opportunity to go back on the street and buy at that local shop around the corner, then they do that. So the good thing is we have a business that benefits from the trend from cash to contactless and cards, and we will continue to drive that as hard as a digital partner. And that gives us the two legs to stand on. And then there's services.", "I think there's a huge opportunity, Lisa's question, we just talked about it in terms of what else we can do, the longer-term trend linked to underlying digital data flowing through. And in places like open banking, we haven't touched on it. New payment flows, B2B, real-time payments, all that. I don't see a dramatic change to our strategy because even those are just early steps on where we are.", "The turban thing, that would basically mean I need to get up like an hour earlier buying the whole thing. So I don't want to." ] }, { "name": "Craig Maurer", "speech": [ "Thank you. Appreciate it." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Tien-Tsin Huang with JP Morgan. Please go ahead. Your line is now open." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey sorry. Thanks. Hope you can hear me. Good morning.", "I wanted to ask -- I asked Visa this, so I'll ask you guys as well. Just the spread between U.S. credit and debit growth, it looks like it was even wider for you than Visa. I'd love to hear your thoughts on why -- how much of it is secular versus stimulus? And also, any impact on yield with this credit and debit shift here?" ] }, { "name": "Sachin Mehra", "speech": [ "Tien-Tsin, it's Sachin. So yes, you're seeing the spread take place in the second quarter between what you would expect in terms of a greater decline in credit and actually pretty good growth in debit. I would tell you that some of the second-quarter numbers are impacted by the stimulus programs, right? So as more and more money gets deposited in people's bank accounts, they're utilizing the debit product to go and access that amount." ] }, { "name": "Ajay Banga", "speech": [ "It's not as stable. Savings in banks have gone up too." ] }, { "name": "Sachin Mehra", "speech": [ "Correct. And so I do think you're seeing a little bit of that impact come through. But by and large, if you just step back and you think about where we are from an economic standpoint, given the uncertainty in the economy, people tend to rely more on a debit product than they do on credit, right? And kind of -- the reality is, we're well positioned to capitalize on both those trends, i.e., the fact that people are accessing their stimuli funds through debit products, but also the fact that our strength in debit, I mean, we go on a global basis and you think about our presence in debit globally, we stand well positioned to take advantage of that situation as people spend more on the debit product. So look, I can't tell you where it's going to go.", "What I can tell you is we're seeing a little bit bump-up in terms of our debit growth rates in the second quarter driven by the stimulus programs." ] }, { "name": "Tien-Tsin Huang", "speech": [ "OK. Good to know. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Sanjay Sakhrani with KBW. Please go ahead. Your line is now open." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. I know, Sachin, you said you wouldn't worry too much about the slowdown in the last week. But I'm just curious if you guys are seeing a meaningful divergence in trends in states that are seeing a spike in the viruses versus not? And then just on cross-border, should we just assume you can't see material improvement unless there's some kind of medicinal cure for the virus or how should we think about the progression of cross-border on a go-forward basis? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. Sanjay, so on the comment around the week of July 21, it's just exactly like I said. Look, I mean, let's not put too much into the week of July 21 because what I'm seeing in the early numbers for the week of July 28 is actually seeing back to the trends we were seeing on the week of July 14, in other words, the growth levels we were seeing back in the week of July 14. What you did have is the impact in the 3rd week of July related to the tougher year-over-year comps on account of some promotional activities done by e-commerce merchants.", "But I wouldn't put too much more into that. The trajectory is a good solid growth trajectory which we've been seeing here. On your question about impact of the back and forth in terms of pauses and reopenings taking place in different parts of the world and different parts of the country, I would just say we run the business based on the full framework which we've got, the whole containment stabilization, normalization and growth. And the reality is it's going to be nonlinear.", "We are going to see puts and takes which will take place. But when I look at it on a holistic basis, if I look at the most recent numbers for the 4th week of July, we're seeing the growth trajectory is on the 2nd week of July. Mike, do you want to take the cross-border?" ] }, { "name": "Michael Miebach", "speech": [ "Yes. On the cross-border side, so interesting question, just picking up from what Sachin just said. So the four-phase framework, what we put in there is we believe we will see normalization on a path to growth once social distancing measures and border restrictions are released. So the point about a vaccine will be a good thing to have and medicine will be a good thing to have, but it -- I don't think that we'll see flat travel until that point.", "We're already starting to see border restrictions being eased in some parts of the world. Europe, for example, there are some early green shoots there. And people do get into their cars and drive across borders. We see domestic travel around the world happening.", "So once border restrictions are lifted, we will see some increase there. So that is the first step. Then you go into therapeutics and vaccines. So just to come back in a big way, I think you're right.", "But it's not going to be kind of like an L where it all happens at one point. It will be a gradual improvement." ] }, { "name": "Sachin Mehra", "speech": [ "And Sanjay, I'll just add to what Michael just said. I mean we should think about border restrictions even in the context of U.S. and Canada and U.S. with Mexico, right? I mean we typically think border restrictions when we're thinking for Europe.", "But to the extent border restrictions are lifted between the Canada and the U.S., the U.S. and Mexico, important corridors by the way from a cross-border travel standpoint, those are good things for us to have. Secondly, the travel bubbles which are being created across various corridors, as you think about in Asia Pacific, between Australia and New Zealand, between China and Singapore, as those start to come into effect, you're going to see probably some of the impact of that come through. I don't know when, but I think those are things to keep your eye on as well." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Andrew Jeffrey with SunTrust. Please go ahead. Your line is now open." ] }, { "name": "Andrew Jeffrey", "speech": [ "Hi. Good morning. Appreciate you taking the question. Michael, I think you mentioned the services as being an important contributor to recent wins.", "I wonder if you and Ajay just generally can comment on sales cycles and in the current environment, and whether perhaps they've shifted, elongated, whether you think there's pent-up demand and we could see perhaps more portfolio flips or more activity generally as the economy recovers. Just trying to get a sense of cadence for new wins." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. Let me start on that, and then Ajay can chime in. So on the services side, when you look at the different elements that we have in our portfolio, so here is -- starting off with cyber, there's an immediate need. So from a customer demand perspective, there is a pull.", "So in terms of this help is needed right now, there isn't any debate, and that makes it fairly easy from a cycle perspective. Most of our solutions, other than RiskRecon, are generally network delivered. So that is relatively straightforward for us to switch on such a capability and make a difference. At the other end of the spectrum would be strategy and consulting projects which involve potentially some travel.", "And here, we've had some impact. Those sales cycles take longer. The demand is lesser because people are worrying more about it today versus the day after tomorrow. So that's what I would say where we are on that.", "We see it. The scaling for the network-delivered stuff is good. The people-delivered stuff, we'll continue to engage. And we do believe, as I said earlier before, being a partner, the best possible partner that we can be in the crisis let's say with our data analytics, test and learn platform or our cyber platforms, make us a good partner for the longer term.", "I think as we go out of this, governments, for example, they're looking at longer-term strategy products. Open banking is an opportunity like that. At any given point in time, there's a whole set of services and engagements around real-time payments, and we expect those to really pick up over time." ] }, { "name": "Ajay Banga", "speech": [ "And to your point about sales cycles on other things like core products, I think the only place where I find a faster sales cycle is their merchants with co-brands and were impacted by severe need for liquidity or circumstances of navigating through this. They have reupped many deals because that's kind of what you would do in their shoes. But I think I haven't seen a big change in the selling cycle with issuers per se. And I don't expect there to be some dramatic change there.", "I do see this thing with some of the merchants, but a few of them were directly impacted. And that business is challenged right now, and you can understand their circumstances." ] }, { "name": "Andrew Jeffrey", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of David Togut with Evercore ISI. Please go ahead. Your line is now open." ] }, { "name": "David Togut", "speech": [ "Thank you. Good morning. Could you comment on the composition of the 5% card growth in the quarter? Was that mostly debit versus credit as people wanted to purchase online? And then my follow-up really relates to Europe which historically has been debit-centric. And historically, Continental Europe has been a real strength of Mastercard.", "Could you comment more deeply on the trends you're seeing in Europe by country? And to the extent we see debit lead us out of this, what are the longer-term implications for revenue yields?" ] }, { "name": "Ajay Banga", "speech": [ "Yes. So let me take the part about Europe for a second. Yes, we have had strength in debit in Europe, in Continental Europe, in particular. We were weaker on debit in the U.K.", "That has begun to change over the course of the last couple of years with the wins we've been telling you about, but they have to all get into the market with those cards. Do I see that as good for us? Absolutely. Europe continues to be a very attractive growth market for our company. Over the years, our growth in Europe has been both due to our share growth and the flips and wins that we've been having and telling you about, but also due to the natural change, not just by the way from large global competitors, but even from domestic schemes by European country where their ability to keep pace with innovation and the things that issuers wanted have hamstrung them.", "And therefore, we have begun to see more and more transactions across domestic European markets. And I continue to be very constructively optimistic about Europe over the next few years. So that's kind of the first part about Europe." ] }, { "name": "Michael Miebach", "speech": [ "Yes. And just a few things to add on that. When you look Europe, maybe Western Europe comes to mind, but we see a huge opportunity for cash displacement in Eastern Europe. That's been driving our growth there, so that will continue.", "And then there's countries in the middle, like Germany which was cash heavy, but then COVID has clearly accelerated the trend there." ] }, { "name": "Ajay Banga", "speech": [ "And it might still contribute to that." ] }, { "name": "Michael Miebach", "speech": [ "Definitely, at least with my cross-border e-commerce. No, but the point here is the contactless is rising. So here's a market that is a significant opportunity that's again riding the wave. To Ajay's point, we are partnering with all the local schemes here, bringing our best practices to bear.", "So Europe, I continue to see noncash displacement on differentiation services and opportunity across the board." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. And Dave, to your question around card growth, we're seeing growth across both credit and debit. There's a little bit stronger growth across debit, and you should expect that. And the reason you should expect that is just general propensity to spend on debit, but also all the work that we are doing as a company on the migration from Maestro to Debit Mastercard.", "And that kind of quarter over quarter, you see that come through in our schedules where you see there's a declining card part of Maestro cards relative to what's there in the Debit Mastercard side." ] }, { "name": "David Togut", "speech": [ "Thank you. Stay safe and healthy." ] }, { "name": "Ajay Banga", "speech": [ "You too." ] }, { "name": "Sachin Mehra", "speech": [ "You too." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Ashwin Shirvaikar with Citi. Please go ahead. Your line is now open." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Thank you. Hi Michael. Hi Sachin. Good to hear your voices.", "I have a broad regulatory question. I just wanted to get your views on a range of things, Durbin, EPI. Any long-term thoughts in the Wirecard saga, what might emerge from that? Any company-specific update on Nets? We've seen some of the news flow recently obviously, but how are you thinking on that?" ] }, { "name": "Ajay Banga", "speech": [ "Look, I'm going to take a start, and then Tim is dying to answer your question. He's right here. He's actually looking. He's beaming from ear to ear.", "And I suspect he emailed you to ask what you asked." ] }, { "name": "Tim Murphy", "speech": [ "Thank you." ] }, { "name": "Ajay Banga", "speech": [ "So we're going to see in general. I continue to believe that this industry of payments, as it becomes more and more important and interesting to governments around the world, as they all take on cash and they try and move their economies to digital, I think you should expect attention from governments, opinion leaders, regulators, legislators around the world to the industry. That's not a bad thing. That is part of what's driving the secular change in our favor.", "It raises the bar for our industry to do so in vain that is seen as value-added to their local countries and their local businesses. And that's kind of what we've been trying to do through our financial inclusion efforts, through our center for inclusive growth, through our partnership with governments. This is not a new thing we take some leadership position in this space. That doesn't make it less of something we should be careful about, just telling you how we're conscious in dealing with it.", "So Tim?" ] }, { "name": "Tim Murphy", "speech": [ "Thanks, Ajay. Yes, no, fully agree. And let me just, in light of that frame, let me just sort of hit the specific things you mentioned in order. So in terms of Nets, you mentioned that, we continue to work through the regulatory approval process for that transaction.", "Feeling good about it. We're making progress. I don't have a lot more to say there, but that continues to be under way and we're moving forward. In terms of, staying in Europe, in terms of the EPI initiative which for others is a potential effort in Europe to create an alternative sort of European payment architecture and ecosystem, we'll see whether that gets traction or not.", "These have been -- there have been multiple efforts over the years. It is actively being considered. And our view is we welcome it, and we look forward to the opportunity to participate in it. I think we've demonstrated both in our core card business and our ACH business, the opportunity or the possibility to really drive value for all parties and to earn some revenue for ourselves by participating in these sorts of local or regional initiatives.", "And so we don't fear EPI. We embrace it. We will see whether it gets traction, but we intend to participate." ] }, { "name": "Ajay Banga", "speech": [ "Particularly with our approach to multi-rail, remember, we are not just card rail dependent. And so our attitude toward multi-rail is our strength there." ] }, { "name": "Tim Murphy", "speech": [ "Yes, indeed. And then just coming back to the U.S. on Durbin, so two things there. The -- you will have seen in our disclosures that the FTC has now opened up a formal investigation into Durbin compliance.", "We feel very good about how we have managed this company and delivered -- very fully compliant, Durbin-compliant approaches. We compete hard in debit. Debit is a very competitive space. Durbin contemplates that.", "It has rules around net compensation which we are rigorous in adhering to. So I look forward to the chance to explain our approach to the FTC, and we will do that as we need to. There's -- that's an early stage investigation, and we're participating fully. And then we might end on Wirecard, and I'll make a comment, and then if Sachin has more to say.", "I think, as you know, Wirecard, in terms of its engagement with Mastercard, there's principally two entities that engage in our network: one, a German-based bank; and then the Wirecard business in the U.K. We're working very closely through this process. They have a number of roles in the payment ecosystem including processing, acquiring and so on. We're very comfortable in our close connections, both with Wirecard and the regulators in Europe, that consumer deposits have been appropriately ring-fenced.", "And so we're staying very close to the situation and making sure that we're working with them and with other parties to minimize any impacts on the wider ecosystem. Sachin, anything else there?" ] }, { "name": "Sachin Mehra", "speech": [ "The only other thing I'll just add is, I think you're all very well aware about the risk management practices which are there at Mastercard. We have very robust risk management practices, and those have actually held us in pretty good stead in this instance as well. So we monitor. We've got real-time engagement taking place in terms of seeing what kind of traffic is going through our network as well as putting the requisite, collateral measures as and when necessary to ensure that we're appropriately covered." ] }, { "name": "Warren Kneeshaw", "speech": [ "Great. Thank you. Ajay, do you have any final comments?" ] }, { "name": "Ajay Banga", "speech": [ "Yes. So all of you, thank you for your questions. I'm going to wrap up with a few closing thoughts. I'm going to begin where we start at the beginning.", "These are difficult times for all of us. Yet, for our business, the pandemic is actually helping to accelerate the secular shift to electric -- electronic forms of payment. The foundational work we have been doing in areas like tokenization, contactless, digital acceptance, cybersecurity, B2B, these position us very well to capitalize on this accelerating trend. And our services capabilities allow us to offer differentiated solutions to a very wide range of customers and, very importantly, to help us diversify our revenue base and build multiple legs to our revenue stool.", "We continue to drive our core business forward. I think our multi-rail, open banking and cross-border solutions are enabling us to address a broader set of payment flows, and you should expect to see us continue to be very focused on these opportunities. Thank you for your support for the company. Thank you for joining us today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2023-10-26	[ { "description": "Head of Investor Relations", "name": "Devin Corr", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "KBW -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "Tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Bernstein Research -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "", "name": "Unknown speaker", "position": "Other" }, { "description": "Retail and Commerce, South Asia", "name": "Ashwin B.S", "position": "Other" }, { "description": "Goldman Sachs -- Analyst", "name": "Will Nance", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Tim Chiodo", "position": "Analyst" }, { "description": "Mizuho Securities -- Analyst", "name": "Dan Dolev", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Ashwin Shirvaikar", "position": "Analyst" }, { "description": "Seaport Research -- Analyst", "name": "Jeff Cantwell", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "William Blair -- Analyst", "name": "Bob Napoli", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mastercard Inc. Q2 2023 earnings conference call.", "[Operator instructions] Mr. Devin Corr, head of investor relations, you may begin your conference." ] }, { "name": "Devin Corr", "speech": [ "Thank you, Audra. Good morning, everyone, and thank you for joining us for our third-quarter 2023 earnings call. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then, that the queue will open for questions. You can access our earnings release, supplemental performance data, and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I'd like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website for 30 days. With that, I will now turn the call over to our chief executive officer, Michael Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Devin. Good morning from New York, everyone. Let me start by acknowledging the recent terror attacks in Israel and the resulting war with Hamas and the growing humanitarian crisis in Gaza. We're deeply saddened by the suffering and the loss.", "Our focus is on the well-being of our people, those who have been directly impacted, and those in our teams around the world, who are dealing with this terrible situation. We will continue to give them support while contributing to relieve efforts. We will monitor the situation closely so we can take action as required. Turning to our results, our quarter three results demonstrate the strong fundamentals of our business, our diversified model, and the continued resilience in consumer spending.", "Quarter three net revenues were up 11% and operating income was up 13%, both versus a year ago on a non-GAAP, currency-neutral basis, excluding special items. On a macroeconomic front, there are a few factors we focus on. First, the labor market remains strong, which is a key driver of consumer spending. However, we continue to monitor aspects such as credit availability and savings behaviors.", "Second, although inflation levels have moderated, they remain elevated. As central banks continue to actively manage monetary policy, we expect the impacts to vary across countries and sectors. Also, geopolitical uncertainty remains a concern, further underscored by the recent events in the Middle East. We are monitoring these moving pieces and stand ready to manage the business accordingly.", "Looking at our switch trends this quarter, domestic volume growth remains healthy, with some moderation in spend in select international markets. Cross-border travel remains strong at 155% of 2019 levels in the third quarter. And cross-border card present X-travel continues to hold up well at 209% of 2019 levels in the third quarter. And this is cross-border card not present X-travel.", "So overall, consumer spending remains resilient and we remain focused on executing against our strategic priorities. We see substantial runway for growth through the long-term potential in person-to-merchant payments, the sizable opportunity to address new payment flows, our diverse suite of fast-growing service capabilities, and our investments in areas of future growth like open banking and digital identity. Let's explore these in more detail. Starting with person-to-merchant payments, where we see a sizable long-term growth opportunity.", "We're winning deals with a diverse set of partners and investing in technology to further drive the shift to electronic forms of payment and capture new ways to pay. The third quarter, our deal momentum across the globe continued. In the US, we're happy to announce that Webster Bank, a leading commercial bank in the Northeast, has chosen MasterCard as their exclusive payment network. They selected us because of our marketing assets, safety and security tools, and commitment to small business.", "This builds up on recent wins in the U.S. like the Citizens Debit Portfolio Flip with the transition on track for 2024. These two wins are clear examples of the value we deliver through our partnerships and the reasons banks are willing to move their debit business to MasterCard. Further, we have partnered with Citi's wealth business to launch their ultra-high net worth credit proposition, targeting their private bank clients in Singapore and Hong Kong.", "And in East Africa, we signed a long-term deal with Equity Bank Group that significantly increases our share across the six markets where they have presence. On the co-brand front, we joined Barclays to launch Xbox, first credit card in the United States. Building off our long-standing relationship with Microsoft, this product is an example of how we're tapping into the fast-growing gaming space. And of course, we continue to strengthen our travel-focused programs, renewing our Frontier Airlines program issued by Barclays, as well as the Turkish Airlines program with Garanti BBVA.", "Winning deals positions us well to capture PCE and secular growth. There's a sizable opportunity across volumes and transactions, and we benefit from both. We're bringing together innovation, technology, the experience, and trust that consumers want and expect in their daily lives. And that starts with our best-in-class digital solutions such as Contactless and tokenization.", "Contactless now represents 63% of our in-person switch purchase transactions, and the convenience and security of our capabilities are helping us to further penetrate verticals like transit. By converting transit to Open-Loop, we gain access to more low-ticket, high-frequency transactions, both at the station and the surrounding merchants. The last quarter alone, we launched Open-Loop programs with two of the largest transit systems in North America, Toronto, and Philadelphia. We're now live with over 25 agencies in the U.S.", "and Canada. This year in the Netherlands, we supported the launch of a nationwide Contactless transit payment system. And in Pakistan, we're helping to digitize daily commutes in Karachi with issuance over one million prepaid Open-Loop cards. On tokenization, it has been 10 years since we first introduced the token standard to the industry.", "Today, it is foundational to the network and it's performing exceptionally well. The number of tokenized transactions has more than doubled over the past two years. We just processed over three billion tokenized transactions in one month. And this functionality is extending to new places to pay.", "For example, Mercedes-Benz customers in Germany can now pay for fuel directly from their vehicle using only their fingerprint. And Hyundai Motor America is enabling in-vehicle payments for parking with additional features and EV use cases to be enabled in the future. Digital solutions are also key to migrating Maestro to Debit Mastercard. This conversion drives a better cardholder experience, including in many cases, the ability to shop online and across borders, which leads to incremental card spend.", "And prior to full transition, we offer a virtual companion card to the current Maestro cards for immediate online use. In Europe, we're in the process of sun-setting new issuance of Maestro, and we will continue to work with our issuers on the migration of well over 100 million cards over time. A lot happening in P2M for sure. Onto the second vector for growth, new payment flows.", "There are substantial untapped flows across commercial payments and the disbursements and remittance space. In commercial, we continue to see strong growth. We're expanding our market-leading virtual card capabilities into new use cases. In the U.S.", "and Canada, our mobile payment solution is now live with BMO and TechPartner Extend, bringing our virtual card capabilities to contactless business payments. We also continue to expand our reach to corporates by partnering with Oracle to embed MasterCard virtual card capabilities into their Fusion Cloud ERP to enable supplier invoice payments and corporate purchases. And we are integrating our commercial payment and open banking capabilities into SAP Firenir platforms to deliver an embedded payment and lending experience. There remains a significant opportunity to convert cash and check to commercial card products.", "We're signing deals across the globe to do just that. We're excited to announce that we have agreed a long-term deal with Citibank to forge a global commercial card partnership covering more than 60 markets. The deal extends our leadership position with Citibank and reinforces our efforts to modernize and grow B2B payment flows. We also signed our first ever commercial contract with Axis Bank in India and a commercial deal with the biggest investment bank in Latin America, BTG Pactual.", "Now, let's focus on disbursements and remittances. With access to more than 95% of the world's bank population, our reach spans more than 180 countries and more than 150 currencies. And we are seeing strong growth. In the third quarter, transactions were up more than 30% on a year-over-year basis.", "To continue growing in this space, we're expanding into new use cases and geographies. A great example is our partnership with Remitly, one of the fastest growing digital remittance platforms with over five million active users. Remitly will leverage our disbursement and remittance solutions to help make international payments faster, easier, and more secure. We're also expanding our collaboration with Paysend in the U.K.", "to enhance cross-border payments for SMEs. Now our value-add services and solutions are another important driver for our growth. Collectively, this suite of capabilities is fast-growing and provides a diversified revenue stream. We have invested thoughtfully to develop services focused on supporting our customers in areas of growing need.", "Cybersecurity threats are rising, a trend that will unfortunately persist. And there's an increasing demand for actionable insights and more personalized experiences. Our services, bolstered by our data-driven intelligence, can help customers reduce fraud, grow their portfolios, and better engage with their end customers. Take our cyber solutions, which protect consumers and the payments ecosystem more broadly.", "One example is SafetyNet, which in the past 12 months has prevented more than $20 billion in fraud. This is just one of our many fraud solutions that we're deploying to deliver more value and support continued growth. AI also continues to play a critical role powering our products and fueling our network intelligence. We're scaling our AI-powered transaction fraud monitoring solution, which delivers real-time predictive scores based on a unique blend of customer and network-level insights.", "This powerful solution gives our customers the ability to take preventive action before the transaction is authorized. This quarter alone, we signed agreements in Argentina, Saudi Arabia, and Nigeria with financial institutions and Fintech's, who will benefit from early fraud detection and with merchants who will experience less friction and higher approval rates. In the end, this all makes for a better consumer experience. We're also using our services, combining our data and expertise to help clients optimize and do more with their portfolios.", "This drives both direct services revenue and incremental payments revenue. Our consulting, marketing services, and targeting analytics help clients design and execute portfolio migrations, drive incremental card acquisition, and stimulate spend. For example, in Spain, we are working with Financiera El Corte Inglés to boost the migration of closed-loop clients to our new open-loop co-badge proposition. And we're working with Saudi National Bank to enable growth in their credit portfolio by increasing penetration from their debit base.", "So the headline for me is the power of our strategy to drive payment network and service revenue for MasterCard. Service improved the performance of a client's portfolio, leading to incremental payment flows which lead to more opportunities to use our services, and so on, and so on. It's a virtuous circle. We also had success in expanding our customer base and services through best-in-class personalization and our leading test and learn analytics capabilities.", "Don't just take our word for it. Gartner recognized the superior value proposition of dynamic yields, personalization activities, and selected it as the leader in its 2023 Gartner Magic Quadrant for the third year in a row. That's why luxury brands like Saks Fifth Avenue work with us to create hyper-personalized experiences for their e-commerce customers. This quarter, we extended our partnership with the merchant ALDI in both the U.S.", "and Australia to continue to leverage our test and learn platform to optimize category reviews, store hours, and marketing spend. And we're working with Duncan International to enhance their foundational data analytics capabilities to improve operational efficiencies. Our best-in-class solutions address the unique needs of a diverse set of customers, giving us ample opportunity to continue to grow across our value-add services and solutions. We have a strong foundation for growth in P2M, as discussed, new-flows and services, and we are also embracing new opportunities for future growth.", "As digital adoption continues to rise, open banking remains a key opportunity. We have a powerful set of assets with connectivity to over 95% of deposit accounts in the U.S. and 3,000 banks across Europe. We engage with a broad set of partners who are increasingly interested in the scale and potential of the open banking solutions we bring.", "This includes the account-to-account bill payments use case. Our open banking solutions enhance existing ACH flows by providing a simple and secure experience, allowing consumers to seamlessly share data with trusted parties. A previously announced partnership with JPMorgan Payments, Pay-by-Bank is now live, and Verizon plans to pilot this offering with their U.S. customers in the coming months.", "In addition to this, we're now collaborating with Worldpay to enable consumers to pay bills directly from their bank account. Our progress here continues. So in summary, our third quarter results reflect the strong fundamentals of our business and the continued resilience in consumer spending. There are substantial runways supported by opportunities to digitize person-to-merchant payments across both the dollar volume of flows and the number of transactions, and opportunities to address new payment flows and extend our diverse suite of services, all while we continue to invest in future areas for growth.", "When you put it all together, our diversified business is well-positioned for strong growth for years to come. Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. Now turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis, excluding where applicable special items and the impact of gains and losses on our equity investments. Net revenue was up 11%, reflecting resilient domestic consumer spending and strong cross-border volume growth, as well as the continued growth in our value-added services and solutions. Operating expenses increased nine%, including a one ppt increase from acquisitions.", "And operating income was up 13%, including a minimal impact from acquisitions. Net income and EPS increased 21% and 24%, respectively, both reflecting the strong operating income growth, as well as a net tax benefit, which was primarily discrete due to U.S. tax guidance released in the current period. EPS was $3.39, which includes a nine-cent contribution from share repurchases.", "During the quarter, we repurchased $1.9 billion worth of stock and an additional $475 million through October 23, 2023. So let's turn to Page 4, where you can see the operational metrics for the third quarter. Worldwide Gross Dollar Volume, or GDV, increased by 11% year over year on a local currency basis. In the U.S., GDV increased by 5%, with credit growth of 7% and debit growth of 4%.", "Outside of the U.S., volume increased 13%, with credit growth of 13% and debit growth of 14%. Sequentially, the debit growth rate was primarily impacted by the lapping of the net West portfolio migration in the U.K. Overall, cross-border volume increased 21% globally for the quarter on a local currency basis, reflecting continued strong growth in both travel and non-travel-related cross-border spending. While this is sequentially lower versus Q2, this is due to tougher comps as we lapped the cross-border travel recovery from last year.", "When you look at the trend versus 2019, as Michael said, cross-border travel remained strong at 155% of 2019 levels in Q3, and cross-border card-not-present ex-travel continues to hold up well. Turning now to Page 5, switch transactions grew 15% year over year in Q3. Both card-present and card-not-present growth rates remain strong. We also continue to increase the percentage of transactions we switch.", "This is strategically important for us as it presents a revenue growth opportunity in both payments and services. An example of this is in Japan, where we began switching domestic transactions last September. In Q3 2023, we switched over 65% of our total transactions worldwide. For historical context, this figure was approximately 55% in 2018.", "In addition, card growth was 7%. Globally, there are 3.3 billion MasterCard and Maestro-branded cards issued. Turning to slide six, for a look into our net revenues for the third quarter discussed on a currency-neutral basis. Payment network net revenue increased 10%, primarily driven by domestic and cross-border transaction and volume growth, and also includes growth in rebates and incentives.", "Value-added services and solutions net revenue increased 14% relative to a strong Q3, a year ago. So let me give you a little bit of color. Our cyber and intelligence solutions continue to grow at a healthy pace driven by our underlying key drivers and demand for our fraud and security solutions. And we continue to see strong demand for our consulting and marketing services, as well as our loyalty solutions, which is partially tempered by other solutions.", "Now let's turn to Page 7, to discuss key metrics related to the payment network, again described on a currency-neutral basis unless otherwise noted. Looking quickly at each metric, domestic assessments were up 10%, while worldwide GDV grew 11%. The difference is primarily driven by mix. Cross-border assessments increased 26%, while cross-border volumes increased 21%.", "The five ppt difference is primarily due to mix. Transaction processing assessments were up 11%, while switch transactions grew 15%. The four ppt difference is primarily due to lower revenues related to FX volatility versus the prior year. Our network assessments related to licensing, implementation, and other franchise fees were $229 million this quarter.", "As a reminder, these other network assessments may fluctuate from period to period. Moving on to Page 8, you can see that on a non-GAAP currency-neutral basis, excluding special items, total adjusted operating expenses increased 9%, including a one ppt impact from acquisitions. This increase was primarily due to increased spending on personnel to support the continued execution of our strategic initiatives. Now turning to Page 9, let me comment on the operating metric trends in the third quarter and through the first three weeks of October.", "Starting with switched volume growth year over year, we lapped the NatWest migration early in the quarter and the commencement of switching in Japan late in the quarter. These factors are the primary drivers of the sequential declines in both Q3 and into October. One point on the U.S., the sequential drop in October primarily relates to the timing of certain Social Security payments this year versus last. Switch transactions follow similar patterns.", "Looking at cross-border, cross-border travel growth is being impacted by tougher comps as we continue to lap the recovery of travel. When compared to the 2019 index, cross-border travel metrics remain strong. Cross-border card-not-present ex-travel continues to show strength. Just for your information, we have included all the data points from the schedule, excluding activity from Russian-issued cards from current and prior periods in the appendix.", "Turning to Page 10, I wanted to share our thoughts on Q4. So let me start by saying consumer spending remains resilient and that our diversified business model continues to position us well for the many opportunities ahead. That being said, we are closely monitoring the elevated macro and geopolitical concerns and stand ready to adjust expenses should circumstances warrant. Consumer spending patterns continue to normalize post-pandemic, while pockets of opportunity remain for further recovery of cross-border travel, notably into and out of China.", "This will take some time as these corridors continue to face a variety of constraints. Having said this, our base case scenario continues to assume consumer spending remains resilient, buoyed by strong labor markets, and reflects recent spending dynamics. With respect to the fourth quarter, we expect year-over-year net revenue to grow at the low end of a low double-digit rate on a currency-neutral basis, excluding acquisitions. Acquisitions are expected to have a minimal impact to this growth.", "Due to the recent strengthening of the U.S. dollar in Q4, foreign exchange is now expected to be a tailwind of approximately zero to one ppt for the quarter, as compared to the three to four ppt benefit we had previously expected. This follows the impact we saw in the third quarter where the stronger dollar led to a foreign exchange benefit of two ppt to revenue, down from our initial expectations of a three ppt benefit. From an operating expense standpoint, we expect Q4 operating expenses to grow at a high single-digit rate versus a year ago on a currency-neutral basis, excluding acquisitions and special items.", "Acquisitions are forecast to add about one ppt to this growth, and foreign exchange is expected to be a headwind of between zero to one ppt for the quarter. Other items to keep in mind, on the other income and expense line, we forecast an expense of approximately $85 million for Q4. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics. Finally, we expect a tax rate of approximately 18% to 19% in Q4, based on the current geographic mix of our business.", "And with that, I will turn the call back over to Devin." ] }, { "name": "Devin Corr", "speech": [ "Thank you, Sachin. Thank you, Michael. Audra, you can now open the call now for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] We'll take our first question from Sanjay Sakhrani at KBW." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. Sachin, when we look at that fourth-quarter revenue deceleration, I think what the outlook implies, how much of it is, like, macro versus timing of incentives or something like that? I'm just curious, what factors are sort of driving that, and how we should think about that outlook, if there's still moderating trends going forward? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Sanjay. So, a couple of thoughts. One, in the fourth quarter, you remember last year, we continued to experience elevated levels of FX volatility in the fourth quarter of last year. And those FX volatility levels are certainly moderated by a meaningful extent.", "You saw some of that come through in Q3. There's more that we would expect at current volatility levels in Q4. So that's certainly, baked into our thinking. And then to your point around rebates and incentives, look, we continue to compete in this market, and we have a strong pipeline of deals.", "We continue to win, as you've seen, in the nature of the various announcements we've put out. And I would say our planning, for planning purposes, we're continuing to, execute on the strong pipeline. You would expect that contra sequentially would be up as a percentage of our, assessment revenue in the fourth quarter, not too different than what you would see in any other year. We typically have higher contra levels in the fourth quarter when you look at them as a percentage of our assessment revenue.", "So really, that's what's there. And to your specific point around macro, it's like I said, our base case assumes, a resilient consumer. And that's very much what we're assuming going forward as well. there are always puts and takes depending on markets in question, but broadly speaking, we continue to see a strong consumer." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll go next to Tien-Tsin Huang at J.P. Morgan." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hi. Thanks. Good morning to everyone. Just on the Europe front, I noted that it's so a little bit, the four points, I think, sequentially, Euro and Euro.", "Is that just a NatWest comp out? Is there anything else to call out? I'm curious if you saw any change in or interesting performance country by country in Europe. Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Tien-Tsin, so a couple of thoughts. First, it's primarily the lapping effect of NatWest. So let's start there. there are always going to be puts and takes by country.", "I would say that, Michael talked a little bit about in select international markets, we're seeing some level of moderation. I would say in Europe, you're seeing that in the UK. But largely, if you see the decel, which you're talking about, that's largely driven by the lapping of our NatWest win last year." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Thanks for clarifying. Thank you." ] }, { "name": "Operator", "speech": [ "We'll go next to Harshita Rawat at Bernstein." ] }, { "name": "Harshita Rawat", "speech": [ "Hi. Good morning. I want to ask about regulation. There's been some unrelated activity recently with Fed proposing new debit interchange caps, REG-II implementation for China present and the credit card competition bill.", "So Michael, taking a step back, how are you thinking about the regulatory environment in the U.S. and abroad? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Harshita. Thank you for directing that straight to me after a few questions on trends. But, there is certainly a lot going on. So that's for sure true.", "it's a lot of activity and they have been overlapping, REG-II, CCCA, the Fed on debit. So all this is related in a way, but it's also not related in a way. And I think this is important for us to take them one by one. And, without any particular order, let me start with CCCA, which has been a topic on this call for a little while.", "this topic is garnering a lot of momentum across our industry and industry participants. We are seeing a more united voice across banks and across merchants to address this point. Senators Durbin and Marshall have been very active over the last quarter since we last walked to attach this particular legislation proposal to other proposals and get a vote. They were not successful.", "And I think we actively used the time and productively used the time to bring across that this is not good for consumers. It is not good for small business. It is not good for merchants, particularly those who are driving large reward programs. So for all those reasons, we think this is a misguided proposal, a misguided legislation.", "We'll see where it goes going forward. But I have not been more optimistic on the industry pulling together to making those arguments understood than at this point. So this is CCCA. We're closely engaged on that.", "Now, on REG-II; so we're in compliance with that. Have we seen any particular outcome? I think it was a question on last call. Do you see this as an opportunity or as a risk? At this point, neither; what I can tell you is we will compete. We have invested billions over the years in the security of our network proposition and we think security is at the center of this whole debate.", "Can the merchant take away decisions from a consumer here and route this to the least cost and possibly the least secure network? Well, that is what we want to point out. That shouldn't be the case. We're leaning in on that. We haven't seen it yet at this point.", "So for us to just monitor and see what happens, we'll surely talk about it again next quarter. The Fed debit pricing piece that was put out yesterday is going into a consulting period. Here again, the same kind of momentum across the industry, across the American Bankers Association, the Electronic Payments Council, put out a letter to the Fed on Friday night along with seven other trades, if I recall correctly, arguing that price caps are generally driving market distortions. This is not a good thing.", "It's not a good thing for the consumer. Yet again, not a good thing for merchants who run reward programs and so forth. So we'll have to see where it goes. It is important, though, to point out that interchange is a balancing mechanism for the industry.", "It does not directly affect our P&L. So those are important things to keep in mind. For all of those, we see ourselves as an industry custodian to make sure that the arguments around safety and security and consumer choice are fully understood by all stakeholders." ] }, { "name": "Harshita Rawat", "speech": [ "Great. Thank you very much." ] }, { "name": "Operator", "speech": [ "We'll go next to Craig Moore at FT Partners." ] }, { "name": "Unknown speaker", "speech": [ "Hi. Thanks for taking the question. Actually, two; one, considering what we're seeing in the U.S. with deterioration in certain, should I say, credit quality buckets and so on and so forth, I'm curious if you could discuss how your spend in the U.S.", "has broken down between sort of the top 1% and the rest versus historical levels. It just might help us understand how insulated spend is to the specific credit issues we might be seeing over the next six months. And secondly, we've seen some pretty strong rhetoric out of Asia regarding moving away from the global networks due to actions taken around Russia and other places. I was wondering if you could comment on how discussions with those markets might have changed in recent times.", "Thanks." ] }, { "name": "Ashwin B.S", "speech": [ "Hey, Craig. It's Ashwin. I'll take your first question on the spending trends in the U.S. and particularly in light of what you're talking about on the deterioration of credit quality.", "The headline for you is the following. Our portfolio in the U.S. is actually a pretty well-diversified portfolio across all spectrums of the consumer base. If you look at our company 10 years ago, I would argue it was a company which was more kind of weighted toward our credit portfolio.", "We have got a better mix right now of credit and debit across the spectrum of consumers. And diversification has always been our friend, whether it's around products, whether it's around geographical markets. That's kind of the way we've kind of tried to drive the strategy of the business. I would tell you, I mean, if you look at the composition of the issuers in the U.S., right, so we have a decent amount of, co-brand portfolios which cater to the affluent.", "And hopefully, from a credit quality standpoint, they stand to actually hold up pretty well even in, in down markets. The other piece I tell you is that we like the fact that we have been recently investing in winning debit portfolios. We've talked about how we won citizens. We talked about -- Michael just talked about how we won Webster.", "These are important portfolios because, as in up and down cycles, right, what happens with the diversified portfolios in down cycles, debit tends to be in favor because of the spend going toward these non-discretionary categories of spend. So, the headline I tell you is pretty well diversified across products and across the spectrum of consumers in the U.S." ] }, { "name": "Michael Miebach", "speech": [ "And as we were saying earlier, we're monitoring credit availability. Credit availability is not an issue as far as we can see. At this point, it's beyond historic level. It's below historic level.", "So that's something that is part of our continuing efforts to understand where the dynamics are going. Now on Asia, you answered the question on their strong rhetoric from Asia. I would probably word this differently and say we're not seeing that. We're seeing this is an argument in a broader conversation around where value is coming from, the value of globalization and global connectivity.", "On the other hand, things like sanctions play into this. It's a very complex mix. And across the world, not just in Asia, there's a conversation around weighing all of that off. So it's important for you to understand that we have been partnering with countries around the world for years.", "Just take Europe to start with. Early on, we talked about Maestro and Debit Mastercard. We're partnering with a whole range of local payment systems for years. And there are no particular concerns around that.", "The same is in many other parts of the world. Where this is going and going forward, we'll have yet to see. But it is understood that as part of a globally connected economy and a world where some de-risking plays into that, trusted cross-border data flows matter. People still want to travel.", "And all of that makes us an important player. Also keep in mind that our capabilities across network level, trusted solutions, cyber-security solutions, gets us a seat at the table. We're seen as a technology company, a global technology company, not necessarily as a U.S. payment brand when we have those conversations because we help across.", "We enable local payment solutions through those services. So I'm not overly worried about this, but it's an active dialogue where we are seeing some really good things coming out of that. Think about some of the advancements in financial inclusion when local governments set up systems that reach consumers that haven't been reached before. That lifts everybody's boat.", "And that is good for the overall payments industry. So it is a broad topic. We've been engaging through the U.S. government, through other governments, multilateral organizations.", "And I personally spend quite a bit of time on that topic to ensure that we don't lose the benefit of a globally connected economy." ] }, { "name": "Unknown speaker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll move next to Will Nance at Goldman Sachs." ] }, { "name": "Will Nance", "speech": [ "Hey, guys. I appreciate you taking the question. I wanted to ask about some of the trends in value-added services. It sounds like the commentary this quarter was similar to last quarter, kind of a tale of two S's, relatively strong growth in services, and maybe a little bit of drag from solutions.", "I was just wondering if you could talk on the drag-in solutions, a little bit of color on what's driving that, and maybe for the outlook, how long should we kind of expect that drag to continue and what's sort of the outlook for the two buckets?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Will. So a couple of thoughts first. Like we mentioned in my prepared remarks, value-added services and solutions net revenue increased 14% this quarter. I will kind of emphasize that our cyber and intelligence solutions continue to grow at a healthy pace.", "This obviously is driven by underlying drivers as well as demand for our various solutions which we offer. And we're seeing similar trends in terms of strong demand for our consulting, marketing, and other quality solutions. To your point about the tempering effect of other solutions, that certainly is having a tempering effect. And what we have in other solutions is the relative growth rates from real-time payments, from what's going on from a bill payment standpoint.", "It's things of that nature which are actually growing at a slower pace, which is, candidly, I mean, something which we should expect. The reality is we've always talked about services in the past. We haven't talked about value-added services and solutions. Now we're talking about value-added services and solutions, which is where you're seeing that tempering effect come through.", "I think if it's helpful, one of the things which I want to actually also share with you is that this overall growth rate can be impacted quarter to quarter by transaction growth, by comps, and by timing. And just as a reference point, when excluding other solutions which have the tempering effect, our value-added services have grown at 19% year-over-year on a year-to-date basis, excluding Russia. So I think what I'm kind of trying to share with you is there is this tempering effect on other solutions. You should expect that tempering effect to continue.", "All of that being said, there is the overall strength we see in our CNI and DNS side, which we're actually very positive of, we're seeing good demand in that space." ] }, { "name": "Will Nance", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "We'll take our next question from David Togut at Evercore ISI." ] }, { "name": "David Togut", "speech": [ "Thank you very much. Given some of the tempering growth that you've highlighted, especially in VAS, how are you thinking about flexing expenses over the next six to 12 months? Where do you have a fair amount of discretion? And what are some of the areas, particularly like R&D, which would be sacrosanct?" ] }, { "name": "Michael Miebach", "speech": [ "Right. So what Sachin said, he wasn't really talking about tempering in VAS. He was talking about tempering in the other solutions. So I just want to kind of get that straight out.", "I think there is potentially a little bit of confusion here with our revenue disaggregation and the definitions here. We've talked about services in a particular way for years, and now we have a slightly different definition, as which we shared with you. So I just want to put that out there first. To your question, so we continue to expect strong growth in value-added services and solutions, DNS and CSI, as we said.", "As far as expenses go, I said it at the beginning, looking at macro, looking at everything that's going on around us, and we have demonstrated this through COVID, we have demonstrated it through Russia, and we will continue to demonstrate as we have a whole range of levers in a not particularly capital-heavy business to adjust our expenses. You've seen us managing for positive bottom-line and top-line growth on a year-over-year basis. We're not managing this quarter by quarter, but that is always something that we keep in mind. So our financial discipline will continue here.", "We have no reason to change that. It's working well, and that is the disciplined way to do this. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "And David, I'll just add, just as Michael said, I think our philosophy from an operations standpoint is to continue to deliver positive operating leverage over the long term. We will do that in a disciplined manner to continue to drive short, medium, and long-term growth, and we will invest prudently. And we will obviously keep an eye on what's going on on the top line and kind of moderate on expenses as appropriate, as we've done historically. So I just want to reiterate exactly what Michael said there.", "Thank you." ] }, { "name": "David Togut", "speech": [ "Yeah. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, David." ] }, { "name": "Operator", "speech": [ "Next, to Bryan Keane at Deutsche Bank." ] }, { "name": "Bryan Keane", "speech": [ "Hi. Good morning. Sachin, I just wanted to ask about more chunkier portfolios and the timing of it. Obviously, NatWest anniversary, that might have surprised some people on the comps, but it's just an anniversary of that.", "So just thinking about Citizens or Webster or others, the timing on when they come on and any others out there?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Brian. So on Citizens, the portfolio transition is on track for 2024. You should expect that that will take place over a period of time as opposed to a flip-the-switch kind of environment. Webster, we just announced, which we're super excited about, right? And the portfolio transition will also begin in 2024 and will take place over a period of time.", "Santander is done. NatWest I already spoke about. The other one, actually, which I kind of point out is Deutsche Bank, right? And there we had talked about conversion of 10 million cards. That conversion has started.", "It's a combination of debit and credit. It will happen over an extended period of time. Again, it's not a flip-the-switch kind of scenario. And the last one I'd mention is around Unicredit, which is something which will happen over multiple years.", "So this is not, and when I say multiple years, I literally mean you'll start in 2024 and this will work its way through over a few years. So that's what I can share with you in terms of at least the chunky ones. Obviously, there are a bunch of other portfolios which we went, all the time, but these are the bigger ones." ] }, { "name": "Bryan Keane", "speech": [ "Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "Our next question comes from Tim Chiodo at UBS." ] }, { "name": "Tim Chiodo", "speech": [ "Great. Thank you for taking the question. I just wanted to take this as an opportunity to revisit some of the mechanics around rebates and incentives. If you could just provide a recap on the portions of rebates and incentives that are volume and performance-based, some of the portions that are maybe more fixed, and then the portions that are more cumulative over the course of a contract? I think that would be appreciated by all.", "Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So first, the reason we do rebates and incentives is to drive volume. I just want to be clear. That's kind of what drives, what we're trying to do, which is to win preference, which allows us to generate revenue from the payment stream, as well as to deliver services to drive our net revenue yield.", "So that's kind of the headline. Your specific question around rebates and incentives, right, it's a combination typically of fixed and variable. It depends on a deal-by-deal basis. If it's a fixed incentive, the fixed incentive is typically amortized over the life of the deal.", "Variable incentives are variable in nature. They vary with the volume, which are coming through, and they are timed with how the volume rolls on. So that's kind of the highest level. The other piece I'd kind of share with you is, rebates and incentives are typically more indexed toward domestic volumes, less indexed toward cross-border.", "So those are the salient pieces I'd mention to you on rebates and incentives." ] }, { "name": "Tim Chiodo", "speech": [ "Greatly appreciated. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "We'll go next to Dan Dolev at Mizuho." ] }, { "name": "Dan Dolev", "speech": [ "Hey. Thanks. Michael, I just want to give you a compliment first because this is close to my heart, and I appreciate you mentioning the terror attack on Israel. I think your competitor made it more like of a politically correct comment on their call, so I really appreciate it.", "And then to my question, a key European merchant acquirer called out a big negative trend in Germany, and as the whole market trended down. Can you make some specific comments on how much of that was stuff that you were seeing? Because it seems like trends are actually pretty solid and pretty resilient, so there's quite a bit of confusion in the market. We would appreciate some comments on the European macro trend. Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Thanks, Dan. As you can appreciate, I keep a close eye on the German market very specifically, and I think there's a lot of confusion and we're not seeing that. Consumer spending remains pretty steady in Germany and generally in Europe. Sachin talked a little bit about one U.K.", "might have a little bit of moderation here and there, but overall we're not seeing that. So what we see on the other hand, as is strong growth for us in Europe on all the migrations, on our debit maestro migrations and so forth. So Europe's been a bright star, continues to be for us. So we don't quite relate to what others are reporting." ] }, { "name": "Dan Dolev", "speech": [ "Thank you. I appreciate it." ] }, { "name": "Operator", "speech": [ "We'll go next to Darrin Peller at Wolfe Research" ] }, { "name": "Darrin Peller", "speech": [ "Thanks, guys. I just wanted to follow up a little bit more on the incentives and rebates. But first, just, Michael, the number of portfolios that you guys are winning on the different parts of the world, really, but just talk a little bit about the competitive landscape, whether it's Unicredit or now Citizens and how that dovetails into incentives and rebates because the growth, I mean, you're about five, 600 basis points faster than gross revenues you're seeing on it. Maybe that part's a more first action.", "And it offsets some of the exciting opportunities we're seeing on gross revenue growth kind of in a few quarters in a row now. And so I just want to get a better sense of what you're seeing in terms of, anything structural on rebates, incentives that may be a bit different and tied to winning business, or is it just more business as usual and not necessarily a competitive landscape? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Let me start off here. So I want to reiterate what Sachin said before. We are trying to win portfolios that are important for market relevance perspective for us to gain access to transactions to drive our services model and, follow through on that virtuous circle that I talked about earlier in my remarks. So that's the whole idea.", "We keep net revenue yield in mind as we do all of this. That is the integrated payments competitive landscape. Payments is competitive. There's a lot of players out on the landscape.", "we like competition and we feel we have a truly unique proposition between our payments and digital solutions on one hand and our services on the other hand. So when you think about Unicredit, so why did they come to us? Well, they were looking at our proven track record in our engagement with Unicredit for the expanded relationships and supporting their customers. They like our sustainability agenda. On Citizens, it was a similar kind of mix and on Webster, yet again, it was a similar kind of mix.", "There's always something across the portfolio of services that sticks out. Citizens, I recall a conversation on open banking, for example. That is clearly one that mattered and the sustainability agenda yet again. So it's a mix.", "There is nothing particularly new here. We always weigh off the volume growth that we can see with the incentives that we give to make this whole equation work for us in a very disciplined manner. We do not want to win. So we're very disciplined about that and I don't see anything out of the ordinary here, but I want to hand over to Sachin to give us a little more color on that." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So, Darren, I think Michael covered kind of the competitive landscape. I think your specific question around the divergence, not divergence, but the fact that gross revenue is growing at a faster clip and the incentives are actually impacting the growth on the net revenue side. The reality is in the growth business, the growth portfolio is up front.", "Going back to the earlier question which was asked, when you're doing a combination of fixed and variable incentives, fixed incentives start to amortize the moment a deal goes live. That doesn't mean the volumes come on at full speed when the deal goes live. Because like we talk, we talk about conversions happening over multiple years. If a conversion happens right away, you get the volume right away and you start to see the associated impact from a revenue standpoint.", "So there is this lag which exists between when we're recognizing the impact of those incentives and when we would expect at full ramp the volumes to come on as we win deals. But that's more of a technicality as in how the math around that works. I think the bottom line still remains which is we would rather be in the payment flow on a disciplined basis to be able to drive higher net revenue yield for our company than not be in the flow. Because you're not in the flow, you're not getting the benefit of PCE, you're not getting the benefit of cash, which are moving from cash to electronic forms of payment, and you're certainly not getting the ability to deliver certain levels of services which we got out there.", "So that's kind of the broad philosophy from a competitive standpoint that we've chosen to take here." ] }, { "name": "Darrin Peller", "speech": [ "All right. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Next, we'll move to Ashwin Shirvaikar at Citi." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Hey. Thanks. So I want to talk about a by-Bank. It's live with JPMorgan.", "I mean, Verizon is piloting. Can you speak to the momentum you're seeing in the product? And given that it uses traditional ACH banking rails, could you maybe more broadly speak to the economic model for this and similar products that maybe tend to not use Mastercard rails?" ] }, { "name": "Michael Miebach", "speech": [ "Right. So this is a combination of bill pay, of open banking. This is for us sitting in the new flow space. Very specifically, what we are addressing is trying to bring value to ACH flows.", "These are, somebody paying a doctor or things like that. And how do we add value to this is by plugging onto a flow that would take place and might not happen because of insufficient funds on an account. We're putting in our open banking connection to make it clear is there a balance on the account. It's called the payment success indicator.", "That is the product. And it is a per-click fee related to the API call. So that is the model. That is bringing value to a part of the payments industry where there wasn't a particular problem to be solved and not anybody willing to pay for it.", "I think we're starting to find these corners where there is real value that we can bring. So for us, this is TAM expansion. This is new flows. And as I said, we're bringing our unique combination of services together.", "We are in real-time payments and we are in digital identity and we're in open banking. All of this is needed here to make the solution work. And this is why a player like JPMorgan comes to us to do this for us. And Verizon, to the point about momentum, will now be piloting it.", "So it would be a little early to talk about momentum. But we'll come back on that as that solution is then rolled out into the market. But it is now live. And that was an important point for us, because it had to be built and put together and we have done that." ] }, { "name": "Operator", "speech": [ "We'll go next to Jeff Cantwell at Seaport Research." ] }, { "name": "Jeff Cantwell", "speech": [ "Hey. Thanks. I wanted to ask about your business update in October specifically. We can see in the U.S.", "switched volume growth is 5%. So that's 200 bps slower versus the 7% you did this quarter. But can you talk a little more about how you see the holiday season developing this year? Because we've seen some estimates that consumer spend could increase by 5% versus last year, which sounds pretty good all things considered. You highlighted resilience and consumer spend this quarter.", "So I just wanted to take your temperature on how the entire quarter might develop, specifically in the U.S. Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Hey, Jeff. So on the U.S. specifically, what you're seeing in the day 21 numbers is, like I said in my prepared remarks, it's primarily related to the timing of Social Security payments between this year and last year. So that's really what you're seeing in the nature of that 7% growth in Q3, which now shows that 5% in the first three weeks of October.", "So this really, from an underlying standpoint, other than that, there's not much we're seeing in the nature of a trend shift in the U.S. in the first three weeks of October. On your question about how we see Q4 shaping up, it's actually very much in line with what I shared, which is basically a scenario continues to be one of where the consumer remains resilient. I mean, the reality is, unemployment levels are at all-time record lows.", "When people have jobs, they hopefully are getting their paychecks, which they're hopefully using toward meeting their spending needs. You also saw GDP came out this morning and it came out pretty strong. So I kind of generally think about this as saying our base case scenario around consumer strength and resilience is what we're assuming going into Q4." ] }, { "name": "Jeff Cantwell", "speech": [ "OK. Thanks very much." ] }, { "name": "Sachin Mehra", "speech": [ "Sure" ] }, { "name": "Operator", "speech": [ "We'll go next to Ramsey El-Assal at Barclays." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi. Thanks for taking my question. I wanted to follow up on Dan Dola's question earlier and I'm wondering about the sort of dislocation between your valuation and the marketplace and the valuation of your distribution channels, the acquirers, and banks that sort of flow transactions to you. Can you give us your updated thoughts on the overall health and TAM penetration of this core kind of value chain? When you look at the heritage distribution channels on both sides, are you seeing upheaval or are you seeing stability? In other words, are the market kind of getting the same benefits as the other?" ] }, { "name": "Michael Miebach", "speech": [ "All right. Hey, Ramsey, let me start off on that. So if you look at how our distribution has evolved over the years, the whole theme of diversification across products and segments also applies here. So we're doing a whole number of things.", "I talked about our work on acceptance. That is part of our distribution where contactless, tap on phone, things like that, a whole range of new merchant groups scaling these kind of technologies with partners like Stripe. Those are all going into areas that we haven't been in. Then you have other parts of our go to market.", "We talked about in B2B, we talked about Oracle and SAP. You go over into the world of acquirers. There's a whole range of acquirers, more traditional acquirers, which are our partners. So across the board, it's highly diversified, it's regionally highly diversified.", "So these blips here really talk about other people's business. But earlier on the question around what we're seeing in Europe, we're just not seeing it in our numbers because we have a highly diversified model. So whatever specific sector focus somebody has that is a partner of ours doesn't necessarily throw through for us. So I don't know if the market got it wrong or not.", "We're not the Oracle, but we make sure we partner with everybody to drive the overall digital ecosystem." ] }, { "name": "Ramsey El-Assal", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Next, we'll go to Bob Napoli at William Blair." ] }, { "name": "Bob Napoli", "speech": [ "Thank you. Good morning. I wanted to follow up on commentary around the open banking, banking as a service. And MasterCard also, you've done a great job of partnering with a lot of fintechs.", "We were just at Money 2020, and I would say this year there were a lot more regulators than I remember in the past. And talking about open banking and how active they are in reviewing all the partners in those relationships. So just any thoughts on your outlook for your open banking investments and then how you think about the regulation, the growing regulation around open banking or banking as a service?" ] }, { "name": "Michael Miebach", "speech": [ "Right. So we continue to believe in the whole notion of open banking and open data at large, where people and businesses use their own data to drive toward better services and better propositions for them. So the idea stands. And I think the idea gets hold and hold.", "If you look at Europe with, more regulation coming in, looking at PSD3 and so forth, you're looking at the CFPB here in the United States putting out some thoughts on how regulation could look like. For us, I put this in context of the idea is understood. How do you make it safer? What does that need? It needs trusted parties in the middle. We're in a world full of a bunch of bilateral relationships where people exchange data in a not so safe way.", "That would be a bad world. That's what regulators want to prohibit. We're coming in and saying we could be one of those parties that really bring the idea to life for consumers. I can use my data for better financial services.", "So when I look at what the CFPB has put out, we largely support the idea. It aligns very well with our data responsibility principles that we put out. It's your data, the consumer. You benefit from it.", "You control it. It is our role as a company to keep it safe, and we're very good at that. So our interlocking circles stand for trust. For open banking to work, you need trust.", "I think that is where we're going. So we're engaging. In fact, we're oftentimes in the room when these things are being thought about. In Europe, we were very much part of the dialogue on how data privacy on this context will look like." ] }, { "name": "Operator", "speech": [ "And we'll take that last question from Jason Kupferberg at Bank of America." ] }, { "name": "Jason Kupferberg", "speech": [ "Hey, thanks, guys. I just wanted to flashback to the analyst day two years ago. I know you had shared a three-year guide at the time for revenue CAGR of high teens through 2024, and it looks like you'll basically be right there through the first two years of that forecast period. So I just wanted to take your temperature on that three-year outlook and give you a rearview mirror." ] }, { "name": "Michael Miebach", "speech": [ "Yeah, Jason. So, look, we're not updating anything on the three-year outlook at this point in time. It's like you said, the first year actually turned out to be a very nice year. Again, in the second year, we've delivered quite strongly year to date, and then we've shared with you what we think will happen from an expectation standpoint in Q4.", "The one thing I just want to kind of orient everybody to is that we're in a very, very volatile time, and the world has actually changed quite meaningfully since then, which is what I'm alluding to here is the invasion of Ukraine by Russia and our suspension of activities in Russia. So that's something to keep in mind. We certainly keep it in mind as part of the fact that what we were assuming at that point in time in period Russia right now, obviously we don't have revenues related to Russia, which are coming through. But beyond that, I have nothing really to share in terms of updated thoughts around our three-year outlook." ] }, { "name": "Devin Corr", "speech": [ "So thank you for the questions today. Thank you for the trust in MasterCard. I always thank our people. And this is yet again the moment to do this.", "Times are not that easy for everybody, and they're leaning in, and they're leaning in for our customers. So thank you to everybody at MasterCard who is on the call, and thank you to all of you who listened in and asked questions. Speak to you one quarter from now. Thank you.", "Bye-bye." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2019-01-31	[ { "description": "-Head of Investor Relations -- Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "-President and Chief Executive Officer -- President and Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": " --Chief Financial Officer -- Chief Financial Officer", "name": "Martina Hund-Mejean", "position": "Executive" }, { "description": "-Autonomous Research -- Analyst -- Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" }, { "description": "-Credit Suisse -- Analyst -- Credit Suisse -- Analyst", "name": "Moshe Orenbuch", "position": "Analyst" }, { "description": "Assal --Barclays Investment Bank -- Analyst -- Barclays Investment Bank -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "Tsin Huang --J.P. Morgan -- Analyst -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "-MoffettNathanson, LLC -- Analyst -- MoffettNathanson, LLC -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "-Susquehanna International Group, LLP -- Analyst -- Susquehanna International Group, LLP -- Analyst", "name": "Jamie Friedman", "position": "Analyst" }, { "description": "-UBS -- Analyst -- UBS -- Analyst", "name": "Eric Wasserstrom", "position": "Analyst" }, { "description": "-Wolfe Research -- Analyst -- Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "-Goldman Sachs -- Analyst -- Goldman Sachs -- Analyst", "name": "Jim Schneider", "position": "Analyst" }, { "description": "-Bernstein -- Analyst -- Bernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mastercard Q4 full-year 2018 earnings conference call. [Operator instructions] Warren Kneeshaw, head of investor relations, you may begin your conference." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Heidi. Good morning, everyone, and thank you for joining us for our fourth-quarter 2018 earnings call. With me today are Ajay Banga, our president and chief executive officer; and Martina Hund-Mejean, our chief financial officer. Following comments from Ajay and Martina, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a currency-neutral basis and exclude special items, unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to their GAAP equivalents. Please note that due to our decision to deconsolidate our Venezuelan entity starting at the beginning of 2018, we have been providing additional information regarding our switched transaction and card growth rates. The adjusted growth rates eliminate Venezuelan switched transactions and card counts from prior periods. In addition, starting this quarter, we are providing further adjusted growth rates for switched transactions and adjusted growth rates for cross-border volume to normalize for the effects of differing switching days between periods.", "These adjustments have been made to current and prior quarters. This information is being provided, so that you can better understand the underlying growth rates of our operating metrics. Our comments on the call today will be on the basis of these adjusted growth rates. A couple of other comments.", "As many of you are aware, we recently announced an agreement on the terms of a recommended offer to buy Earthport. We will not be at liberty to further comment on this potential transaction as it is regulated by the takeover panel in the U.K. I'd also like to announce that we are planning to hold our next investment community meeting on September 12, 2019. We initially planned to hold this event in Q2 but has settled on a September date as a result of some scheduling issues.", "Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days.", "With that, I'll now turn the call over to our president and chief executive officer, Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thank you, Warren, and good morning, everybody. So we had a very strong end to the year, bringing 2018 to a record close. For the year, revenue was up 20%; EPS, up 41%, and these are both on a currency-neutral basis and excluding special items. If you exclude the impact of accounting changes, acquisitions and the $100 million contribution to what we are now referring to as the Mastercard Impact Fund that affect year-over-year growth comparisons, so basically, apples to apples, on an underlying net revenue growth, was up 15%, and operating income was up 21%.", "These results essentially reflect broad-based growth across each of our regions and I think are a clear reflection of our focus on execution. We continue to invest in the business for the long term and believe that we are very well-positioned to drive strong growth in the future, and Martina will discuss this in much more detail when she lays out our new multiyear performance objectives. Turning to the macroeconomic environment. We continue to see solid overall growth and expect this to continue in 2019, although, with some moderation.", "Having said this, like others, we're keeping a close eye on a number of items: increased trade tensions, rising interest rates and other economic and political factors that could slow growth over the longer term. In the U.S., economic growth remains positive with low unemployment and overall still healthy consumer confidence. Our spending cost estimates for Q4 show retail sales remained strong, up 4.8% versus a year ago, same period, ex-auto, ex-gas. In Europe, we continue to see moderate growth, with U.K.", "spending holding up really, really well, again, according to spending cost estimates with year-over-year retail sales up 3.5% in Q4, ex-auto, gas and restaurants, despite the debate around Brexit. We have, however, seen some recent declines in consumer confidence in countries such as France, Spain and The Netherlands. In Latin America, we're watching to see how the economic and fiscal policies develop in both Brazil and Mexico, now that the elections are behind us. We are seeing some positive consumer and business confidence indicators in Brazil, in particular.", "We're monitoring a few potential headwinds in Asia, including trade negotiations and the talked about slowdown in the Chinese economy. As we don't participate domestically in China, this has a limited impact to us directly. But given the size of the Chinese economy, it does impact the global economic picture. So against this backdrop, we just continue to see a strong secular shift through electronic forms of payment, and we are driving healthy, double-digit volume and transaction growth for Mastercard across most of our markets.", "And as I said earlier, these results are a function of us successfully executing against our strategy. We are growing our core products and diversifying our customer base, and we are building out new capabilities. And I'm just going to give you a few examples. First, we are driving growth in the core with new wins like Westpac Bank, one of the largest banks in Australia.", "They will become an exclusive Mastercard issuer for all their Westpac-branded consumer credit and business card portfolios, and we retain exclusivity across their debit business. Westpac will also leverage several of our value-added services, such as Advisors and loyalty platforms. In addition, we renewed our agreement in New Zealand, securing the majority of Westpac's credit and debit portfolios and flipping their loyalty platform. We've also executed three renewals with leading banks across several markets.", "So we signed a long-term deal with Credit Agricole, the largest bank in France, which includes new consumer and commercial issuance beyond our existing base. And as part of that deal, they will also use the range of our data analytics platforms, including Applied Predictive Technologies, APT, to help optimize their customer acquisition and retention efforts. In The Netherlands, we renewed our partnership with Rabobank, enabling us to maintain a leading market share position in credit and debit in that country. And in China, we will be the exclusive international scheme partner for ICBC's global travel plus card.", "On the co-brand front, we signed a long-term extension with WestJet in Canada; won a new co-brand program at Square, which will enable Square sellers to access their receivables through a Mastercard debit card. We were selected as the partner for JetBlue programs across 19 Caribbean markets, which, together with our U.S. co-brand, make us the partner on each of JetBlue's co-brands around the world. I'm also pleased to report that our major U.S.", "co-brand conversions have been successfully launched. L.L.Bean and Kroger are fully converted. And Cabela's, which are all contactless card, by the way, is scheduled to be completed by the end of this quarter. In addition, to building co-brand relationships with merchants, we're also diversifying our customer base through partnerships with governments.", "One recent example is in Mexico with BANSEFI, the commercial banking arm of the Mexican government, where we have just been chosen to help distribute a wide range of social benefit disbursements to citizens across the country. This exclusive program will involve the issuance of approximately 20 million new debit cards that will be used to receive and spend social benefit payments. So turning to B2B, we continue to see momentum in our core commercial card business. We're developing a new fleet co-brand product with U.S.", "Bank that enables greater customer choice by combining U.S. Bank's proprietary closed-loop fleet product with our broad, open-loop acceptance footprint. We're also making progress in the accounts payable space, taking the Mastercard B2B Hub model international through a new partnership, which I think is very exciting, with MYOB in Australia and New Zealand. MYOB provides an invoice-capture facility, supplier-enablement payments and payroll solutions for small- and big-sized businesses and brings the local market expertise and customer relationships that are critical to success for these kinds of businesses in the B2B space.", "The initial launch will focus on invoice payments and payroll solutions distributed to MYOB's existing customers. In the U.S., we are expanding virtual card distribution through an exclusive partnership with Bill.com and Comdata. Now this partnership integrates our virtual cards within Bill.com's automated accounts payable solution, and that should enable us to reach their 60,000 customers who, by the way, currently make over $60 billion in annual payments. The addition of these virtual cards creates a safe, seamless and secure way for businesses to be paid and provides the data needed to help merchants easily match payments with receivables.", "On the digital front, we are driving the adoption of new capabilities to improve the customer experience and enhance safety and security across all transaction types and channels. So a few examples, in the U.S., contactless momentum continues to grow on both issuing and acceptance sides. We have received commitments from issuers representing approximately two-thirds of our total U.S. consumer volume to issue contactless cards within the next two years.", "Now this includes Citi, Capital One, KeyBank, Santander, HSBC and others. We're also working with leading processors like FIS to bring contactless to smaller issuers and to credit unions. On the acceptance side, large retailers like Target and CVS have announced that they will now accept contactless payments. And in total today, over half of the U.S.", "card-present transactions are happening at contactless-enabled merchant locations. And we continue to scale our merchant tokenization service with partners who have recurring bill pay models, including large telcos like AT&T and insurance companies such as Liberty Mutual. And we are supporting merchants and acquirers via our Payment Gateway Services, which provides a white-labeled technology platform for payment processing for fraud prevention and for digital payment acceptance. And JPMorgan Chase has selected Mastercard Gateway Services to enhance its global connectivity and support of alternative payments, as they continue to expand global digital payment solutions for their merchants.", "And finally, we are partnering with digital players who offer payment capabilities through new devices and channels. And for instance, in Poland, we just recently announced the strategic alliance with Blik, a mobile payment system provider, and this integrates a virtual tokenized Mastercard debit card, so Blik users can make contactless payments at any Mastercard acceptance location. In South Africa, Bank Zero, which is a new bank with no physical branches and has app-only value prop, will be issuing debit Mastercard in 2019. And in Taiwan, E.", "Sun Bank will launch a Mastercard co-brand with Pi Wallet, which is a leading mobile wallet provider in that country. So with all of those updates, let me now turn the call over to Martina for an update on our financial results, operational metrics and going forward estimations of growth. Martina?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Thanks, Ajay, and good morning, everyone. Turning to Page 3. You will see that we delivered another very strong quarter to end the year. Here are a few highlights on a currency-neutral basis, excluding special items related to certain legal and tax matters.", "Net revenue grew 17%, in line with our expectations and closing out a great year of growth. This includes a five ppt benefit of the new revenue recognition rules. Excluding this benefit, revenue growth was 12%. Operating income grew by 21%, including a seven ppt benefit due to the new revenue recognition rules.", "Net income was up 36%, reflecting strong operating results and the impact of the U.S. tax reform, which contributed approximately 1two ppt to this net income growth. And EPS was $1.55, up by 40% year over year, with share repurchases contributing $0.03 per share. During the quarter, we repurchased about $888 million worth of stock and an additional $773 million through January 30, 2019.", "Let me turn to Page 4 where you can see the operational metrics for the fourth quarter. Worldwide gross dollar volume, or GDV, growth was 14% on a local currency basis, up one ppt from last quarter. We saw solid double-digit growth across all regions. U.S.", "GDV grew 10%, up approximately one ppt from last quarter, with strength in consumer credit driven by the implementation of recent deal wins. And outside of the U.S., volume growth was 16%, slightly up from last quarter. Cross-border volume grew at 17% on a local currency basis, in line with expectations and driven by double-digit growth in all regions, except for Latin America. Q4 cross-border growth was slightly lower than the growth you saw in Q3, primarily due to the high volume of cryptocurrency wallet funding in Q4 of 2017.", "Turning to Page 5. Switched transactions continued to show strong growth at 17% globally. We saw healthy growth in switched transactions across all regions led by Europe and the U.S. In addition, global cards growth was 7%, and globally, there are 2.5 billion Mastercard and Maestro-branded cards issued.", "So now let's turn to Page 6 for highlights on a few of the revenue line items, again, described on a currency-neutral basis, unless otherwise noted. The 17% net revenue increase was primarily driven by strong volume and transaction growth as well as growth in our services offerings, partially offset by rebates and incentives. The new revenue recognition rules contributed five ppt to the growth rate. As I said before, excluding this, net revenue growth was 12%.", "Looking quickly at the individual revenue line items. So domestic assessments grew 18%, while worldwide GDV grew 14%. And the difference is mainly due to the new revenue recognition rules with some pricing offset by mix. Cross-border volume fees grew 16%, while cross-border volume grew 17%.", "The one ppt difference is mainly due to higher intra-Europe growth. Transaction processing fees grew 17%, in line with the 17% growth that we saw in switched transactions. And finally, other revenues were particularly strong this quarter, up 19%, driven by increases in our Advisors and safety and security services. Moving on to Page 7.", "You can see that on a currency-neutral basis and excluding special items, total operating expenses increased 14%, which includes a two ppt increase related to the new revenue recognition rules and acquisitions. The remaining 12% was primarily related to the company's continued investments and strategic initiatives. So turning to Slide 8, let me first discuss what we have seen through the first four weeks of January. The numbers through January 28 are as follows: starting with switched volume, we saw global growth of 15%, similar to the fourth quarter.", "In the U.S., our switched volume grew 12%, a sequential increase of one ppt with strength in both credit and debit. Switched volume outside the U.S. grew 17%, and that's down two ppt from the fourth quarter, was still strong at slightly slower growth in Europe. And globally, switched transaction growth was 17%, similar to the fourth quarter.", "With respect to cross-border, our volumes grew 12% globally, down five ppt sequentially. So let me put this 12% in perspective. In 2019, we will face difficult year-over-year comps due to the strong cross-border growth we saw in 2018. This is especially true for January as we are lapping significant cryptocurrency wallet funding and particularly strong European activity, in part due to timing of certain holidays a year ago.", "This has been further impacted by some poor weather conditions in Europe this year. For the year, we expect cross-border growth will be about mid-teens, and this is contemplated in our thoughts for revenue growth for the year. So now I'm going to switch gears a little bit and talk about our long-term performance objectives, and we will start here on Slide 9, how we did against our 2016 to 2018 performance objectives, which were set out on a currency-neutral basis, excluding special items and acquisitions made during the period and were built off an earnings base that excluded certain onetime tax benefits recognized in 2015. So recall that we actually updated our estimates last February for the impact of the new revenue recognition rules and the U.S.", "tax reforms. So as you can see here on the slide, we delivered very strong results over this period. Net revenue grew at a CAGR of 15%, slightly ahead of our most recent estimate. We achieved our annual margin commitment and delivered 28% compound annual EPS growth over the period, which includes a three percentage point benefit due to U.S.", "tax reform. So now I'm turning to Slide 10 to lay out our new performance objectives, again, for a three-year period, so from 2019 to 2021. And as usual, all the numbers I'm going to give you will be on a currency-neutral basis, excluding future acquisitions and special items. So based on the excellent performance over the last few years, we believe that we are very well-positioned to continue to: one, grow our core consumer and commercial business through expanded solutions and market share growth, enhance our digital capabilities to enable more online and mobile transactions in a seamless and secure way and grow our overall acceptance footprint; two, advance our B2B capabilities with new solutions like the Mastercard B2B Hub and Mastercard Track.", "At the same time, we will continue to lay the groundwork for future growth and faster payments by investment in infrastructure, applications and value-added services; and finally, further expand our capabilities in services such as safety and security solutions, data analytics and loyalty, which, together, we expect to grow faster than the core business. As a result, we believe that we can deliver a low teens compound annual net revenue growth rate over the next three years. This is based on a PCE growth of approximately 4% to 5% globally and, therefore, does not assume a significant economic downturn. These objectives also exclude progress on our goal of entering the domestic payment market in China and reflect minimal net pricing over the period.", "In terms of our operating margin objective, we continue to focus on top and bottom line growth by investing for the long term. As you all know, we are not managing to a particular margin outcome. But for those of you who would like to see some assurance that we continue to be prudent with our investments and expenses, we're keeping the minimum 50% annual operating margin threshold as part of our long-term performance objectives. So consistent with the revenue profile I just described and based on the 2018 non-GAAP EPS number of $6.49, which excludes special charges, we expect a high teens earnings per share CAGR over the 2019 to 2021 period.", "This assumes a tax rate of 19% to 20% and includes the impact of continued share repurchases. So now let me give you a little bit more for our thoughts on 2019, and you can see that on Slide 11. Again, I will describe those on a currency-neutral basis and exclude special items and future acquisitions. We anticipate continued strong growth in our business in 2019 but have assumed a slight moderation in the overall economic environment from 2018.", "So for net revenue, we expect to grow at a low teens rate. In the first quarter, growth will be about two ppt lower than the annual estimate, primarily due to the difficult comps in the year ago quarter. You may recall that in Q1 last year, we had a relatively strong cross-border and services revenues and relatively low rebates and incentives. And as this normalizes through the year, as we implement business wins, we expect that the currency-neutral net revenue growth rate will increase in the balance of the year.", "Foreign exchange is expected to be about a two ppt headwind to annual growth. And given the current strength in the U.S. dollar, this will be a much larger headwind in the first quarter at about five ppt due to the profile of the year ago exchange rates. On operating expenses, we expect growth for the year at the high end of the high single-digit range, as we continue to invest in expanding our digital solutions, safety and security products, data analytics, geographic expansion and platforms to address new payment flows.", "In the first quarter, we also intend to fund the Mastercard impact fund at a similar level to what we contributed last year in Q1. Based on current rate, we expect foreign exchange to have a one ppt tailwind to operating expenses for the year and a two ppt tailwind for the quarter. From a sensitivity standpoint, a $0.01 change in the value of the U.S. dollar relative to the euro is expected to have just under a $50 million annual impact to revenue, considering both transactional and translational effects.", "Similarly, the $0.01 change in the value of the U.S. dollar relative to the Brazilian real is expected to have an approximately $25 million annual impact to revenue. We estimate the tax rates to be approximately 19% to 20% for the year. So with that, let me turn the call back to Warren to begin our Q&A session.", "Warren?" ] } ]	[ { "name": "Warren Kneeshaw", "speech": [ "Thank you, Martina. Heidi, we're now ready for the question-and-answer session." ] }, { "name": "Operator", "speech": [ "Thank you. [Operator instructions] And your first question comes from the line of Craig Maurer with Autonomous Research. Please go ahead." ] }, { "name": "Craig Maurer", "speech": [ "Yes. Hi. Thanks. Two questions for you.", "First, versus what your main competitor said last night, your commentary on the global outlook seems far more sanguine. Is this a reflection of generally Mastercard's progress in taking share globally and how that's informing your view of the year? And secondly, to what degree should we expect progress in Vocalink this year and progress in real-time ACH payments across geographies? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "OK. I think the first part is a combination of two or three things. One of which is, yes, we have been growing share for the last few years, and that gives us some degree of a better leg to stand on. But remember, we've also been diversifying our revenues with more legs to the revenues tool, so to say, which include services.", "And as Martina told you, we expect services revenue to grow faster than our core payments revenue. And so they do have a sense in our business, of our numbers. I cannot compare those from what competitors feel. Remember, I'm talking about ours as the vision of our company, and I feel relatively good about those numbers.", "The part about the world economy as a whole, I mean, look, it's based on assessments of travel and knowledge and research and data. And my sense is that our worldwide economic situation is still in a relatively good place, even though we are reaching the 10th year of the global expansion. And will that change over the next year or two? Who knows? Will it change someday? For sure. Just I don't think that 2019 is a year in which you will see more than some moderation.", "That's our current assumption over 2018. That moderation is built into Martina's commentary about the way we think about our performance in 2019. So that's the way we have put our parts together. The part about Vocalink and about Fast ACH.", "We are -- my sense is, first of all, in the U.K., Vocalink's position and business and its relationships with all the contracts we have has received good support and extension. So that's a good thing. In markets outside software has been implemented in the U.S. and is rolling out.", "It's there in a number of markets, in Thailand and parts of the Nordics. We believe that tons of opportunity is coming along for infrastructure in a number of countries. Now once the RFP is won, it takes years to actually put those switches up on the ground. There's also opportunities to partner with domestic switches to improve their capabilities, some of which you will see us talk about over the next six to nine months.", "But you should remember that to me, faster payments is not a strength, like digital payments and acceptance. These are marathons, and we are willing to play the marathon." ] }, { "name": "Craig Maurer", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Moshe Orenbuch with Crédit Suisse. Please go ahed." ] }, { "name": "Moshe Orenbuch", "speech": [ "Great. Thanks. Maybe we could kind of talk about the outlook in the U.S. I mean, you alluded to some wins, and I think Cabela's was certainly one of them.", "Are there others that we would see during 2019 that are going to be converted? And how do you think about the underlying situation? Is there likely an impact from what's going on with tax refunds in terms of either amounts or timing of consumer spending?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "We don't really see a very significant change in terms of what we see in our numbers from the U.S. When you look at the GDV growth in the United States, in fact, we had a little bit of a higher GDV growth versus Q3 that is predominantly driven because of the conversions and the wins that we had. We continue to see some of that for the rest of 2019. And even when you slit -- when you split that out, we believe that the U.S.", "is actually still performing relatively well. We also see, actually, while it has been good, cross-border trends from people traveling from the U.S. to other countries, we saw a very, very small decline from other countries traveling into the U.S. given the stronger U.S.", "dollar, but it was a relatively small decline from growth rate. So it's still growing, but it was just a little bit of a smaller growth rate. So we feel relatively good. As you heard what I said in my prepared remarks as well as what Ajay reinforced, 2019, in our numbers, we put a little bit of a moderation from a personal consumption expenditure in there.", "Personal kind of assumption expenditure worldwide last year was a little over 5%, like 5.3%, 5.4%. And you can see that we've put a little bit of a lower number for our 2019 numbers also for our three-year long-term performance outlook in there because, at some point in time, you do have to expect a bit of a downturn." ] }, { "name": "Moshe Orenbuch", "speech": [ "Thanks very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Ramsey El-Assal with Barclays. Please go ahead." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi, thanks for taking my question, guys. You mentioned in guidance that your three-year CAGR does not -- includes minimal pricing. I guess, just very generally speaking, how would you characterize your ability to take price versus the last three-year cycle or even prior to that?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "So Ramsey, we really have not made any significant changes on the philosophy of how we do pricing. Pricing is value added. The customer has to feel that they would like to have that product and that service, and that, that product and that service brings value add to the company, to the customer. And therefore, we are getting compensated for it.", "And we really have not changed that in any shape or form. And as part of that, of course, from time to time, we are able to make some price adjustments. But believe me, these are not only up-price adjustments. Some are also actually down-price adjustments.", "And that's what we do from list price point of view. We do it in many countries around the world. Some is regional pricing. In addition to that, you have to factor in, of course, deal pricing.", "And this is a competitive situation. As you know, it gets more and more competitive as you're talking about larger clients. Larger clients are more demanding than some various smaller clients. And so you have to be responsive to that.", "And so our comment about minimal pricing includes, really, both of those components, list price and the changes that we make from time to time as well as deal pricing." ] }, { "name": "Ramsey El-Assal", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "And your next question comes from the line of Tien-Tsin Huang with JPMorgan. Please go ahead." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hi, thanks. Good morning. I just want to expand on Craig and Ramsey's question. And I'm looking at the next three years versus the past three years.", "I'm curious if you see a difference in the way that growth is actually coming from. Does it -- it feels like you have more contribution from fintechs than the net new logo wins. Is that fair? And does your cycle guidance include any meaningful contribution from the new payment flows that you've been investing a bunch in?" ] }, { "name": "Ajay Banga", "speech": [ "Yes, Tien-Tsin, it includes all those. I'd say, as Martina has said, clearly, we expect our diversified revenues from services, from the new businesses to give us a higher growth rate than what we will get from our core payments over the coming three years. And that's what you would expect, considering they're growing off: one, a smaller base; and two, we are really getting into our stride with some of those, which we've been investing in, for three, four, five years. There are others where the investment is one and two years old, and those probably will only show results, hopefully, maybe toward the latter part of this next three-year cycle or maybe even in the next three-year cycle, after that.", "And that's kind of the marathon comment that I was making in response to Craig. So it's a mix of stuff where you should expect us to continue to grow our services revenue at a faster rate than our core payments revenue. Within our core payments, clearly, you see growth and secular movement to electronic forms, of course, helps, and share wins help, and a broader and expanded platform of products helps. So does acceptance and so does digitization.", "So it's a mix of things that are built into growing the core, diversifying our client base. But remember that building new services will give us more than the other two growth rates over the next three years." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Yes. And just to add to that, on the B2B side, of course, that is also adding something to the bottom line, and that's where we're looking at it in two different parts: one, our commercial business that we have today, which is really our core commercial business, which is more card-based, that is continuing to grow. Actually, we are seeing very good growth rates in that. But in addition to that, all the B2B verticals that we are building out both from a domestic and from a cross-border point of view, such as the B2B Hub, such as Mastercard Track.", "And again, as Ajay said, we think that by the end of the period, you are going to see some added numbers because of that." ] }, { "name": "Ajay Banga", "speech": [ "That's why I was -- Tien-Tsin, I was talking about being excited about the MYOB business in Australia. I was just in Australia last week, and it's a really interesting effort to take the B2B Hub outside of the U.S. So that's early days. That's one of those that we're in the early stage of investing." ] }, { "name": "Tien-Tsin Huang", "speech": [ "That's great. Thanks for that. Good results, and thanks for the FX sensitivity, Martina, as well. Appreciate it." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Lisa Ellis with MoffettNathanson. Please go ahead." ] }, { "name": "Lisa Ellis", "speech": [ "My question is related to the longer-term trends around cross-border. I was just looking back, and I mean, back in, I guess, fiscal '16, your overall cross-border volume growth on an FX-neutral basis was around 12%, more or less in line with purchase volumes. But then it upticked in '17 to about 15%, upticked again in '18 to more like 18%. And I know you said it's going to moderate a little bit but still be strong in '19.", "Can you just -- putting aside the sort of quarterly gyrations, can you just talk about that evolution over multiyear period? Like what's driving that sustained outperformance? I think Martina, you've mentioned before that you've kind of got an internal team focused on it. Can you just give a little bit more color there to give us a sense for where that's headed over the longer term?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Yes. I mean, we really have a multifaceted effort, really kind of like they're running this like a business in terms of what we're doing from a cross-border focused point of view. And you're seeing the fruits of the labor really coming through, even though, I have to tell you, 2019 where we have a 19% cross-border growth, as we had said before, that was extraordinary, and you shouldn't expect that to repeat itself every year..." ] }, { "name": "Ajay Banga", "speech": [ "In 2018." ] }, { "name": "Martina Hund-Mejean", "speech": [ "In 2018. So in..." ] }, { "name": "Ajay Banga", "speech": [ "Yes. We are already in '19 mentally, but we are still talking '18." ] }, { "name": "Martina Hund-Mejean", "speech": [ "So 2019, yes, that's why I guided you guys more to around a mid-teens rate. So all of the work that we have been doing, obviously, it all starts on what kind of portfolios you are going after, right, what kind of clients are you working with, what kind of portfolios are you getting from the clients. But then, secondly, once you have the portfolios, you have to do very particular things in order to get cross-border growth going in terms of how people are using that particular product, how you make sure that people know that this is a fantastic product to use, that if you do certain things, you actually get the best foreign exchange rates, which Mastercard can give. So there are many, many different facets, which allow us to work.", "And by the way, this comes out of our Advisors group in a very big way with a client in terms of optimizing those kind of portfolios. And we have a very honed skill in order to be able to do that. In addition to that, when you look at the various verticals -- so what I talk mostly about right now is the consumer and the commercial portfolios where travel effect to using the cards was being used in the e-commerce space. As you know, we have also focused, for many years now, really, on the virtual card product that is being used by a number of our clients also in the sense of a cross-border transaction.", "And that has made a fairly significant difference over those years." ] }, { "name": "Ajay Banga", "speech": [ "Lisa, the only thing I'd add to you is putting an envelope around this and start with the thinking of cross-border both determined by the level of travel and tourism on the one hand at a consumer level, combined with corporate travel and commercial travel at a commercial level, combined with cross-border e-commerce. When you look at all three together, you get what the market is growing at in a secular way. How much you extract from that secular growth is the effort that our team tries to put in using analytics and data and targeted offers, the types that Martina is referring to. And then the third part of it is if you have the right portfolios, you can get a little bit more out of it.", "And I think we've got a little bit of all of those working some as tailwinds, some as headwinds. I'm pretty certain that most people and most companies in this space will try and do things off the type we are talking about. This is not rocket science. It's a question of disciplined execution." ] }, { "name": "Operator", "speech": [ "And your next question comes from the line of James Friedman with Susquehanna." ] }, { "name": "Jamie Friedman", "speech": [ "It's Jamie. I just want to ask, with regard to the cycle guidance, I realized that services is contemplated to grow in excess of the corporate average. Is commercial a bit large, including B2B, is that also contemplated to grow faster than corporate average?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Jamie, we're really not providing any individual guidance on this. So most of the commercial portfolio is part of the core. And as you just heard us say, the new stuff in B2B, we are building out as we speak. So that's the B2B Hub, that is Mastercard Track and a number of things that we're doing on the cross-border space." ] }, { "name": "Operator", "speech": [ "And your next question comes from the line of Eric Wasserstrom with UBS." ] }, { "name": "Eric Wasserstrom", "speech": [ "Two questions, please. The first, Martina, just on the -- going back to the three-year performance objectives, just intuitively, the delta between the low teens on revenue and the high teens on EPS, if we extrapolate the current level of share repurchases still implies something around 100 basis points of annual operating margin improvement. So can you just maybe touch on that issue?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "So listen, as I said in my prepared remarks, we only do not run the company by just expanding operating margin. We run the copy for top-line growth and bottom-line growth. And depending on how you put it together, and you just said it, you can do math, I can do math. By itself, it might imply an expansion in the operating margin, but I don't want you to take this to the bank because investments will continue to be made in a number of areas in order to continue to have the top line grow for many, many years to come.", "So we have that flexibility to be able to do that." ] }, { "name": "Ajay Banga", "speech": [ "Just in terms of management philosophy, this is very important. We do not measure ourselves by expansion of operating margin. We do not. If you were to do that, you would think that we would be in an industry of a very mature type where expansion of margin is what I should be holding up as my management objective.", "So I feel we're in a growth industry with enormous opportunity that I've been saying for the last decade, for the next decade. In that industry, having the management disciplined to focus on expanding the franchise but doing it in a profitable way is the way we present our goals. So the idea of sticking to a minimum operating margin -- and just for you all, every investor during that time do realize that we are not throwing the company out of the water. We are really working it hard and working every line of the P&L, but also to be partners to the way in which we operate every day and every minute of the day, which is grow the franchise and do it profitably as compared to find ways to expand the operating margin as the only management objective.", "That's what we are trying to give you as a trading of the [indiscernible]. Given to myself, I would even have dropped the idea of talking about the 50% operating margin because we are [indiscernible] already. I'm just doing it to reassure you that we are sensible and disciplined of managing profitable." ] }, { "name": "Eric Wasserstrom", "speech": [ "Got it. OK. That's very clear. And then, Ajay, if I could just follow up on one strategic initiative, the expansion of the B2B Hub into Australia.", "Is that targeting a similar sort of middle-market corporate profile? And can you give us a sense of how you're defining the TAM opportunity?" ] }, { "name": "Ajay Banga", "speech": [ "Yes. No, it's targeting small and middle-market, not just middle-market. In fact, MYOB is one of the most interesting providers of local on the ground expertise in providing payments and supply enablement and reconciliation services through both small and middle-market corporate clients in Australia. And this partnership with them that has been a year in the making is actually very interesting for us because it is validation of the idea of the B2B Hub that originated in the United States has been possible in other market.", "And I want to take it to more markets as the next few years go by. That's the objective. But right now, in Australia, we're just focused on executing it well to get to the 60,000 customers that MYOB has. As I've said, we've got a fairly large volume of revenue and payment size going through them.", "It kind of gives you [ risk assessment ], supply enablement, payments capability, reconciliation of payments versus what's [ new in the build ]. It gives you all that capability through this relationship with MYOB." ] }, { "name": "Operator", "speech": [ "And your next question comes from the line of Darrin Peller with Wolfe Research." ] }, { "name": "Darrin Peller", "speech": [ "Quick question on e-com growth, when you think about -- I'm sorry, on overall cross-border growth. I mean, in terms of the deceleration, can you just quickly touch on the components? Was e-com holding up? Was the physical point-of-sale? And then what kind of contribution from Maestro? And also, just a high-level question, when you think about the backdrop of an uncertain macro, can we revisit your willingness and ability to manage expenses, if it were necessary? And how much are you able to -- could you see a low single-digit expense growth if the economy really turned? I'm just curious on your thoughts." ] }, { "name": "Martina Hund-Mejean", "speech": [ "OK. First of all, on cross-border. So let me give you a little bit more detail. 2018, Ajay said, was 19% for the whole year.", "The fourth quarter of 2018 was 17%. And in part was obviously because of the cryptocurrency that we had in the year ago quarter, and then there are a few ups and downs, quite frankly. Just to give you a little bit more detail on this one. So for instance, when you look at Brazil, when you look at Argentina, of course, with the devaluation of the currency, there was a bit of an impact on it.", "In Sweden, we had a deal lapping. In Canada, because of the stronger U.S. dollar, you have that a little bit going down. But that all was offset pretty much by a terrific performance in China and in Japan, and that's why you're not seeing a lot of variations in the Q4 numbers.", "And then when you go to January, 28 days, the 28-day number, down to the 12%, it -- pretty much all of these factors were the same factors other than the ones that are called out, which were on top of it, right? The year ago quarter had been particularly large. European cross-border in it, and part of it was because of how the French take vacation, by the way. And then this year, we were hit by the snowstorm that started in -- at the end of the first week of January..." ] }, { "name": "Ajay Banga", "speech": [ "I just want you to know, she's nothing to offend, but just to be clear. I don't want to start a political circumstance, but she has nothing to offend." ] }, { "name": "Martina Hund-Mejean", "speech": [ "So that is a little bit -- was it -- was a hit on that one. And we called out the cryptocurrency on that one already. So there is really nothing that serious going on, and that's why we have the confidence for the rest of the year. On e-com, you asked a particular question on that.", "Cross-border e-com, we saw the growth rate just going down a tad." ] }, { "name": "Ajay Banga", "speech": [ "To your question on expenses, I'm not going to tell you what number we could come to because I don't know until we are dealing with it again. We -- just as a fact, in the 9 and 10 -- 2009 and '10 period, you should know that if we see a sustained economic downturn, then it's when we'd like to take a look at some of the expenses. My desire to play with expenses only works in a sustained downturn. If it's a quarter here or a quarter there, I'd be loathed to stop investing in the right things, whether it's new product development or its service capability or it's even the investment in the brand.", "But we've got a number of levers in our expenses. Some of it have a shorter-term turnaround. Some of it have a longer-term impact. And you should -- if you go back and look at our behavior around expenses some years ago, we're very committed to be managing our way through it.", "As you can imagine, when we make budgets for the year, we go through upside and downside scenarios. And given all the chatter in the environment around 2019, we've been even more careful this year in our downside scenario and our thinking around." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Yes. And I think I certainly say it many times, we don't leave this up just to scenarios. We actually operationalize these scenarios. So if we ever see that something is happening in particular in the economic environment and we need to course correct from an expense point of view, all of our business units already know today what they would have to do, and it will take them very little time to revisit the plan and to execute the way that we should be executing for you guys." ] }, { "name": "Operator", "speech": [ "And your next question comes from the line of Jim Schneider with Goldman Sachs." ] }, { "name": "Jim Schneider", "speech": [ "I was wondering if you could maybe make just one question and one clarification. First of all, you talked about the various drivers of the longer-term outlook. But can you maybe quantify for us or dimensionalize the size of the B2B opportunities, especially for accounts payable and receivable? And how big that could potentially be toward the end of your forecast outlook period? And then maybe as a clarification, talk about exactly how much of a PCE slowdown you're expecting in 2019 relative to the broader longer outlook period." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Jim, it really sounds like we should be helping you with your modeling questions. So listen, I'm not going to give you a lot more on B2B. You're going to have to reflect back to what we talked about the overall B2B opportunity, which is $120 trillion opportunity, and what we said is that we are going after very particular slices of that B2B opportunity. So we're not going to run after all of the $120 trillion.", "And some of the things that we're already investing in like the B2B Hub, like Track, like what you're hearing from us from a cross-border point of view, actually attacking those kinds of opportunities. And of course, over the next three to five to seven years, we are going to expect that some of that will manifest itself in revenue growth. For your 2019 question, really, what we did is we put it in a moderate downturn. So it's something that we can digest within the thoughts that I gave you from a low teens revenue number for 2019." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Harshita Rawat with Bernstein." ] }, { "name": "Harshita Rawat", "speech": [ "I want to ask about emerging markets. Now emerging markets such as India are likely a decent portion of what you can see with your business addressable market. And on one hand, these markets are greenfield with a lot of growth opportunities. On the other hand, the competitive landscape is very different, and you also have some accelerating government expansion by Chinese giants.", "So in that context, can you talk about some of the steps you're taking to grow these markets and mitigate the risk of share losses and the risk of being disadvantaged by government nationalism?" ] }, { "name": "Ajay Banga", "speech": [ "The emerging markets are certainly attractive for the next decade or two. I would tell you that total revenue that they comprise today of our business, you would be surprised at how small they are in the totality. So I think you've got to just think through, like I said even in my remarks in China, we really don't play in the domestic market as of now. And so the impact on us directly is relatively small.", "India is an interesting market as well. It's growing well? But at the end of the day, the total impact to our revenue is still relatively small. That does not mean that a decade from now, they won't be more attractive markets. They're growing, and they're attractive.", "Their dynamics are different, as you said. We are trying to play on multiple levels. The first is we believe that our attitude toward of the emerging markets, be it Asia or Africa or Latin America or the Middle East, is that we are there because the governments want us there. And so we go there with respect to that government and its sovereignty, and we try and work with them in a way that shows that we bring value to their economy to convert from cash to an electronic payments, to get safer transactions with better data being used for safety and services of that type as well as to get simple, seamless experiences, expand acceptance, improve the tax net, those things that governments find to be useful, and also distribute services to the bottom of the pyramid, so financial inclusion.", "That's why you find us working so hard on expanding inclusive growth around the world. That's why we made that commitment of 500 million people to be reached by 2020. We're now at 360-plus million and counting. We just got 20 million more in Mexico that I've talked about.", "So you can see us approaching it, first, from a societal and government level with respect for what they need for their citizenry. We do request as far as possible that we get a level-playing field to be able to compete and bring the best of quality and the best of capability, so their local consumer can win. After that, if the government chooses to buy us a system in some way toward the local player versus another player, that's their decision. They're entitled to make a decision in their market, playing by their rules or whatever they're signed up for global engagement.", "That's up to that country. If their rules require them to open their market, they should. If their rules allow them to operate in a closed market, they should. It's their decision.", "That's the first part. Then the rest of it is the playable field for everyone else, best quality product, no differentiation on what's offered there versus the developed market, best quality of pricing, best capability of people being attached to it, global technology, global data, global safety and security standards, one technology release around the world. So if you exert something in one country that's available to every emerging market, trying doing that market by market, it's very expensive. That's what we are trying to do, just tackling it piece by piece, working on acceptance, right from various points.", "And look at India. Acceptance in India has grown to more than five million points from one million a couple of years ago, not just because of our efforts but also because of the government's efforts to make it happen. Or QR acceptance in India. So India still has a huge opportunity.", "That's 60 million merchants. We have reached five million. There's 55 million more to go. So my concern is this, and I'm going to shut up after this, on this topic about our share from within a small pie is electronic payments.", "My interest is more in growing the pie of electronic payments in the emerging markets. I think that opportunity is much more liberating and much more thoughtful than trying to argue about your share in a small pie." ] }, { "name": "Warren Kneeshaw", "speech": [ "We've come to the end of our allotted time. So Ajay, any final comments?" ] }, { "name": "Ajay Banga", "speech": [ "Sure. Thank you all for your questions. And a few closing thoughts. We had a very strong end to the year, bringing 2018 to a record close.", "We are executing against our strategy. We're growing our core products and diversifying our customer base, and we are building new capabilities in so many sectors and services. We continue to drive solid deal momentum. And I think Martina and I are very pleased to our plan and the company's new performance objective.", "We feel we have positioned ourselves well with our investments and our execution to drive continued strong growth in the future. So with that, thank you for your continuing support of all of us in the company, and thank you for joining us today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2018-07-26	[ { "description": "President and Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": "-- Chief Financial Officer", "name": "Martina Hund-Mejean", "position": "Executive" }, { "description": "Executive Vice President of Investor Relations", "name": "Warren Kneeshaw", "position": "Executive" }, { "description": "William Blair -- Analyst", "name": "Robert Napoli", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" }, { "description": "Wolfe Research -- -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "-- Keefe Bruyette and Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "Bernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Citigroup -- -- Analyst", "name": "Ashwin Shirvaikar", "position": "Analyst" }, { "description": "Goldman Sachs -- -- Analyst", "name": "Jim Schneider", "position": "Analyst" }, { "description": "SunTrust -- -- Analyst", "name": "Oscar Turner", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mastercard second quarter 2018 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, please press * and the number 1 on your telephone keypad. If you would like to withdraw your question, press the # key. Thank you.", "Mr. Warren Kneeshaw, head of Investor Relations, you may begin your conference, sir." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Krista. Good morning, everyone. Thank you for joining us for our second quarter 2018 earnings call. With me today are Ajay Banga, our President and Chief Executive Officer, and Martina Hund-Mejean, our Chief Financial Officer. Following comments from Ajay and Martina, the operator will announce your opportunity to get into queue for the Q&A session. It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data, and the slide deck that accompanies this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning.", "Our comments today regarding our financial results will be on a currency-neutral basis and exclude special items unless otherwise noted. Both the release and the slide deck include reconciliations of non-GAAP measures to their GAAP equivalents.", "Please note that due to our decision to deconsolidate our Venezuelan entity starting this year, we are providing additional information regarding our switched transaction and card growth rates. The adjusted growth rates eliminate Venezuelan switched transactions and card counts from prior periods so that you can better understand the underlying growth rates of our business. Our comments on the call today will be on the basis of these adjusted growth rates. These are the only supplemental operational metrics which are significantly impacted by the deconsolidation.", "Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days.", "With that, I will now turn the call over to our President and Chief Executive Officer, Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thank you, Warren. Good morning, everybody. Our strong performance continued this quarter with net revenue growth of 18% and EPS growth of 48% versus a year ago on a currency neutral basis and excluding special items. Even if you exclude the impacts of the accounting changes and the acquisitions that affect year-over-year growth comparisons, our underlying net revenue growth was 14% and operating income was up 26%. These results were achieved while investing for the future and reflect solid underlying business fundamentals and the continued execution of our strategy by all our employees around the world.", "Let's start with the macro-economic environment as usual. We continue for now to see solid overall growth. However, we are keeping close tabs on the potential impacts of reduced fiscal stimulus by central banks and the increased trade barriers, which as you all know, could impact global economic growth over the longer term.", "In the U.S., economic growth remains positive with low unemployment and healthy consumer confidence. Retail sales are strong and our quarterly SpendingPulse estimates are up 4.7% versus a year ago, ex-auto ex-gas. As this does represent a slight decline sequentially, primarily due to the weather at the beginning of the second quarter and difficult comparisons over last year.", "Conditions in Europe are stable overall, although we do remain concerned about the potential impacts of Brexit. Consumer confidence in the U.K. has been declining and we have seen some deceleration in U.K. retail sales growth rates year-over-year, according to SpendingPulse data. In contrast, consumer confidence in the Nordics and Germany remain strong. In Latin America, there's still some question marks. In Mexico, although the elections are now behind us with a clear verdict, policy uncertainties remain. In addition, exchange rate volatility continues, primarily related to the NAFTA renegotiation. In Brazil, concern over the upcoming October elections has, I think, contributed to the deprecation of the real.", "We are monitoring a few potential headwinds in Asia, trade tensions, rising U.S. interest rates, and oil prices are weighing on sentiment in some countries, including China and Korea. In the Middle East and Africa, on the other hand, recovering oil prices are generating some optimism in oil-producing countries. So, overall, there are some geopolitical and trade-related risks that we are keeping a close on. But as of now, they've had limited impact to date, and global economic trends remain generally positive.", "Against that backdrop, we are driving healthy double-digit volume in transaction growth in Mastercard across most of our markets, with momentum across our core products and services. Let me give you a few examples, starting in the United States, where we continue to make excellent progress with core brands. By leveraging our differentiated data and analytics capabilities, we won the L.L. Bean consumer credit card brand and we also renewed our long-standing relationship with Hawaiian Air, for both consumer and business core brand cards.", "We expanded our portfolio of PayPal core brands with the new Venmo consumer direct card, which as you know, will enable Venmo users to cash out their balances and use those funds online or in store, wherever Mastercard is accepted.", "In addition, we are partnering with leaders in the healthcare industry such as Anthem, as they move their prepaid consumer spending accounts to Mastercard. And on the commercial side, we recently extended our agreement with J.P. Morgan Chase. We are very pleased to continue this strategic relationship with one of the largest banks in the market.", "Going to Europe and building on some of the significant wins we've been announcing over the last few quarters, we've continued to secure renewals and new business with customers. An example is Crédito Agrícola, where the team in Portugal will be flipping their consumer credit and debit business to Mastercard. Crédito Agrícola also leveraged our LaunchPad service, which enabled them to work closely with Mastercard teams and using design thinking, to rapidly develop a prototype for their new digital bank.", "On the topic of digital banks, we continue to drive digital payment solutions with Challenger Banks, including to an expanded consumer and commercial debit partnership with M26 in Germany. In Latin America, we have customers in a number of markets who are leveraging the solution that we've developed that combines our Mastercard Black premium credit product with our cross-border travel rewards, which provides a very powerful valuable prop for their affluent customers.", "Banco Popular in Puerto Rico, for example, has chosen to leverage Mastercard's affluent solutions, including differentiated rewards, benefits, and marketing assets for the bank's customers, as well as advisors consulting, managed services, and data analytics to optimize their cash back, airline co-brand, and other Mastercard portfolios.", "In Asia, we continue to pursue single-branded issuance in China by renewing relationships with large issuers, such as China Construction Bank, and by winning new targeted portfolios like Bank of China's newly launched women's card and the Bank of Communication affluent youth card. We are also very pleased to establish an expanded relationship with Standard Chartered Bank across 11 markets in Asia, including Hong Kong, Singapore, and India.", "Moving to the Middle East and Africa region. We're so pleased that we've deepened our strategic partnership with several key customers. For example, we've renewed and extended our agreement with National Commercial Bank in Saudi Arabia, winning exclusive, new, commercial issuance and maintaining exclusivity in prepaid and credit, with advisors and loyalty services embedded as part of the deal.", "On the product front, we are executing on our commercial strategy, including by building out new products and scaling existing solutions, such as our In Control virtual cards platform, smart data, and the Mastercard B2B hub that's powered by AvidXchange, which as you know, optimizes accounts payable payment for small and medium-sized businesses in the U.S." ] }, { "name": "Ajay Banga", "speech": [ "We are expanding our accounts payable automation capabilities to mid-sized and larger businesses, and are further leveraging existing partners, such as [inaudible] and in the second quarter, we also launched In Control for commercial payments and business travel in Italy with Nexi, a partner that will help us build scale in that new geography for us. Over time, we expect these and our full suite of commercial solutions to be very valuable tools for our partners and their customers.", "We're working on the fact that providing choice to customers, merchants, and bank partners is essential to our business, and that includes offering capabilities that reach beyond cards, such as with account-to-account transactions. Let's give you a couple of examples on the progress we've made this quarter. First, the example of our ability to combine our proprietary assets to offer one convenient end-to-end solution is the recently announced U.K. launch of Mastercard Send.", "Now, that's our push debit solution, which is combined with VocaLink's real-time payments capabilities. That fully integrated solution will enable financial institutions, fin-techs, digital customers, and other businesses to send real-time payments to U.K. bank accounts and also receive payments from U.K. bank accounts. The connection of Mastercard Send to the faster payments network enables a variety of use cases, including P2P payments and B2C disbursements in a seamless way.", "Additionally, we expect to expand the reach of pay-by-bank app through the launch with HSBC later this year. Worldpay makes this capability available to its merchant customers in the U.K. starting early next year, early 2019. As I've spoken about in the past, the pay-by-bank app enables consumers to make online payments for goods and services via a mobile banking app and directly from their bank account with no need to link a card. Worldpay's reach, together with our existing distribution arrangements with Barclays and ViAcard I think will provide a significant U.K. acceptance footprint for this new capability.", "Finally, we continue to advance our secured digital solutions. The Worldpay partnership I just referenced is actually much broader and it's focused on expanding acceptance and making digital payments more convenient and secure. As you may have seen in Worldpay's announcement last week, our relationship will extend to tokenization, Mastercard Send push-to-card disbursement solutions, and support of [inaudible]'s secured and more common framework for a common check-out partner. So with that, let me turn the call over to Martina for an update on our financial developments and operation metrics. Martina?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Thanks, Ajay. Good morning, everyone. Turning to Page 3, we are very pleased to deliver another strong quarter, even when you exclude the 2 ppt tailwind from foreign exchange to net revenue and the 3 ppt to net income, which is primarily due to the appreciation of the euro since last year.", "I will now highlight the numbers on a currency neutral basis and also exclude special items related to litigation provisions, most of which we had already announced in late June. Net revenue grew 18%, driven by strong underlying performance, and includes a 4 ppt benefit from the new revenue recognition rules and acquisitions. Excluding this, underlying revenue growth was 14%. Operating expenses increased by 6%, which includes a 6 ppt increase due to the new revenue recognition rules and acquisitions. Operating income grew by 28%, or 26% if you exclude the revenue recognition and acquisition-related impact that I just noted.", "Net income was up 45%, reflecting strong operating results and the impact of the U.S. tax reform, which contributed approximately 7 ppt to this net income growth. EPS was $1.66, up by 48% year-over-year, with share repurchases contributing $0.03 per share. During the quarter, we repurchased about $1.5 billion worth of stock and an additional $279 million through July 23, 2018.", "Let me go to Page 4. Here you can see the operational metrics for the second quarter. Worldwide gross dollar volume, or GDV growth was 14% on a local currency basis, similar to last quarter. We saw solid double-digit growth across most regions. U.S. GDV grew 9%, down 1 ppt from last quarter, and was made up of credit and debit growth of 8% and 11%, respectively.", "Outside of the U.S., volume growth was 16%, similar to last quarter, primarily due to the Europe and Asia Pacific. Gross dollar volume grew at a healthy 19% on a local currency basis, driven by double-digit growth in all regions, with the strongest growth contribution coming from Europe. This was down 2 ppt from the first quarter due to lower cryptocurrency purchases and one less switching day in Q2. This was in line with our expectations.", "Turning to Page 5 now, switched transactions continued to show strong growth at 17% globally, normalized to exclude Venezuelan transactions, as we no longer consolidate that entity. We saw healthy double-digit growth in switched transaction across all regions, led by Europe and the U.S. In addition, global card growth was 7%, again normalized for Venezuela, and globally, there are 2.4 billion Mastercard and Maestro-branded cards issued.", "Let us go to Page 6 for highlights of a few of the revenue line items, again described on a currency neutral basis unless otherwise noted. The 18% net revenue increase was primarily driven by strong volumes and transaction growth, as well as growth in services. The new revenue recognition rules and acquisitions contributed 4 ppt to the growth rate. Excluding these impacts, underlying net revenue growth was 14%. This solid growth was in line with our expectations as an increase in deal closings and implementations in Q2 caused rebates and incentives to pick up from Q1 levels as planned, and we lapped the VocaLink acquisition at the end of April." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Looking quickly at the individual line revenue items. The domestic assessments grew 22%, while worldwide GDV grew 14%. The difference being primarily due to the impact of the new revenue recognition rules. Cross-border volume fees grew 18%. But cross-border volume was up 19%. The 1 ppt gap is mostly due to higher [inaudible] Europe growth. Transaction processing fees grew 20%, primarily driven by the 17% normalized growth in switched transactions, as well as revenues from our various service offerings. Finally, other revenues grew 13%, driven by increases in our advisors and safety and security services.", "Moving on to Page 7. You can see that total operating expenses increased 6%, excluding special items on a currency neutral basis. Underlying operating expense growth was 7%, primarily related to investments and strategic initiatives, such as digital infrastructure, safety and security platforms, data analytics, and geographic expansion. The difference of 1% relates to the nearly offsetting effect of a 7 ppt benefit associated with FX hedging gains and a 6 ppt impact related to the new revenue recognition rules and acquisitions.", "Let me turn to Slide 8. First, let's discuss what we have seen for the first three weeks of July, where our drivers are generally similar to what we saw in the second quarter. The numbers through July 21 are as follows. Starting with switched volume, we saw global growth of 15%, similar to the second quarter, with solid growth in all regions.", "In the U.S., our switched volume grew 11% and outside the U.S. it grew 19%, both similar to what we saw in the second quarter. Globally, switched transaction growth was 17%, the same as in the second quarter with healthy growth in each region. With respect to cross-border, our volumes grew 18% globally, down 1 ppt sequentially due to slightly lower growth in Europe and Asia Pacific. This is in line with our expectations and as a reminder, we anticipate facing more difficult cross-border comps in the second half of the year.", "Turning to our thoughts for the full-year of 2018, which I will describe on a currency neutral basis, excluding special items. Frankly, not much has changed, with the exception of foreign exchange. As you heard from Ajay, although we are monitoring certain macro-economic factors, they have yet to show up in the numbers and global economic trends are generally positive. Our business fundamentals remain strong, as we had a solid first half, and we continue to expect year-over-year revenue growth to be in the high teens. As a reminder, this growth includes the impact of the new revenue recognition rules that we adopted in 2018, and the full-year effect of acquisitions.", "With the strengthening of the U.S. dollar, we now expect foreign exchange will be a benefit to revenue of between half a ppt to 1 ppt for the year. We had previously estimated a 2 ppt benefit. This means that we expect FX will be a headwind in each of the next two quarters.", "On operating expenses, not much has changed. Although we had some foreign exchange hedging benefits in Q2, we continue to expect year-over-year expense growth to be in the mid-teens. This growth includes the impact of the new revenue recognition rules, the full-year effect of acquisitions, and our investments in our Center for Inclusive Growth.", "For Q3, we do expect marketing expenses to increase sequentially and total operating expenses to grow in line with our annual expectations. With that, let me turn the call back to Warren to begin the Q&A session. Warren?" ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Martina. Krista, we're now ready to begin the question-and-answer session." ] } ]	[ { "name": "Operator", "speech": [ "Certainly. At this time, if you would like to ask a question, please press * followed by the number 1 on your telephone keypad. Again, that is *1 on your telephone keypad.", "And your first question comes from Bob Napoli with William Blair. Your line is now open." ] }, { "name": "Robert Napoli", "speech": [ "Thank you very much. Two questions, if I could. One on VocaLink and then one on Mastercard Send. First of all, are you comfortable with the trends in VocaLink? Ajay, there are several contracts there and I think some of those contracts are up for bid. Is there some risk of losing part of that business or in expanding it? What are your thoughts on VocaLink? I just wondered, does Mastercard Send, do you view that as the equivalent of Visa Direct and the opportunities to be the same? Thank you." ] }, { "name": "Ajay Banga", "speech": [ "First of all, VocaLink is doing well. We're actually happy with all the underlying trends, as well as the opportunity that we see with VocaLink in other parts of the world. We've got VocaLink in both licensed software form, as well as a little more role to play in different countries. In Sweden and Thailand, PromptPay is run by VocaLink software. In fact, our business in Thailand is benefiting not just from the relationship with the Central Bank of Thailand that comes from the ACH work there, but also on debit.", "And so, VocaLink and us, I think that's working the right way. The contracts that VocaLink has in the U.K. and specifically, what I think you're referring to, they actually got an extension on the largest one out until 2022. But look, all contracts are competitive. They come up for bidding. People are going to bid against us and we're going to try our best to extend it beyond that and keep winning them. And there will be some that you win, some that you won't. Right now, things are OK with VocaLink and they look good. The expansion opportunities with VocaLink look good. That's the first part of the story.", "The part about Mastercard Send. Mastercard Send is a loosely used term to include both the ability to move money from a card to a card, but also in combination with VocaLink's capabilities from an account to an account, and also in combination with our JV with HomeSend -- to many sends in these words -- but with that JV, you also have the change to move the money to mobile phones and the like around the world. So, when you look at the capabilities that you've got together, it's not just the card-to-card capabilities, it is the account-to-account and also to mobile phone numbers. That, I would believe, is far superior to what most other institutions can claim to have once you actually dig into the details of what we're capable of doing. That is what we're trying to put together.", "For example, in my opening remarks, I talked about the U.K. There, it's a combination of the card-to-card but also VocaLink's faster payments network link to be able to do account-to-account payments. That's what gives you the P2P business case and the P2C disbursement business case. So, my belief is it's the combination of assets that matters and the choice that we provide to banks, and merchants, and governments. What us they can get what they want out of their combination, like a menu-driven approach.", "So, all in all, I'd say that we're in a good place with VocaLink. I like what I see we're doing elsewhere. I think in the U.K. we're doing well with VocaLink. I think the opportunities of the combination of assets of Mastercard Send, VocaLink, and, in fact, the HomeSend JV, all that put together is really a good plus for us." ] }, { "name": "Robert Napoli", "speech": [ "Thank you very much." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Bob, let me just add a couple of operational stats on some of the Mastercard Send rails. We have access to more than 3 billion bank accounts in over 100 countries. We have fairly rapid growth rates, albeit still on a very low base." ] }, { "name": "Robert Blair", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Craig Maurer with Autonomous Research. Your line is now open." ] }, { "name": "Craig Maurer", "speech": [ "Thanks. I was hoping two things -- you could comment, one, on U.K. PSR's report that was published two days ago on acquiring, if you can just give your thoughts on the broader industry from that. And secondly, if you can comment on the outage that was recently reported. What caused that and if there will be any impact we should think about for third quarter?" ] }, { "name": "Ajay Banga", "speech": [ "Hi, Craig. First of all, for third quarter, nothing. The U.K. PSR's report, by the time they actually get together and analyze all the aspects of the U.K. card acquiring services and that practice, that's going to take a fair amount of time to work our way through it. Look, what typically the PSR does is they will do a broad assessment of the market. They'll figure out is it working properly? Is it delivering the outcomes they want? They're going to look at all the range of factors related to the services which acquirers provide to merchants. I think this whole thing of the year, two years in the making for them to get to that.", "I'm sure they'll also want to talk to us about, even those we're not an acquirer, they'll want to talk to us about the role we play in that whole ecosystem. That's a good thing. I actually believe that transparency and a dialog around the role we play, the role acquirers play in the ecosystem is great in a market like the U.K.", "As far as the outage is concerned, honestly, the outage was for a short period of time. It related to extra traffic on a server in certain sites got zapped after that. We were back to normal soon after that and moved right on. So, I don't even know that you'll see an impact in any quarter out of that kind of an outage. That's not really an outage. It's a slowing down of the approval rate of transactions, the speed of approval of those transactions in a period of time which lasted for an hour to an hour and a half, depending on which part of the market you were in." ] }, { "name": "Craig Maurer", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Darrin Peller with Wolfe Research. Your line is now open." ] }, { "name": "Darrin Peller", "speech": [ "Thanks, guys. Just first question is really around the margin sustainability. When we back out some of the M&A adjustments, it looks like it was pretty flat and margins were-I mean, expenses were generally flat. Margins look pretty strong. Give us your thought process on that and rationale and strategy of whether or not you still think that could just be a side effect of what you need to invest and grow revenues versus letting it expand. Then just quickly, Martina, on the tax rate expectation for the year, if you don't mind updating us on that." ] }, { "name": "Martina Hund-Mejean", "speech": [ "I'll do the last one because it's easy. It's just basically a same repeat of what I said at the last quarter. It's going to be 19% to 20% given all the benefits that are running in from the U.S. tax reform, as well as on the [inaudible] businesses that we have, what kind of minimum margin profile should we have as a company, which is that 50%+ that you get to hear from us when we iterate our three-year financial performance targets.", "What we do is we take the extra margin that we are making on the core business and investing it very significantly in terms of expanding and the other things that we have been talking about. One is the services. Many of these different services have actually lower margin, other than safety and security front services, but we're investing in that still heavily, such as data analytics, such as loyalty, etc., and that will continue to happen. The second expansion that we have been talking about in a fairly significant way since our last investor day in September of 2017, is the investment that we're doing in the B2B space. Remember the $120 trillion of opportunity which we are taking certain slices of the opportunity and those kind of investments will continue to stay with us.", "So, no changes. When you see some margin expansion coming through from time to time, there are really two factors. One is our revenue line happens to be higher than what we set up in the budget. We're not going to be able to course correct that quickly to be taking the extra dollar to be investing it in additional investment. And No. 2, you should be expecting that over time in our services line items, the margins are going up, simply because we're going to run more volume over that." ] }, { "name": "Ajay Banga", "speech": [ "The services business, you've heard me talk about just a little while ago. Somewhere in there's first question I think I talked about Thailand and PromptPay and ACH and debit. By doing all those things with the Central Bank of Thailand, not only are we doing the fast ACH and the debit switching partnership, we're also running our services through them, which gives us scale. Be it safety and security, be it other kinds of data analytics.", "What that does is it gives us a much broader, wider relationship and that is what we're investing our money into, is to create the stable system of having broader, wider relationship beyond just the core payment transaction revenue stream that used to be in this company the primary source of revenue 8, 9, 10 years ago. That's what we're trying to build. Then to get to scale with those services, as Martina said, you expand the margin on each of them as you go along." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Lisa Ellis with MoffettNathanson. Your line is now open." ] }, { "name": "Lisa Ellis", "speech": [ "Good morning, guys. I was hoping to drill in a little bit on your purchase volume growth number. If I'm looking at it, it looks like FX neutral purchase volume growth was about 15.5% in the quarter, which our quick look back looked like we hadn't seen a number close to that since about 2012. So, could you just parse apart a little bit what's driving that acceleration and in particular, is this underlying secular cash displacement? Is this e-comm-related acceleration? Is this share gains? Is this, you know, some early impact from Mastercard Send? What would you call out?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Lisa, Mastercard Send is, as I said before, that's still a relatively low base. So, that is not really driving the numbers. The numbers are really driven by our core business and all the good work that all of our employees are doing around the world. So, when I start with the U.S., you can look at the numbers, and I know you're talking purchase volume. I really generally talk gross dollar volume because it shows the entire deal of the company and what we're going after. But you obviously see in the United States really nice step-up, both from a credit and a from a debit point of view, as you're looking over the last 5, 6 quarters.", "That is we have been talking about the U.S. in terms of winning quite a few businesses. In particular, in the co-brand space, we're starting slowly but surely to getting all these wins coming into the numbers.", "When you look at overseas, we actually had terrific growth in many of the regions. Europe is obviously outstanding. I mean, you can see those numbers every year. There's really no change in terms of how Javier and the team are going after those kind of businesses. We will be added down the road a little bit more in the U.K. because some of the U.K. businesses that we have won and a couple of other countries. But I would suspect that would just continue to be providing this fantastic double-digit growth trend that we're seeing from a volume perspective in Europe.", "When you go to Asia Pacific, Asia Pacific -- I'm throwing Middle East/Africa in it -- as Ajay talked a little bit this morning, there's some ups and downs in it. We have seen China, still good growth, but it's in the high single-digit kind of range at this point in time. But you're seeing from the other countries really good growth that's additive. By the way, in India, if I were to do a list, I mean, it's almost a 30% growth rate at this point [inaudible] still, some with the benefit from the demonetization. Middle East/Africa, some of the numbers have been starting to come back, simply because the countries feel a little bit better as they're oil-producing.", "Then when I look at Latin America, that is where you see a bit more challenge, in terms of the numbers. While you might think that the domestic volume is OK, we have from a cross-border point of view, a bit of a challenge because of the devaluation of the currency, particularly of the real. By the way, my comment for the third and the fourth quarter where I said that we probably will see tailwinds on the foreign exchange, is mostly related to the real, not really to the euro." ] }, { "name": "Ajay Banga", "speech": [ "Only two things I'd add to that Lisa. One is that the U.S. --" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Pardon me, headwinds. Let me just say, I said tailwind, headwind. I'm sorry." ] }, { "name": "Ajay Banga", "speech": [ "Headwinds. The only thing I'd add to that is in the U.S., remember we also won affluent product like the Capital One Savor card and Bank of America cash rewards card. Those issuings are beginning to happen. You will see results of that. In India, we have actually done very well on debit growth. Last quarter, I talked about Bank of Baroda. This quarter, actually, I didn't mention it, but I was there a little while ago, we signed a deal with Bank of India. These are large, public-sector banks. We already had the State Bank of India and a bunch of others. Our debit business in India is doing well. Our ability on debit to be seen as a real partner for growth is good.", "So, I'd say you're seeing the result of both secular movement in a country like India, but you're also seeing in a lot of the countries around the world some of the impact of some of the business wins of the last few years. I would be a little cautious about cross-border in some places because of both foreign exchange. We're also a little cautious about the impact in China and Korea right now caused by what's going on with Central Bank actions and oil prices and the like." ] }, { "name": "Lisa Ellis", "speech": [ "Terrific. Thank you." ] }, { "name": "Martina Hund-Mejean", "speech": [ "You had one more question which was e-commerce. I just want to add to that. E-commerce continues to grow in a terrific way. For this quarter, it was about 24%." ] }, { "name": "Lisa Ellis", "speech": [ "Perfect. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Tien-tsin Huang with J.P. Morgan. Your line is now open." ] }, { "name": "Tien-tsin Huang", "speech": [ "Thanks. Good morning. Just to build on your answer to Lisa's question. I'm curious on the timing of some of the new wins like L.L. Bean, Santander, Bank o f America, as you mentioned. Have we seen those kick in yet? I think some of that comes in next year, I know. Then also, as a quick follow-up, I know you mentioned some Challenger Bank wins, like M26 in Germany. Why have you guys done so well, do you think, with the Challenger Banks? I know Revolute and even Venmo PayPal, etc. issued under Mastercard. Why is that? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Tien-tsin, the first part, [inaudible] are all rolling and you know this business well and you know how it comes. I would tell you that the L.L. Bean stuff is very early stages, very, very. It's just begun, literally. The U.K. wins, TSP, Santander, they are all early next year. They're actually just not even coming yet. That's why in Lisa's answer I was saying you should expect to see more of these recent wins roll in later, but some of these earlier wins are showing up today. So, it's the nature of the mix of our business.", "I think that on the whole, the trends on our share growth, as well as secular movement, are helpful to us at this stage. The aspect of digital banks. I actually believe that the reason we're winning digital banks is just that in addition to our good looks, we're guys who actually care deeply about the fact that the environment, the ecosystem is adapting and changing around the world, where digital banks are having a role to play that's smaller today. They're offering a different product sentiment, a different construct. You have to be capable of flexibly moving your product offering and your benefit system to suit what they want and the hold as valuable as compared to what a merchant may hold or a different kind of bank may hold. It's just different strokes for different folks.", "I'm a believer that our future will be built on choice and on offering bundled solutions. Those are the two things I've very focused on building -- choice across every category of payment. So, we want to digitize every form of payment and we want to allow every form of payment to be available as a one-stop shop from us. You want it, we've got it. That's the approach that we're trying to use. You combine that with bundling both payments with all these other services solutions that a number of the newer banks want. They don't have capabilities of self-paid, fraud management, data analytics, processing, loyalty and rewards. If you can try and bundle these things together, then you get a good, attractive conversation going with them. I think that's probably what's helping us right now." ] }, { "name": "Tien-tsin Huang", "speech": [ "All right. Good to know. Thanks a lot." ] }, { "name": "Ajay Banga", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Sanjay Sakhrani with KBW. Your line is now open." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. I'm just following up on VocaLink. I believe there's also an initiative to overhaul the fast ACH infrastructure. Ajay, could you just talk about how that might affect VocaLink and maybe it's positioning there? Then just one quick question on FX. Martina, I know you mentioned the cross-border volumes were in line with expectations and they were obviously quite strong. I'm just curious if there's any signs of impact from a strengthening dollar. Thanks." ] }, { "name": "Ajay Banga", "speech": [ "I was in the U.K. last week or the week before. This idea of looking at the fast ACH infrastructure is actually not something that's got either clarity or dimension to it. VocaLink, the faster payment system, the banks are all talking to the payment systems regulator and the others there about what the future of faster payments in the U.K. should look like. What other feature functionality should be built into it and the like. So, as far as I'm concerned, even if you look at VocaLink itself, the technology being used to drive faster payments in the U.K. it's scale, scope capability, speed, number of transactions, the amount of data that flows and back and forth with each transaction. You compare that to what currently we are bidding with in other markets with VocaLink and already there's a difference because that technology is moving very fast.", "What we do is we build in another place and we roll that technology back into the prior market. it's a bit like we do with Mastercard. When new releases go back and they build the quality of the original infrastructure in the older markets as well. Honestly, we're involved with that discussion. I don't whether it's got legs here or not. I don't know what the dimensions will be, but we're very deeply embedded and involved with all conversations on faster payments in these countries." ] }, { "name": "Martina Hund-Mejean", "speech": [ "On the strengthening dollar question, we're seeing a bit of an impact on U.S. acquiring, so it's still double digits. It's in the low teens. It used to be high teens last quarter. Really what we're seeing is inbound from LAC and from Asia Pacific tempering a little bit. So, early days. We'll see if that has more legs." ] }, { "name": "Warren Kneeshaw", "speech": [ "Krista, we're ready for the next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Harshita Rawat with Bernstein. Your line is now open." ] }, { "name": "Harshita Rawat", "speech": [ "Hi, good morning. Thank you for taking my question. Ajay and Martina, I want to ask about QR codes. As you know, QR codes dramatically reduce the cost of payments acceptance and it does appear that many emerging markets such as India will evolve to use that as one of the payment methods. I know you have the pilot QR code standard, which you are rolling out in other emerging countries as well. So, my question to you is, how do you envision competing with very nimble local players and internet giants in the QR code front when you often have to rely on banks as a distribution channel in many markets?" ] }, { "name": "Ajay Banga", "speech": [ "So, first of all, QR codes reducing acceptance costs drastically. Let us parse that statement a little bit. What it actually does is reduce the initial capital cost of installing a terminal in a merchant's store, as compared to a QR code system which could be a static code which is put on a merchant's counter; which, by the way, has all kinds of issues involved with ensuring that it is managed well. Compared to a dynamic code which could be generated and put onto a mobile phone either by the merchant or the consumer and clearly has more security features built into it. That capital cost is substantial in terms of an older terminal, which could cost $500.00. But that capital cost is not that substantial a difference when you're comparing it to a dongle, like a Square dongle, or someone else's dongle.", "So, what I'm trying to get across to you is the actual story around the cost of acceptance of QR codes needs to be understood in its entirety, not in one of the buzzwords that get passed out by companies that believe that QR codes are the answer to the future of mankind on acceptance. I would tell you that acceptance growing from current 50 million merchants to get it to the next 50 million or in to go from the current India 3 to 4 million, which is a dramatic growth over the 1 million of a year ago, to get to 60 million, which is the opportunity in India, that QR codes may not be the only solution. It'll be a mix of dongles, QR codes, and terminals that'll go through the system.", "Within QR codes, it will be static QR codes versus dynamic QR codes and within dynamic QR codes, it'll be consumer-presented ones versus merchant-presented ones. That is a fairly complicated ecosystem. I'm not trying to compete with somebody else building out their own QR code. I'm just trying to say when you've got that kind of complexity, there is a benefit in having standardized ways of rolling these out.", "The standardized way of rolling out QR codes that EMVCo is putting out there, which as you know, is supported by all the members of EMVCo, which include Visa, AMEX, Discover, but also China Union Pay, is that we are trying to put these standardized QR codes out there as a way of making it simpler for acquirers and merchants to integrate one time, as compared to multiple times. Not different to the story of secure remote commerce to single checkout button online, which also is trying to take away from the complexity of merchant and acquirer integration for online payments.", "So, I kind of view all this as a developing ecosystem and I view us as being people who place bets on every one of these acceptance expansion systems as compared to picking winners and losers because our job is to create standards that the rails can be built on so that we can get to scale. I am participating in all of these activities. Whether it's in India with BharatQR. Whether it's in other markets across Pakistan, Africa, parts of Asia where I consider this to be a real opportunity, but I want to do it with standardization and I want to do it with safety and security and I would prefer to do it therefore in collaboration not just with banks, but, for example, in India with the payment banks.", "We're only out there with a bunch of offers with ETel Bank and with the Indian Post Office Bank for quite a while in India. Not now. We're doing ETel Bank sort of issuing and acquiring for a while. To be honest with you, I think of QR codes and SRC as an ongoing evolution of acceptance efforts, just as dongles were a great evolution from the older terminal." ] }, { "name": "Harshita Rawat", "speech": [ "Perfect. Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Ashwin Shirvaikar with Citi. Your line is now open." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Thanks. Hi, Ajay. Hi, Martina. You guys mentioned the global deal with Worldpay. So, a two-part question related to that. One is any thoughts on pay-by-bank rolling out beyond the U.K. and the opportunity there? Secondly, maybe use the tokenization comment to kind of parse out the monetization opportunity associated with tokenization broadly?" ] }, { "name": "Ajay Banga", "speech": [ "So, on the tokenization and monetization. We don't either try to monetize tokenization by charging a fee for it. Neither do we force that method of steering any transactions around that. That is not our way. Our attempt with tokenization is to raise the level of water in the river so that the [inaudible] finds it tougher to swim. You don't do that by charging fees for raising the level of the water. What we are trying to do here is make it safer for the industry as a whole.", "The effort is to get digital transactions and then card and file transactions and then eventually every account-to-account-based transaction. You have the benefit of a secure cryptogram protected token in front of you. That's the visualization of where we are going over the next few years. That's the journey we're on and I think that's a journey most people in the industry are on. It's a way of raising the level of the water in the river. That's the idea.", "So, back to pay-by-bank. Pay-by-bank is a really interesting idea, but you've got to make sure that it has real acceptance in the marketplace. In the U.K., it's very early days because it's only now with HSBC, Barclays, WorldPay as I mentioned, the wildcard guys, and I'm beginning to think of the U.K. having a certain amount of scale, being attached to rolling out pay-by-bank, at least for online purchases for consumers to pay with their mobile banking app.", "I consider pay-by-bank to be an interesting app in other markets where let's assume, if there is an ACH or fast ACH system in a country in which we cannot play directly -- somebody else is outbidding that fast ACH, then we have a choice. We could help get that fast ACH to operate more like a scheme by providing chargeback dispute management, revenue sharing rules, and then add the app on top of it. Or if the scheme is also running locally, still provide the app to our member banks and to merchants and non-banks, digital players as a way to get to enable consumers to pay directly with their bank account.", "I view pay-by-bank as having many different roles, only one of which is the U.K.-type role, where they're also the infrastructure. There could be roles in other markets where they're not the infrastructure or where they're part of the infrastructure. You will see over the next few years effort on this space. These things have a longer gestation period because it's a difference in the way bank or a merchant has to interact, as well as a difference in the way the consumer has to think about paying.", "The same thing is true of commercial B2B things. This these don't change on a dime. You put our product, you put out capability, and then you've got to work you way into ecosystem for people to care about them and switch onto to them and scale. Both pay-by-bank and our commercial efforts are things we're putting into the pipeline for the next 3, 4, 5, 6 years of driving our revenue." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Jim Schneider with Goldman Sachs. Your line is now open." ] }, { "name": "Jim Schneider", "speech": [ "A question on your B2B strategy for a moment. Could you maybe talk about your sales and distribution strategy for B2B? You talked a lot about the technology solutions in the past, but can you maybe talk a bit more about the ways you're going to market? Is it sufficient for you to go to market through partner banks? Do you intend to open up other distribution channels or maybe even direct distribution channels? Then collectively, when might the B2B opportunity start to be material in terms of revenue where it's notable to us on the P&L? Is that 2, 3, 5, or more years out?" ] }, { "name": "Ajay Banga", "speech": [ "It depends what you mean by B2B. B2B is a very big word. Inside that, it's thought that it's very material in our P&L today, which is our commercial card business. [Inaudible] cards, fleet cards, virtual cards, that is material today in our business. Growing handsomely. Giving us good margins and, in fact, delivering good returns for us, not just domestically but also cross-border.", "Then there's the B2B space that comprises of things we could do with Mastercard Send or VocaLink or HomeSend, as I was talking earlier, or combinations of those. Those products are both for consumer reasons, but also B2B, also B2C, also P2P. That stuff is what you see over the next 2, 3, 5 years being done.", "The distribution channel for that, as compared to the traditional commercial business, the distribution channel for that is, in fact, very effective through banks because of one very simple reason. Most banks tend to be focused on larger-sized transactions in the cross-border B2B space. There is a great deal of space in the relatively smaller cross-border B2B space, which is inefficient both in terms of the [inaudible] settlement times involved, involved, but also relatively inefficient in terms of the data that is exchanged at the point of payment and the fraud opportunities that exist in that system. All of which we can bring to the party through these larger banks as their partner to extend their target market as well.", "But there's also other ways of getting to that marketplace. There are ways of getting to that marketplace which go through distribution channels run through a digital company, but very often they will need partner banks anyway because those companies are not banks and without being a bank, how do you operate a digital or other cross-border P2P or B2B business of exchanging money? You need banks in the system.", "So, you have to be careful about what you mean by distribution. Does distribution mean getting to get someone to start understanding the product to then use it? Or does distribution mean that the rails still need banking to run? I will tell you, in most places, the rails still need banks to run them. The question is how you get them to those SMEs or those middle-sized companies. You could do it directly through banks or you could do it in terms of change that you could utilize over time. We're doing all. We're doing all of them. For we believe that banks are great partners in this case because they need to play the role where the money needs to be exchanged. They play a very critical role in that process." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Jim, first of all, what Ajay mentioned in terms of our commercial business that we already have, I just want to remind you it's about 11% of our global volume, so clearly significant. In 2017, it grew in the mid-teens. The secondly, in terms of the distribution channel and how Ajay had described it, a real example of that is what he has actually mentioned in his remarks, which is AvidXchange. AvidXchange works with the distribution channel of the bank, so we can avidly bring the power of those relationships to it and making sure that these great products are getting to the smaller companies and medium-sized companies. That does not mean that AvidXchange is not working and we are not working with other fin-techs, but it has to get distributed to those small companies and the connection point is through their banks." ] }, { "name": "Ajay Banga", "speech": [ "I'm really glad you asked this. You take, for example, the work we do with commercial payments. We've partnered with WEX for the last 15 years across multiple geographies, and multiple verticals: travel, cable, media. We're growing our business together in both those verticals and emerging verticals. We're doing joint business develop campaigns with them. We do virtual card acceptance initiatives. We've done research studies with them focused on travel trends and vertical deep dives. So, actually, partners like WEX, partners like [inaudible], partners like ENet, these are interesting and incredible ways to distribute the product that we've been building for the years that I can recall being a part of this company." ] }, { "name": "Jim Schneider", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Andrew Jeffrey with SunTrust. Your line is now open." ] }, { "name": "Oscar Turner", "speech": [ "This is Oscar Turner on for Andrew. Just had a follow-up question on B2B payments and the Avid partnership, specifically. I was wondering if you can provide insight on how the B2B hub is progressing versus your internal expectations and I guess, specifically, how is the bank partnership and merchant pipeline looking? Also, could you give any color into the feedback you've been receiving?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "First of all, we told the market some time ago that the product is first rolling Fifth Third. It has started to roll out. And so we are going to see what kind of feedback we are getting, but obviously they are a key client and depending on how it's going, it's very early days. We're talking literally a few weeks that it has been in the market. Depending on how this is going, we actually have a whole pipeline of clients stacked up that are also wanting to expand on this product. Remember, this is a product that goes really for mostly small and medium-sized companies and there are only two handfuls worth of banks in the United States who are really reaching those kind of clients, and those are the ones that are interested in it. But first, we're going to have to get through the initial couple of months with Fifth Third." ] }, { "name": "Ajay Banga", "speech": [ "I actually think of the B2B hub as having incredible applicability as an idea in markets in Asia and the like as well, because that's where SMEs drive a very large part of the business, both domestic and export. It's close to 60, 65% of the GDP of some of those countries comes out of the SME export and manufacturing capability in those countries. And so you will have to do it differently there. That's why this requires a real [inaudible] both in terms of technology and partnerships to the earlier question. We are deep in the midst of that." ] }, { "name": "Warren Kneeshaw", "speech": [ "Krista, I think we have time for one final, quick question." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Dan Perlin with RBC Capital Markets. Please go ahead." ] }, { "name": "Warren Kneeshaw", "speech": [ "Dan, are you there?" ] }, { "name": "Dan Perlin", "speech": [ "Can you hear me?" ] }, { "name": "Warren Kneeshaw", "speech": [ "Yes." ] }, { "name": "Warren Kneeshaw", "speech": [ "Now we can't." ] }, { "name": "Ajay Banga", "speech": [ "Dan, you went off again." ] }, { "name": "Operator", "speech": [ "Dan, your line is open." ] }, { "name": "Warren Kneeshaw", "speech": [ "Dan, we're having trouble. I think we'll just go to the next caller. Sorry." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Jason Kupferberg with Bank of America Merrill Lynch. Please go ahead." ] }, { "name": "Jason Kupferberg", "speech": [ "--tell us when we'll get an update and extension of the long-term guidance. I know it expires at the end of this year, but we're --" ] }, { "name": "Warren Kneeshaw", "speech": [ "Sorry, Jason. We're having a little trouble hearing you, but I think the question is when will we update the long-term guidance?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Jason, yes. At the end of this year, the long-term guidance will have run out. That is our three-year guidance. I told the market that I would like to make sure that we have a little bit more time with the revenue recognition rules so that we really understand how that is going to roll into the future. You should be looking forward, after we are closing off 2018 for our new long-term guidance. Again, it will be a long-term guidance period that we will be putting out." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you. Ajay, do you have any final comments?" ] }, { "name": "Ajay Banga", "speech": [ "Yes, just a few closing thoughts. We've delivered a strong first half to the year as we continue to execute on what we've been discussing as our strategic priorities with you. I think we're pleased with our deal momentum. That came up in a number of questions a little earlier, in both consumer and commercial as we strike new relationships and expand existing ones. We're focused on building our product capabilities, all aimed at providing choice to consumers, to merchants, to bank partners, including solutions that reach beyond cards.", "The services that we provide to advisors, loyalty, data analytics, and our fraud management systems and processing continue, I believe, to differentiate our business and provide a great support to our core payments operation. With that, thank you all for your continued support for the company. Thank you for joining us today." ] }, { "name": "Operator", "speech": [ "This concludes today's conference call. You may now disconnect." ] }, { "name": "Jason Kupferberg", "speech": [ "More MA analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
MA	2020-01-29	[ { "description": "Executive Vice President of Investor Relations", "name": "Warren Kneeshaw", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "Eric Wasserstrom", "position": "Analyst" }, { "description": "tsin Huang -- JP Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "Christopher Donat", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Trevor Williams", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Cantor Fitzgerald -- Analyst", "name": "Joseph Foresi", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by. And welcome to the Mastercard Incorporated Q4 Full Year 2019 Earnings Call. [Operator Instructions] After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions].", "I'd now like to hand the conference over to your speaker today, Warren Kneeshaw, Head of Investor Relations. Please go ahead, sir." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Marcella. Good morning, everyone. And thank you for joining us for our fourth quarter 2019 earnings call. With me today are Ajay Banga, our President and Chief Executive Officer; and Sachin Mehra, our Chief Financial Officer. Following comments from Ajay and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session. It is only then the queue will open for questions.", "You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted.", "As a reminder, in Q2 we updated our non-GAAP methodology to exclude the impact of gains or losses on our equity investments. We are excluding these items as we believe this will facilitate a better understanding of our operating performance and provide a meaningful comparison of our results between periods.", "Our non-GAAP measures also exclude the impact of special items, which represent litigation judgments and settlements and certain one-time items. In addition, we present growth rates adjusted for the impact of foreign currency with the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Please note that the growth rates we provide for switched volume, switched transactions and cross-border volume have been adjusted to normalize for the effects of differing switching days between periods.", "Starting this quarter, we are further adjusting these growth rates to normalize for the effects of differing number of carryover days between periods. Carryover days are those where transactions and volumes from days where we do not clear and settle are processed. Generally, we do not clear and settle dual message transactions on Sundays. These adjustments have been made to current and prior quarters. This information is being provided so that you can better understand the underlying growth rates of our operating metrics.", "Our comments on the call today will be on the basis of these adjusted growth rates. We do not normalize GDV growth rates. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days.", "With that, I'll now turn the call over to our President and Chief Executive Officer, Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thank you, Warren, and good morning everybody. So we closed our 2019 on a strong note. And for the year, revenue was up 16% and EPS was up 23%, on a non-GAAP currency-neutral basis. I think these results reflect broad based growth across each of our regions and the ongoing execution of our strategy as we continue to invest for the longer term.", "On the macroeconomic environment, consumer spending remains relatively healthy, and we expect this to continue in 2020. We are however monitoring, a number of economic and geopolitical factors as well as the potential effects of [Technical Issues] corona virus that could impact results.", "In the US, we are seeing stable growth with low unemployment and healthy consumer confidence. Our SpendingPulse estimates for Q4 show retail sales remained solid, up 3.1% versus the year ago ex auto, ex gas. In Europe, we see continued modest growth. UK spending actually held up reasonably well again, according to our SpendingPulse estimates with year-over-year retail sales up 3 [Technical Issues] in Q4 ex auto, gas and restaurants despite uncertainty around the potential impact of Brexit.", "In Asia Pacific, we are seeing modest GDP growth in the region overall, in part due to the support of favorable monetary policies in several markets. We are pleased with the recent trade deal with China. And obviously, we'll continue our efforts to pursue a license to participate in that market domestically.", "The outlook in Latin America is mix of growth in Brazil and Colombia, partially offset by weakness in Argentina and Mexico. Meanwhile, we are driving healthy double-digit volume and transaction growth for Mastercard across most of our markets and these results are a function of us growing our core products of differentiating with our unique services of expanding our digital solutions and footprint, and are leveraging our multi-rail capabilities to capture new payment flows.", "So let me start by talking about driving growth in the call. We've done that through new wins as well as key renewals and expansions. Following on the heels of our recently announced extension with Citibank, we are excited to announce a renewal and extension of our relationship with Capital One. We also signed an agreement with software payUS to launch new debit, credit and payroll solutions for small and medium-sized businesses later this year. And we renewed our deal with the Standard Bank Group in South Africa, the largest bank in Africa, which includes new issuance and will help us grow our share in that market and throughout the region.", "On the co-brand front, the Amazon Rewards Mastercard has launched in Canada. MoneyLine, a US-based mobile consumer finance platform has selected Mastercard as their exclusive partner for their new credit co-brand program, and we'll flip that existing consumer debit portfolio to us as well. In the travel space, we won a new co-brand deal with Vistara Airlines in India, and have also expanded a long running co-brand relationship, Norwegian Cruise Line in the United States.", "Turning to prepaid, we have renewed our agreement with the network for Direct Express, which is the largest prepaid program in the world. This card issued by Comerica Bank is used by the US government to make fast, convenient and secure federal benefits disbursements. And in debit, we have expanded our presence in key emerging markets in China and India. In China, we entered a new deal to be the preferred debit partner of China Construction Bank, the second-largest bank in China. And are also launching our first debit program with China CITIC Bank.", "In India, we have maintained our debit leadership to renew debit deals with both HDFC Bank and State Bank of India, the largest public sector bank in the country. So now to differentiated services and co-products wins such as these I've just talked about frequently included [Technical Issues]. We continue to grow these services both organically and inorganically, and are making good progress in this regard. And for example, Brighterion's artificial intelligence platform and new data behavioral biometric capabilities have been broadly integrated into our core security solutions to help customers minimize fraud and manage risk.", "And so joining Mastercard, Ethoca has signed over 350 new deals including our recent agreement with Microsoft [Technical Issues] streamline their dispute process and improve the cardholder experience. And while on the topic of acquisitions, I think we have bolstered our Cyber Intelligence Suite, a step further with our recent acquisition of RiskRecon, a leading provider of AI and data analytics solutions.", "RiskRecon's best-in-class Cyber Risk Assessment capabilities are designed to help financial institutions, merchants, corporations and governments secure their digital assets. [Technical Issues] build on their current customer base and develop new cyber security services. We are very pleased to have the RiskRecon team as part of the Mastercard family, and we look forward to offering these solutions to our customers.", "So on to digital initiatives and our footprint there, we are expanding our digital solutions the rollout of Click to Pay with new deals on our merchant tokenization solution and real progress on the Contactless front. On Click to Pay, we can announce that merchants such as Fresh Product, [Technical Issues] and Saks Fifth Avenue are now live, enabling a faster, most secure guest checkout experience for their customers.", "Further, beginning in mid-2020 this year, Citibank plans to streamline the checkout experience at participating merchants by leveraging pushed provisioning to make the Click to Pay enrollment process much easier for Citi branded credit card holders in North America.", "We also signed several deals with merchants for our tokenization capabilities, which as you know [Technical Issues] security and they sort of approve -- the approval rates improve and a better experience for merchant's customers. Recent partners to sign on to use this tokenized card-on-file solution include Amazon, Stripe, MercadoLibre, PayPal and several of the largest US wireless and telecom providers. And on to Contactless, well I said, we're making real progress. This quarter, Contactless made up over 30% of global card present purchased [Technical Issues]. Contactless provides a frictionless and fast payment experience, which is opening new categories of spend including displacing cash on small ticket purchases.", "The US point for growth on this front and the New York City MTA is a good example of the potential for rapid adoption by consumers. In fact, they have surpassed 5 million taps since the launch in May and the MTS plans to rollout contactless acceptance systemwide by the end of 2020. And onto new payment flows [Technical Issues] capabilities, which we're using to penetrate new flows, including recent successes of Mastercard Send.", "Bank of America will now use Mastercard Send for their business to consumer card disbursements in the US on an exclusive basis. In the insurance space, All States will expand the use of Mastercard Send across their enterprise to power instant insurance claims payouts. PayPal will utilize Mastercard Send in 10 new markets across Asia Pacific [Technical Issues] to enable users to transfer funds from their PayPal wallets to their eligible accounts. And also leveraging our capabilities to help facilitate more efficient cross border payments.", "So here, as an example, Swiss Bankers, a Swiss prepaid card issuer launched a new money transfer service using Mastercard Send that enables consumers to make secured payments to recipients' bank accounts, digital wallets and eligible cards in 18 countries. We're also partnering [Technical Issues] which is the switch in Russia and the Central Bank in Russia to bring cross border functionality to the Russian domestic faster payment system.", "Moving on to bill pay, we've gone live in the US with our Bill Pay Exchange product, we are leveraging technology from our transacted cycle position. Bill Pay Exchange provides an enhanced bill pay experience for banks, for consumers, and for billers, and our initial launch partners include US Bank, a large buyer and Avidia Bank, with Jack [Technical Issues] Associates agreeing to participate later this year.", "We plan to add additional functionality and new partners throughout 2020. We've also entered into a partnership with Pine Labs. They provide a range of point-of-sale and prepaid solutions to merchants across India, Southeast Asia and the Middle East. This partnership is focused on offering installment payment solutions to merchants and consumers across both card and real-time payment rails. [Technical Issues]", "We're also going to work with Pine Labs to offer a range of prepaid, loyalty and cyber security services to customers, and this partnership is consistent with our strategy to deliver greater choice to consumers and be the partner of choice for our customers.", "Open banking is another area where we work some time to develop the right set of comprehensive solutions and services that work for all the players in the ecosystem, banks, fintechs merchants and consumers. Our solutions are live today in Europe and we are focused on ensuring that the ecosystem can provide for the real-time exchange of information and transactions but most importantly protecting the interest and data of all participants, including our fintech and bank customers.", "We see open banking is an important global trend and a significant opportunity and believe that our leadership in data privacy as well as our scale in real time and cross-border payments are very good [Technical Issues] key to optimizing open banking solutions for banks, for fintechs, for merchants and for consumers globally.", "Now beyond payments, we made good progress on our digital identity solution. Here digital identity is aiming to allow individuals to own, control and share their identity credentials their way on the devices they use every day. We believe that our commitment to the responsible handling of personal information, letting consumer [Technical Issues] ownership of their own data and giving them control over which data is used and how it is used is critical to our consumers increasingly digital life.", "Mastercard's network is able to check a consumer's chosen credentials and confirm them for the intended recipient and purpose without ever taking possession of the underlying Identity data. So Mastercard is uniquely positioned in this field, given our experience in governance and operating [Technical Issues] our focus on financial inclusion, our announced and clear sensitivity of data privacy and our commitment to investment in a global, interoperable infrastructure.", "We recently launched pilots in public and private institutions in Australia, which actually is one of the countries at the forefront of digital identification, and this set of pilots enabled participants to use their digital identities to access certain government and student services. We've also additional digital identity [Technical Issues] and pilot, if you would see us introducing in more markets throughout 2020, and we look forward to continuing to innovate and grow and embed ourselves on this front.", "With that, let me turn the call over to Sachin for an update on our financial results and our operational metrics. Sachin?" ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Ajay. So turning to page 3, you will see that we have delivered strong performance in the fourth quarter to end the year. Here are a few highlights on a currency neutral basis and excluding special items, as well as the [Technical Issues] losses on the company's equity investments.", "Net revenue grew 17% driven by solid broad-based momentum in our core products and services. Acquisitions contributed approximately 1 ppt to this growth. Total operating expenses increased 12%, which includes a 4 ppt increase related to acquisitions.", "Operating income grew by 22% and net income was up 25% reflecting our strong operating performance and which includes a 2 ppt and [Technical Issues] ppt reduction due to acquisitions respectively. EPS grew 28% year-over-year to $1.96, which includes a $0.05 contribution from share repurchases and $0.02 of dilution related to our recent acquisitions.", "During the quarter, we repurchased about $1 billion worth of stock, and an additional $438 million through January 27, 2020. So now let's turn to page 4 where you can see the operational metrics for the fourth quarter. Worldwide gross dollar volume or GDV growth was 12% on a local currency basis down 2 ppt from last quarter, primarily due to the impact of the differing number of processing days between periods, as well as some lapping of previous wins.", "US GDV grew 9%, down approximately 3 ppt from last quarter with credit and debit growth of 12% and 7% respectively. Outside of the US, volume growth was 14% down 2 ppt from last quarter. Cross border volume grew at 16% on a local currency basis, driven by double-digit growth across most regions.", "Turning to page 5, switched transactions showed strong growth at 19% globally, reflecting in part the ongoing adoption of contactless. We saw healthy double-digit growth in switched transactions across most regions. In addition, card growth was 5%. Globally, there are 2.6 billion Mastercard and Maestro branded cards issued.", "Now let's turn to page 6 for highlights on a few of the revenue line items, again described on a currency neutral basis unless otherwise noted. The 17% net revenue increase was primarily driven by strong transaction and volume growth, as well as strong growth in our services offerings, partially offset by rebates and incentives. As previously mentioned, acquisitions contributed approximately 1 ppt to this growth.", "Looking quickly at the individual revenue line items. Domestical assets grew 14% while worldwide GDV grew 12%. The 2 ppt difference is primarily driven by pricing. Cross-border volume fees grew 16% in line with cross-border volume growth of 16%. Transaction processing fees grew 18% while switched transactions grew 19%. The 1 ppt difference is primarily driven by mix. Finally, on other revenues, which were up 25% including a 4 ppt contribution from acquisitions [Technical Issues] the remaining growth was primarily driven by our cyber and intelligence and data and services solutions.", "Moving on to page 7, you can see that on a currency-neutral non-GAAP basis, total operating expenses increased 12%. This includes 4 ppt related to acquisitions, as well as 2 ppt related to the differential and hedging gains and losses versus the year-ago period. The remaining 6 ppt of growth related to our continued investment in strategic initiatives such as [Technical Issues] safety and security, geographic expansion, and new payment inflows.", "Turning to slide 8, let's discuss what we've seen through the first three weeks of January where each of our drivers are generally consistent with what we saw in Q4. The numbers through January 21st are as follows. Starting with switched volume, we saw global growth of 15% similar to the fourth quarter. In the US, our switched volume grew 11%, switched volume grew -- switched volume outside the US grew [Technical Issues] 18%. Globally, switched transaction growth was 19% similar to the fourth quarter.", "With respect to cross-border, our volumes grew 15% globally, down 1 ppt sequentially. For the year, we expect cross-border growth to be in the mid-teens range and this is contemplated in our thoughts for revenue growth for the year. Turning now to slide 9 and our thoughts for 2020. We expect the economic outlook to be similar to what we saw in 2019. Our business [Technical Issues] remain strong with growth driven by a mix of new deals, renewed agreements, and the expansion of our differentiated service offerings. We expect net revenue to grow at a low teens rate on a currency neutral basis, excluding acquisitions.", "Rebates and incentives growth is expected to be higher year-over-year, driven by renewed and expanded deals that Ajay just commented on. In the first quarter, net revenue growth is expected to be about 2 ppt lower than this annual estimate [Technical Issues] primarily due to higher growth in rebates and incentives. We expect that net revenue growth will increase throughout the balance of the year as we implement new wins and fees related volume.", "Foreign exchange is expected to have a minimal impact to annual growth, but is expected to be about a 1 ppt headwind in the first quarter. In terms of operating expenses, we expect growth for both the year and the first quarter at the high end of the high-single digit range on a currency [Technical Issues] basis, excluding acquisitions and special items. This is driven by our continued investments in digital, analytics and security products, and platforms to address new payment flows. Foreign exchange is going to have a minimal impact to opex growth for both the year and the first quarter.", "Turning to M&A. As you know, over the years, we have used acquisitions to supplement our organic efforts and diversify our revenues. You have seen this in areas such as data analytics, cyber and intelligence, loyalty [Technical Issues] and developing multi wave solutions for our customers. This has helped expand our addressable markets, drive new revenue streams and strengthen our core product solutions.", "As a reminder, we are disciplined in our approach, as we work with our acquisitions to breakeven within 24 months of close. With that context, let me outline the expected 2020 impact of our recent acquisitions, which are progressing well.", "In terms of net revenues, we expect acquisitions to add about 2 ppt [Technical Issues] for the year and about 1 ppt for Q1, assuming that the transaction with Nets closes in the second quarter, which is our current estimate. For opex, acquisitions are expected to add an additional 7 ppt to 9 ppt to growth for both the year and the quarter. For the year, this estimate includes the full year effect of the acquisitions made in 2019 including purchase accounting and integration-related costs. This also assumes the anticipated closing of the transaction with Nets.", "A couple of other items of note beyond acquisitions. In other income and expense line, we are at a quarterly expense run rate of approximately $50 million based on our current debt levels. This excludes gains and losses from our equity investments. With respect to tax, you should assume a tax rate of approximately 17% to 18% for the year.", "So just to sum all of this up. 2019 was an excellent year both in terms of financial performance and in setting us up for the [Technical Issues]. We have signed a number of important deals, developed a strong pipeline of products to address growth in the short, medium and long-term and made several acquisitions to broaden our capabilities. We are pleased with the progress we are making and our outlook for 2020 is for continued strong growth.", "With that, let me turn the call back to Warren to begin the Q&A session." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Marcella, we're now ready for the Q&A session." ] } ]	[ { "name": "Operator", "speech": [ "[Operator Instructions] Your first question comes from the line of Eric Wasserstrom from UBS. Your line is open." ] }, { "name": "Eric Wasserstrom", "speech": [ "Thanks very much, and good morning. Ajay, I just wanted to see if we could get an update on the progress on Mastercard Track. And in terms of the US experience and maybe Australia, which I think was also recently initiated in the past year." ] }, { "name": "Ajay Banga", "speech": [ "Yeah. So Track actually, you've got different elements. So Australia was part of the whole B2B [Technical Issues] hub we are referring to. The US also had a B2B hub but Track is an overall approach to the B2B payment space. That starts with having the right merchant directories, and then connects sort of small business and business directories that are all compliance run through and the fully informed directory attached to a invoice presentment engine but also enable to payment optimization engine and a reconciliation system. That's all built inside, then it uses [Technical Issues] distribution channels, one of which is something like the B2B hubs that we have talked about in the past. But you can also go to what are issuers' agents and buyers' agents, and there is a whole ecosystem there that we're getting into and putting our footprint into.", "So that's kind of where we are. We piloted during 2019 with customers the full business payment service kind of solution, which we've been developing in the US and in fact also in Latin America, we are rolling it out globally starting in the US in the first quarter [Technical Issues]. You will get to more geographies and more payments over time, that's what we are at, that's where we are going." ] }, { "name": "Eric Wasserstrom", "speech": [ "Okay. And if I may just have one follow-up on that. To the extent that -- to what extent is the, are the volumes and revenue benefits from the Mastercard Track hub in the SME B2B space contemplated in the 2020 outlook?" ] }, { "name": "Ajay Banga", "speech": [ "As we told you when we were discussing this at Investor Day as well, this [Technical Issues] more developed. For example, our corporate purchasing cards, our fleet cards, our SME cards, our virtual account numbers, our cross-border travel payment systems, those are all relatively well developed and are well factored into the way we think about 2020. The B2B hub to an extent because it's got Bank of America, First Hawaiian and Fifth Third in the US, and MYOB in Australia, but that's like four customers across the world.", "And for a company of our size, well that's important for B2B [Technical Issues] bigger picture. What we're really talking about is adding those on over the course of the next two years to three years. So we don't have that built in any great way in 2020. If we knock the lights out of that that will be great, but I have a view that this kind of thing takes a little time. Remember as I explained the ecosystem, not only do you build the technology across all of those phases. You also have to sign up all the distribution that enables you to connect with this relatively new ecosystem that tracks specifically them." ] }, { "name": "Eric Wasserstrom", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Tien-tsin Huang from JP Morgan. Your line is open." ] }, { "name": "Tien-tsin Huang", "speech": [ "Thanks, good morning. Great results here. I was encouraged to hear the mid teens outlook for cross-border. I think getting a lot of questions on the Corona virus and how to maybe frame that's all I'll ask you guys, if you don't mind. How much of your cross-border book is tied to the China region? And is there a way to maybe look back or reference SARS or swine flu or something else to maybe give a clue on what -- what this one might do? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Hey Tien-tsin, good morning, it's Sachin. Let me give you a little bit of a color on cross-border, right. So as I mentioned, we could see double-digit growth across most of our regions as it relates to cross-border. And as I kind of sit back and I think about, it would be a good solid steady performance coming out of the US. As it relates to EMEA, and that's Middle East and Africa and Asia Pacific as well, we continue to see solid growth. We saw some softness in [Technical Issues] and Mexico, a function of the local environment out there, but by and large the business is running in a very healthy pace.", "To your specific question around the impact of the Corona virus, here's what I'll tell you. It's early days. Fortunately, a decent portion of our inbound and outbound cross-border from China is e-comm related. So it provides some level of a hedge. And we will continue to monitor the environment. It's too early to tell at this point in time, how this thing plays out." ] }, { "name": "Ajay Banga", "speech": [ "Remember, Tien-tsin people have bought air tickets and they still time it out for the Lunar New Year. Now if this thing goes much bigger, and becomes a much more sort of urgent and immediate crisis across many parts of the world, then we'll take a look at those numbers once again. But you're going to take this as it comes, one step at a time, and that's the only way to look at this carefully. Because remember when SARS was on, and that was way back in the early part of the last decade in 2003 and 2004, the total business in China was also smaller. The total size of our company was also smaller, and our ability to be a real player in cross-border across many corridors 18 years ago was very different. So I kind of wouldn't go too much on that. I would rather think about the natural hedge that e-commerce provides, the fact that there's still a lot of travel there but that could change over the next few weeks. And we will keep an eye on it, very carefully." ] }, { "name": "Tien-tsin Huang", "speech": [ "Okay. Now that's helpful, thank you for that. Just real quick follow-up if you don't mind, just on the -- I think I heard you say, Bank of America Mastercard Send that was an exclusive arrangement, is that the case? And I'm curious if that's maybe a new model that we can -- we can expect with that product?" ] }, { "name": "Ajay Banga", "speech": [ "Factually correct, you did hear correctly. Your ears are in good shape, Tien-tsin, even if you had an airpod shoved inside, but I'm not a -- I can't tell you if that's a new model going forward. It's the way that in this particular case, Bank of America found value from what we are doing. I don't know yet [Technical Issues] these don't make a trend." ] }, { "name": "Tien-tsin Huang", "speech": [ "Great, thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Craig Maurer from Autonomous. Your line is open." ] }, { "name": "Craig Maurer", "speech": [ "Yeah, hi, thanks. I had a question about recent acquisition activity in the space. Your largest competitor seems to have gone in a somewhat different direction from what we've seen from your acquisitions, and I wanted to get your updated thoughts on acquisitions that moved Mastercard closer to the consumer or closer directly to the merchant. Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Hi, Craig. We've done it -- well closer to the consumer. You got to remember we are a B2B2C company. And so what we are not trying to do is get in between our customers and their consumers. That's really not. What we are trying to do is to provide services or capabilities or product sets [Technical Issues] that enables that customer to be a merchant. It could be a government funded authority, a bank, or fintech reach their consumer better. That's yes, 100%, that we are into.", "So for example, and your specific question are around how you reach fintechs and the like. I'm assuming that's fair. The reference to our competitor comes from -- we've built a series of capabilities in Europe where as you know PSD2 has changed the layout between fintech and banks, very substantive there. And there we are actually live with the whole idea of connect, protect and resolve and consult capabilities across a number of fintechs and banks and AISPs and PISPs and all the terminology that has now become part of the day-to-day conversation in Europe.", "That's a fairly strong position for us. What I do want to make sure in all of this with merchants, for example, your question on merchants, we've done a series of transactions that provide data analytical and cyber security services to merchants. Ethoca is a most recent example. RiskRecon is even more recent than that. Loyalty rewards schemes that we bought some years ago are connected to that. Brighterion does a series of things with merchants and banks and fintechs.", "So most of our acquisitions kind of cross this ecosystem. What I am committed to, is to doing it in a way that respects the rights and the privileges of all the different players of the ecosystem, and doing it in a way that [Technical Issues] data and privacy all through the system. So we will keep looking for acquisitions that enhance those few words I just mentioned. Security and privacy of data, these responsibilities and rights and the priorities of different players in the ecosystem. You'll see us doing that very carefully, very sensibly and keeping at it." ] }, { "name": "Craig Maurer", "speech": [ "Okay. If I could ask one follow-up. Just on the guidance, what's the thought process for rebates and incentives for the full year as a percentage of gross revenue?" ] }, { "name": "Sachin Mehra", "speech": [ "Sorry, could you say, you broke out there Craig --" ] }, { "name": "Craig Maurer", "speech": [ "Yeah, yeah. Sorry, sorry." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah I think I got rebates and incentives. Your question was what's the guidance on rebates and incentives? I'm not going to give you specific guidance, but what I will tell you is we do expect the level of growth in rebates and incentives to pick up in 2020. That's on the back of the deals, which we've signed, that's all of the news as far as I'm concerned, because the way it kind of plays out is these are new and expand [Technical Issues] these expanded deals come with incremental volume. All of that kind of plays into the thoughts I've shared for 2020." ] }, { "name": "Craig Maurer", "speech": [ "Okay. Thank you." ] }, { "name": "Ajay Banga", "speech": [ "Hey, Craig, one last point on acquisitions. You should expect us to remain relatively committed to the idea of buying something that can breakeven at the end of the year too. And then it becomes part of our base. We no longer pull it out and you should expect that discipline from us. I believe that adequate targets in the ecosystem, [Technical Issues] our priority areas that can help us grow while doing that in a way that transforms our company as it has done for the last 10 years in a sensible way, that is the right way to approach the value of an acquisition." ] }, { "name": "Craig Maurer", "speech": [ "Okay, thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Lisa Ellis from MoffettNathanson. Your line is open." ] }, { "name": "Lisa Ellis", "speech": [ "Hi, good morning guys. So looking for a few comments on China, not on the Corona virus, just more broadly. It feels like with the recent trade agreement and then some of these announcements with Alipay and WeChat Pay opening up their wallets to cards, PayPal's I guess recent acquisition of GoPay there, it feels like the market might actually finally be loosening up. But on the other hand, we felt this way before. Ajay, I was just kind of curious, what's your current sort of optimism level around Mastercard getting access to the domestic China market, sense of timing likelihood. And then an updated view maybe on how you're thinking about approaching this market, given it's so different from others around the world. Thank you." ] }, { "name": "Ajay Banga", "speech": [ "Yeah. Lisa, I'm going to have to take away anything to do with the Corona virus, I have obviously no answer, because that's got an impact that I don't yet know how to predict specifically for China. I mean we as a company had on that particular topic, we've actually given our employees two extra weeks to work from home, using that ability so that we try to help them manage their own families and their own situation, in a way that's responsible for them. So we are clearly [Technical Issues] nervous like everybody else is, about what's going on there. So just move on from that. And I've said the trade deal itself, it is the first time that I've seen a trade deal where companies are mentioned by name, in terms of what should be agreed upon between two different governments in a bilateral trade deal.", "I hope that means that all of us will get a better chance to play in the domestic ecosystem in China and then we will bring them our [Technical Issues] party and then we will fight and win what we can win. We are late to the party because the digital players there have already built substantially good businesses and frankly very good offerings. So they deserve to have won, what they have won. The question would be how do we then break in and how well do we do in that and that's going to be our task in China. My general attempt about that part of the business is, I've seen this movie earlier, I'm going to only say anything about [Technical Issues] actually see something in writing that changes what our position on the ground is. Meanwhile, we're doing things. We publicly, there's been speculation that we are looking at partners to be able to go into the domestic processing business with. That's kind of one angle, which everybody is looking at, so are we. There's clearly an effort to build out the acquiring footprint, so that our acceptance expansion can begin to happen. There's an effort to build out the issuing relationships so that that hit the ground running.", "Meanwhile, you referred to Alibaba and WeChat accepting our cards into their domestic wallet, that's also been part of some effort. There's conversations going on with them on all kinds of partnership opportunities where we may compete or may not compete. So it's kind of -- there's a lot going on in China. We are hiring people. We've been doing that for the last two years or three years. We're building talent and skills on the ground. So kind of that's where we are. And I think my approach to the market there is, there will be infrastructure capability, build acceptance, build the right partnerships, build people and skills on the ground and learn how to do that in a market that is as you said dramatically different from the others. So, I think local presence, local knowledge and local capability is going to be really important in China." ] }, { "name": "Lisa Ellis", "speech": [ "Terrific. And then maybe as my follow-up, just a quick update on the contactless deployments in the US. Do you have any updated stats on sort of where we are in terms of card issuance, merchant acceptance? And are you expecting in the 2020 outlook, an uptick in US volumes as a result of that, or is it more of a 2021 dynamic? Thank you." ] }, { "name": "Ajay Banga", "speech": [ "I'm pretty certain that US contactless associate growing throughout 2020 quite attractively, because if you look at the numbers of -- the number of bank partners that have committed to issue contactless cards, for a minute, let's even forget Apple Pay and Samsung Pay that enable every card through their RFID devices to be used. If you just look at the number of cards, we are talking about 70% of our total cards in the US market will be reissued over this 12 month to 14 month period. My own personal cards are already contactless from Citi. And so, I think you will see that happening, Cabela's is doing that. There's a bunch of others that are actually deeply embedded into the idea of contactless cards.", "On the acceptance side, as you know, all new terminals going out are embedded with contactless. So [Technical Issues] the large retailers like Target and 7-Eleven and CVS have announced that they will accept contactless payments. And in fact, over half of US card-present transactions are now happening at contactless enabled merchant locations. And when the MTA rolls it out systemwide in New York City there are other transit systems beginning to do the same in their cities, I think you will get the impetus. Some of it will come in 2020, to your earlier question. More of it will come in 2021. But outside the US that kind of growth pattern is pretty strongly embedded. You know that in Australia, over 80% of transactions under AUD100 are contactless. So there is a lot going on in that space." ] }, { "name": "Lisa Ellis", "speech": [ "Excellent. Thank you. Nice quarter as always guys, thanks a lot." ] }, { "name": "Ajay Banga", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Chris Donat from Piper Sandler. Your line is open." ] }, { "name": "Christopher Donat", "speech": [ "Good morning. Thanks for taking my question, and thanks for the work on contactless as an NPA writer, I deeply appreciate not having to swipe anymore. The question I want to ask, Ajay, was about the other revenue and the percent -- or the portion of that that's organic. Just how sustainable is this roughly 20% level of growth in organic other revenue and/or is it even possible to accelerate with some of your work on the data and other offerings?" ] }, { "name": "Ajay Banga", "speech": [ "Sachin, go ahead." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. Hey, Chris. Sure. Hey, Chris. So very quickly some color around the other revenue line item, right. I mean, you've seen that in Q4, we've talked about 25% growth rate in other revenues. That had about 4 ppt coming from acquisitions. So that's why you come up with your number of about 20% for Q4. Let me give you some context. There are three main components, which are there in other revenues. Some of our services lines roll up here, things like cyber and intelligence products, data analytics, consulting and managed services as well as loyalty, right. A significant portion of [Technical Issues] recurring in nature. Although there are some such as consulting and loyalty engagements that are project-based and can have some timing between quarters.", "The second item which is there in other revenues is our Vocalink related revenues. And again this is recurring in nature. And finally, we put a number of our recent acquisitions and I know you said net of acquisitions, but remember the acquisitions, which we have done will at some point in time become the equivalent of organic growth, to your sense. And we put those into the other revenue because of the [Technical Issues] model. So net-net-net, I would tell you a decent portion of other revenues is recurring in nature, although we are not providing specific estimates for this line item, I will say other revenues excluding acquisitions. We expect that will grow faster than the overall company growth rate." ] }, { "name": "Ajay Banga", "speech": [ "Just remember that the -- a lot of the acquisitions are basically either meant to enhance what Sachin started with, which is our data analytics capability or our cyber and security capability or our management [Technical Issues] loyalty capability. A number of them, not all of them, a number of them. When you do that and two years into acquiring them to become part of a base, they then become part of organic revenue and expenses.", "So we have to manage the business in a way that at the end of the second year breakeven each of them individually and then starts becoming margin accretive in the third year. That's the discipline that's embedded inside the P&L line by line with each business that acquired single entity during the year. Absolutely, I expect that organic growth will continue to be good in that line item. And as Sachin said probably higher than that of the whole company." ] }, { "name": "Christopher Donat", "speech": [ "Okay. And just as a follow-up, Sachin, on the project-based component of that, is that, that's relatively small though, right. The recurring component of the other revenues much more significant. Right." ] }, { "name": "Sachin Mehra", "speech": [ "[Technical Issues] The recurring component is more significant than the project based component. As I mentioned, it's the project-based stuff is typically our consulting and managed services, so this is -- and loyalty pieces. But then again you go back into cyber intelligence recurring in nature, Vocalink recurring in nature, a lot of these things are things where you signed agreements and then they kind of stay in play for some time. So, yes." ] }, { "name": "Ajay Banga", "speech": [ "There's been a lot of effort that has gone into convert some of the non-recurring into recurring in the manner in which we sign deals and have to work with partners. [Technical Issues] the idea of what we like is recurring revenues, but that's non-recurring because it opens it all." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Darrin Peller from Wolfe Research. Your line is open." ] }, { "name": "Darrin Peller", "speech": [ "Hey, thanks guys. I just want to hone in a little more on cross-border for a minute just given that it did show a little bit of a deceleration into January, I think you said 15% and comps do get easier. So just, I know you talked about mid-teens for the year. But can you give us more color on what type of activity you're seeing in terms of specifically e-comm versus travel. And then I don't think I've ever heard you update what the e-comm percentage of cross-border actually is, if you can help us with that." ] }, { "name": "Ajay Banga", "speech": [ "Yeah, so on cross border. First, I would just kind of caution and say, we're three weeks into the month of January and the 1 ppt decline, which we're seeing between 16% in Q4 and 15% in the first three weeks of January, I wouldn't make too much of that, right. Hence the comment which I made about [Technical Issues] we still expect mid-teens from a cross-border standpoint. Just but more specifically around some color on what we're seeing on cross-border standpoint, steady growth in the US, right. As it relates to our card-not-present cross border, we see that approximately 20% and that's fairly consistent as we've seen over the past few quarters. As it relates to region by region, in Q4, our APMEA region, which is a combination of Asia Pacific and Middle East and Africa saw some [Technical Issues] as I mentioned earlier. And on the flip side, in LAC, we saw some level of weakness in Mexico in particular. But there are puts and takes every quarter on this. That's really the color which I've got. It's steady as it goes as far as growth right now. And then we'll pick it up from there." ] }, { "name": "Darrin Peller", "speech": [ "All right. Just a quick kind of housekeeping, I mean you still expect Nets to close, I think you said first half. I just want to verify that. And if you could remind us of any potential financial impact that we should expect on the year with that on the top and bottom line. And then also when you think of, Ajay, just make sure that deal doesn't preclude you from doing other meaningful deals this year, are you really on the active hunt right now for something in the first half?" ] }, { "name": "Ajay Banga", "speech": [ "So on the deal front, as I said earlier, we look at 40, 50, 60 deals in a year. And in some years we close none or one or two. And last year, we provided more than that number. And [Technical Issues] people who are like [indecipherable] in Santa's Shop, they're working very hard on this [Technical Issues] I'm sure you like that reference. And they're working really hard on this thing, right and they produce stuff and then we kind of look at it and say that one doesn't make sense either because it doesn't fit our strategic profile or the M&A numbers don't make sense or that somehow it doesn't respect those principles I was speaking about when I was asking Craig's -- answering his question.", "Or some of them do and then yet others get lot longer because the negotiation doesn't work out or the due diligence scares the heck out of us. And so it just carries on like that, I don't know how to give you an answer. I would tell you, nothing's changed. I've been on the hunt from the day I joined and still in the hunt." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. I'll just add to Ajay's comment, you asked specifically about Nets. Obviously, we're going through the regulatory approval process as we speak right now. It's our estimate to close Nets in the second quarter of this year, that's the basis of what I've given in the nature of thoughts for 2020, where I kind of mentioned to you that on a portfolio basis, we expect about 2 ppt contribution from acquisitions on revenues and so we're in that 7% to 9% growth in opex related to acquisitions." ] }, { "name": "Darrin Peller", "speech": [ "All right, guys. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Trevor Williams from Jefferies. Your line is open." ] }, { "name": "Trevor Williams", "speech": [ "Hi, good morning and thanks for taking my question and sorry to pile on the China theme, but I'm just curious on the outbound cross-border volume from China. So is China UnionPay and WeChat and Alipay have been partnering more with acquirers globally to expand their acceptance footprint outside of China. I guess I'm just wondering, longer term, how much of a risk you think there could be to your outbound cross-border volume just if acceptance of those three big Chinese players reaches critical mass, just at least in the major tourist hubs. And I'm not sure if I caught this, in response to the question from Tien-tsin. But I was just wondering what percentage of cross-border is Chinese outbound?" ] }, { "name": "Ajay Banga", "speech": [ "Second part, is there any [Speech Overlap] The first part, I can tell you what's was going on. I mean look first of all, this is not a new issue of these bilateral agreements between both card and the Chinese digital wallets with players outside. You should know that card specifically is concerned because the way the Chinese rules changed over time, what used to be a dual branded card which are still a large number of that, all the new issuance is single branded. So banks that are issuing our cards in China and we are issuing lot of cards there every year. Those are all now single branded and therefore when they go overseas those cards can only be running on Mastercard rails and their transaction [Technical Issues] taken on to somebody else's risk, that's just factual.", "And so just as there is a put and a take on both sides of that, similarly in the case of digital wallets outbound while in -- both inbound and outbound used to be not us playing in Alipay and WeChat. You've now known and seen that they have announced for inbound and there is always ways for them to work with them like they are already doing on different aspects of their outbound work. Will that lead to a complete, open system or not? I don't know. Will that change? We have been also operating domestically, because the total scale and size of our operation with them will change. I don't know, we'll see.", "Meanwhile there's, a lot of volume that comes out of China, which has been enabled by the new digital players that I don't believe is going away from us. This is -- it's the bigger size of the pie game that we are also talking about. And so our growth on cross border out of China has been relatively healthy. It goes through its quarterly ups and downs, it goes through stuff but it's relatively healthy and I presume that will stay that way over the next few years.", "Obviously, Corona virus and stuff as we discussed already could change a quarter here or quarter there. I don't know that yet. And we are very carefully keeping an eye on it, but in the big picture, I still see lots of opportunity on our cross border from China." ] }, { "name": "Trevor Williams", "speech": [ "Okay. Now, that's really helpful. Thank you. And just one quick follow-up. I was hoping to just get a little bit more color around some of the mix dynamics. So I know last quarter was a bit unique, you had negative mix across domestic assessments cross-border and transaction processing. On the domestic assessments, there was a couple hundred basis point benefit this quarter just with pricing, but it looks like transaction processing was lower again due to mix, just relative to process transaction growth. Just curious anything there that you can provide just color wise to help explain the delta. Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, so our transaction processing growth rate, as you know switched transactions are growing at a nice clip at 19% and we're pretty much in line from a transaction processing fee standpoint. What I would tell you is, as the business grows, and as we do more in the nature of contactless payments so on and so forth and you start to proliferate down into smaller ticket payments, it does have an impact from a mix standpoint. You would expect to see that.", "It's depending on market and [Technical Issues] question, I wouldn't make too much of the disparity between the two. The other thing I would tell you is in transaction processing fees there are line items, which are beyond just the high correlation to switched transactions. In other words, some portion of our services related revenues also are comprised in the transaction processing fees." ] }, { "name": "Trevor Williams", "speech": [ "Okay. No, that's very helpful. Thanks guys." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Jason Kupferberg from BoA. Your line is open." ] }, { "name": "Jason Kupferberg", "speech": [ "Thanks, good morning guys. Wanted to start with a question just on US credit volume growth still remains quite robust here. I'm wondering how many more quarters of tailwind do we have from Cabela's before that lapse? Are you seeing any noticable uptick from the Apple Card, Venmo card or any commentary on kind of the consumer versus the commercial pieces of US credit? And just at a high level trying to get a sense of the sustainability of these double-digit levels as you do get to some tougher comps I think in the next few quarters." ] }, { "name": "Sachin Mehra", "speech": [ "Hi Jason, it's Sachin. So very quickly I want to give you a little color on -- I mentioned earlier about, in my prepared remarks, something about lapping wins. The Cabela's portfolio has begun to lap, right as part of our Q4 metrics, as I mentioned earlier. So also Krogers but then for all the market share wins, which we've had over the course of the last 12 months, that's starting to roll on. So you are starting to see some of the effect then in the nature of Apple Card, so on and so forth.", "Also I will mention that we talked about the deals we signed with Citi, and Capital One. We would expect that, that will also start to roll-in. So there will be puts and takes, there will be previously won portfolio which will lap. And then there will be new portfolios and new market share wins, which will come in. So all in all, a good performance from a credit standpoint in the US, as you mentioned." ] }, { "name": "Jason Kupferberg", "speech": [ "And just one for Ajay. I'm curious to get your thoughts on synergies potentially between Nets and Vocalink. I know there's some differences there in geographic exposure, but are there some broader enhancements to your alternative network capabilities from the Nets deal, or are these just kind of separate offerings for different segments of the real-time payments market?" ] }, { "name": "Ajay Banga", "speech": [ "Yes and yes actually, it's a really good question. Yes and yes, actually. So it's a really good question. What you are buying with Nets Corporate Services in the Nordics is not just the similar thing to what Vocalink does. So Vocalink both operates the infrastructure, provides for the software real-time payments as well as batch processing and ATM [Technical Issues] but also provides applications and services on top of that infrastructure in the United Kingdom.", "That is more similar to the 327 deal that we have signed in the Nordics where with the banks in the Nordics, we are going to implement fast and real-time payments capabilities using Vocalink's sort of structure and then operate it for them in the Nordics. We are doing that in a number of other countries around the world. We're doing it in different flavor, some of them are software deals, some of them we will operate everything [Technical Issues] Saudi, Peru, the Philippines and so on, right? So there's that element.", "The Nets Corporate Services piece, that we've bought in -- that we are trying to close on in the second quarter of the Nordics, actually provides for using all those underlying services for payments and bills and they connect all the B2B payment systems, they connect all kinds of players in the Nordics and outside of the Nordics with Nordic players. So, that's a whole different capability. We are quite hopeful that we can apply both these solutions to different segments as well as enhance each other's capabilities in different markets around the world. So Paul Stoddart who runs all this for us and came out of Vocalink. He used to be the Chief Operating Officer of Vocalink when we first bought them.", "Paul is kind of the guy who is running all this for us and stitching it together over the next period of time. It's a great question." ] }, { "name": "Jason Kupferberg", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Joseph Foresi from Cantor Fitzgerald. Your line is open." ] }, { "name": "Joseph Foresi", "speech": [ "Hi, I was wondering if you could talk about the margin profile of the business, short and long term. I know you've given comments in the back past that you don't run the business to the margin, but given the differences between you and your competitor, I was wondering if you could give a little bit more color on your, on the progression or cadence there?" ] }, { "name": "Ajay Banga", "speech": [ "My view has been that we will -- it's a mathematical calculation on business in some ways. So long as you keep revenue and the margin appropriately and you manage your expenses right, this business has a higher fixed costs in a lower variable cost per transaction. If you add more capacity and you pump more volume through it, you will find us growing at the margin, even on your operating margin, that's just math. What's changing along the way is that we are trying to take that math and apply that surplus we get to building and diversifying the revenues of this company and those -- when you acquire those businesses, they may not follow that. But over time they get there as a number of our services businesses used to be less recurring back to an earlier question, now they have got a much higher profile of recurring revenue.", "A number of our services businesses, their margins have grown over time as the volume being put through them. Thanks to their access to our network of distribution and partners increases. So our attitude toward our margin is healthy growth, not kind of pushing that at what we've managed to. We managed gross and net revenue and we managed to expenses and we managed that kind of space for our future. We don't actually manage to margin. That's why I said, we'll keep a healthy margin of 50 plus because I want you to know I'm not going to throw money away, kind of my reference to even the acquisitions and the discipline around the acquisitions, but the idea is that we would eventually, always through math, be growing sensibly. You could see it over the last few years." ] }, { "name": "Joseph Foresi", "speech": [ "Got it and then just as a follow-up [Speech Overlap] Okay, great. I appreciate it. Well, this will, I'll make it a softball then. So you can end on a good note. [Speech Overlap] yeah, well, I'll do my best now. Focus is on it, right. So, but you've done a great job of expanding your addressable market into new areas. We talked about B2B and contactless and I know China is on the horizon, maybe over the long term. Which of these areas are you most excited about in the short term over the next year? Where should we be spending our time because there's just it seems to be an expanding amount of areas in their expanding addressable market? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "I think over the short term, we should continue to remain very focused on our cyber and intelligence services business and you should look forward to more growth in contactless. Everything else just by the nature of the ecosystem that we work in, has a longer time to result than these. These ones we are able to put to a solution system, in a form that enables us to have a little more control over the outcome than we would in the others and we got to work everybody toward it." ] }, { "name": "Joseph Foresi", "speech": [ "Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "All right, thanks, any final comments Ajay." ] }, { "name": "Ajay Banga", "speech": [ "Yes, sir. First I want to wrap up very quickly. Thank you for all your questions. We've had another strong year. We've had broad based growth across each of our regions. With driving solid deal momentum, we're trying to capture new flows through the conversation, we were just having with our multi-rail capabilities. Our recent acquisitions are performing well within the [Technical Issues) that we've talked again today. We look forward to working with our new colleagues from RiskRecon. We've got another one, the Nets Corporate Services on the horizon. When that comes in, we are going to work hard with them and we are progressing well against the three-year performance objectives that we laid out for you for 2019, 2020 and 2021.", "With that, thank you all for being a part of this journey and thanks again for joining us." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
MA	2020-10-28	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": "President", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "William Blair -- Analyst", "name": "Bob Napoli", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "James Faucette", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "Chris Donat", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2020 Mastercard Inc. earnings conference call. [Operator instructions] I would now like to hand the conference over to your speaker today, Warren Kneeshaw, head of investor relations. Thank you.", "Please go ahead, sir." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you Casey, and good morning, everyone, and thank you for joining us for our third-quarter 2020 earnings call. We hope you are all safe and sound. With me today are Ajay Banga, our chief executive officer; Michael Miebach, our president; and Sachin Mehra, our chief financial officer. Following comments from Ajay, Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the investor relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website. With that, I will now turn call over to our chief executive officer, Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thank you Warren. Good morning, everybody. We are now a few quarters into the pandemic. And while individuals and businesses and society at large continue to face many challenges, we are also seeing some positive trends, both in terms of the trajectory of spending and the acceleration of digital payments that we are helping enable.", "For example, our SpendingPulse estimates for quarter 3 show U.S. retail sales up 1.8% versus a year-ago ex auto, ex gas. We've also seen positive numbers in countries like the United Kingdom. Looking at the trends.", "Volumes improved throughout the third quarter. In fact, if you exclude travel and entertainment which has been particularly hard hit, our switched volume growth rates in September were similar to what we saw before the pandemic in Q4 of 2019. Using our four phased framework, we have seen markets go through the containment and stabilization phases, and now we believe that most markets are in the normalization phase domestically with some approaching growth. And so consistent with this, we have seen our revenue going in the right direction this quarter as year-over-year currency-neutral growth was 3 percentage points better than last quarter, and the domestic spending trends so far in October continue to remain steady.", "Now we have seen some improvement in domestic travels in the quarter including spending in categories such as lodging and restaurant. Cross-border travel however remains constrained. And while we have seen some improvement in travel within the EU during the quarter, cross-border travel outside the EU has shown only limited recovery. We believe travel improved and consumer confidence recovered as a result of improved testing and safety protocols being put in place, medical advances occurring and as border restrictions are lifted and there is increased international coordination of travel across borders.", "When cross-border travel does improve, we will be very well-positioned to capitalize on that recovery. So overall, we see signs of improvement. OK, not out of the woods yet, but we are seeing in places like Europe restrictions being put back in place. As we said in the past, progress through the phases may not be linear.", "It's going to take some time, and it will be positively impacted by the broad availability of successful therapeutics and vaccines. During this time, we remain focused on the things we can control, continue to execute against our strategy, invest in our business for the longer-term and manage our expenses in a disciplined way. Our digital technologies help us drive the secular shift to electronic forms of payment that support our broad range of customers, banks, fintechs, neobanks and merchants. We are growing our core payment capabilities in credit, debit, prepaid and commercial with new and renewed deals.", "Our services which are helping our customers and consumers adapt to the changing environment, are continuing to grow well, and they provide meaningful differentiation and revenue diversification. And our multi-rail capabilities are providing choice to customers and consumers by addressing a wide range of payment flows. So with that, let me turn the call over to Michael." ] }, { "name": "Michael Miebach", "speech": [ "Thanks Ajay. Picking up where Ajay left off. We're positioning ourselves for the future by driving this accelerated shift toward electronic payments. According to our research, almost seven in 10 people globally say the shift will likely be permanent.", "We believe that as the economies reopen, people will shop in stores again. But e-commerce will remain elevated from pre-pandemic levels as behaviors have changed and payment preferences have shifted. Our research also shows that about 60% of consumers plan to use less cash even after the pandemic subsides. As a result, merchants are becoming more digital and consumers and businesses are adapting how they interact at the point of sale, both in-person and online.", "Regardless of how these trends play out, our solutions are available to support consumers, issuers and merchants. The debt preferences and needs evolve, be it in store or online. And we are partnering with digital enablers to bring our digital solutions to market at speed and at scale. Let me give you some examples.", "First, consumers. Consumers want choice. Whether they want to pay using contactless, card-on-file, QR or via installments, we are enabling that choice. Contactless growth continues to be fueled by increasing consumer adoption.", "In the third quarter, contactless penetration represented 41% of in-person purchase transactions globally, up from 37% in the second quarter and 30% a year ago. At the same time, we are enabling a safe and simplified experience for consumers across digital channels with our tokenization capabilities. This foundational technology is growing rapidly with the number of tokenized transactions doubling year over year in the third quarter, now accounting for 8% of our switched transactions. We're also enabling more consumers to participate in digital commerce.", "For example, Santander Chile has rolled out digital debit Mastercard to all of their Maestro cardholders. This quarter alone, we won deals that will lead to about 10 million Maestro cards being migrated to Debit Mastercard in the near future. Second, let's talk about issuance. We have a set of digitally enabled products and solutions that drive this accelerated secular shift including digital-first solutions tailored to fintechs and neobanks, and issuing plans with which we have an established leadership position.", "We're partnering with large global players like PayPal as we make the PayPal business Debit Mastercard available to businesses in five new markets in Europe, in addition to its current availability in the U.S., the U.K. and Germany. We've extended our deals with Nubank, one of the world's largest neobanks, and will maintain a leadership position with them in Brazil as one of the new markets as they expand their operations in Mexico and Colombia. Masterpass also helps fintechs build and scale their businesses.", "We've signed several deals with fast-growing neobanks around the world like Nickel in France and Bnext in Spain. Third, we're focused on helping merchants, merchants as they shift to digital and develop omnichannel capabilities. For instance, we launched a POS capability in India with Worldline and Axis Bank that transforms smartphones into point-of-sale terminals with the ability to accept contactless QR and remote payments. In the buy-now-pay-later space, in addition to our previous partner announcements, we recently announced the partnership with TSYS to deliver installment capabilities to issuers.", "In addition, we're also piloting simplified shopping experiences using AI and computer vision, such as enhanced drive-thrus at White Castle and Sonic and checkout-free pilots at Dunkin' and Circle K. And finally, we're partnering with digital enablers to bring our digital solutions to market. We just announced an expanded partnership with Marqeta, a digital processor, to introduce new products and launch additional card programs in new geographies. And talking about geographies.", "In Africa, we have partnered with Samsung, Airtel Africa and Assante to enable access to digital financing to consumers, entrepreneurs and merchants. In parallel, we're driving hard to grow our core products, leveraging these differentiated digital capabilities to set ourselves up well for the future. In the U.S., we are excited about our partnership with Chase to launch the new Freedom Flex Mastercard, offering card members cash back on everyday spend as well as our leading world of these benefits. We also expanded our relationship with Barclays Bank US which will now include new products and services in addition to their consumer and small business credit portfolios.", "In Europe, we continue to strengthen our position. We signed a regional agreement with the Santander Group for their card business, securing a long-term partnership. We're also extending our relationship with ING as they grow internationally. And we've agreed to a long-term renewal with Swedbank, our largest customer in the Nordics and Baltics which will become an exclusive Mastercard customer.", "The co-brand front in the U.S., the Wayfair Mastercard with Citi, has launched. And we will be the new exclusive network for the AARP credit co-brand program. In Canada, we have extended our co-brand relationship with Walmart. And we're happy that Taobao just launched its Mastercard co-brand issued by Bank of China in Hong Kong and Macau.", "We're also focused on positioning ourselves for the return of travel. This includes partnerships with Emirates Skywards on their first co-brand credit card in the U.S. and a renewal of our exclusive co-brand agreement with Miles & More, the largest travel and loyalty program in Europe on their German portfolio. It also includes the focus on travel-oriented portfolios like WEX that you've heard us talk about over the last several quarters.", "We're also working hard to improve cross-border approval rates and optimize portfolios, both cyber and intelligence and data and analytics services. Now speaking of services, it is important to note that our services have played a critical role in easing the wins I just mentioned. For example, our renewal and extension with ING will include our data analytics and data insights services. Services are immaterial driver of our revenue growth and a source of diversification while we help our customers adapt quickly and securely as they navigate through the pandemic into a rapidly digitizing world.", "One way we're helping our customers is through our cyber services and the use of artificial intelligence, an area we have been investing in both organically and inorganically. We have developed a broad set of scalable AI capabilities which have been integrated into our network, our products and services. And here are some examples. Citibank is assessing our AI platform to determine enhanced capabilities to mitigate credit losses.", "And Itau and Santander Mexico are using our AI to provide added security for consumers while ensuring good transactions are approved. And with that, let's turn to the account-to-account space, where we believe there are significant incremental flows to address. For the last several years, we've developed a set of assets to comprehensively address these opportunities in the infrastructure, applications and services layers. We believe this combination allows us to best address the broad range of customer needs.", "At the infrastructure level, we continue to make good progress with our build-outs and have a strong position in all major geographic regions including key markets like the U.S., the U.K., Nordics and Saudi Arabia. Building off our strong position in infrastructure, we're also making good progress in the application layer, utilizing our multi-rail capabilities. Starting on the consumer-to-merchant front. The Pay by Bank app in the U.K.", "which extends our ability to compete for everyday spend along with our debit products, is growing both in consumer accounts and merchant acceptance. With Barclays set to launch their 9 million mobile banking app customers before the end of the year, together with the customers already onboarded by HSBC, we will have around a third of the U.K. mobile banking customers enabled. We have streamlined our merchant onboarding process and currently have more than 700 merchants signed up, such as the WHSmith Group.", "And with our distribution partners like Worldpay and others, we are well-positioned to expand acceptance even further. In the Bill Pay space, several new partners will be supporting the Mastercard Bill Pay Exchange including FIS, WestCom Credit Union, Payrailz and MoCaFi on the consumer side and KUBRA, PNC Bank and CSG on the biller side. Bill Pay Exchange will now have access to approximately a third of bill paid annually in the U.S. and be able to reach about a quarter of active U.S.", "Bill Pay consumers. In the B2B, we continue to develop the ecosystem around Mastercard Track business payment service with Fiserv now live on the platform. We are also excited to announce an expansion of our long-standing strategic relationship with PayPal, who can now use Mastercard Send to power fund transfers to consumers and small businesses through all their brands including Braintree, Zoom, Hyperwallet and iZettle. And finally, we are continuing to make progress in the services layer including consulting, fraud prevention and a recent extension in the U.K.", "for our trace anti-money laundering services. In summary, we're managing our business through this normalization phase with agility. We're winning share and have good deal momentum. We're driving the accelerated shift toward digital payments, and our clients see us differentiating ourselves with our services.", "We see domestic volumes rebound and are positioning ourselves well for the medium- to long-term growth opportunity including the return of travel through continued investment in our strategic priorities. With that, let me turn the call over to Sachin for an update on our financial results and operational metrics." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks Michael. So turning to Page 3 which shows our financial performance for the quarter on a currency-neutral basis and excluding the impact of gains and losses on the company's equity investments. Net revenue was down 14% reflecting the impacts of the pandemic and include a 1 ppt benefit from acquisitions. Operating expenses were down 5% year over year or down 8%, if you exclude the 3 ppt impact of acquisitions.", "Operating income was down 20% and net income was down 26%, both of which include a 1 ppt decrease from acquisitions. EPS was down 25% year over year to $1.60 which includes $0.03 of dilution related to our recent acquisitions, offset by a $0.03 contribution from share repurchases. During the quarter, we repurchased about $2.1 billion worth of stock and an additional $392 million through October 23, 2020. So let's turn to Page 4 where you can see the operational metrics for the third quarter.", "Worldwide gross dollar volume or GDV increased by 1% year over year on a local-currency basis reflecting the effects of the pandemic. U.S. GDV increased by 4% with debit growth of 20% partially offset by a credit decline of 12%. Outside of the U.S., volume was flat.", "Cross-border volume was down 36% globally for the quarter. As we have previously mentioned, the pace of recovery in lower-yielding intra-Europe volumes is stronger than other cross-border which is higher yielding. Specifically, intra-Europe volume was down 23%, whereas other cross-border volume was down 49% as border restrictions were eased in Europe in advance of other locations. Turning to Page 5.", "Switched transactions showed growth of 5% in the third quarter globally. We saw positive growth in switched transactions across most regions, aided in part by the continued adoption of contactless that Michael mentioned earlier. In addition, card growth was 5%. Globally, there are 2.7 billion Mastercard and Maestro-branded cards issued.", "Now let's turn to Page 6 for highlights on a few of the revenue line items again described on a currency-neutral basis unless otherwise noted. The decrease in net revenue of 14% was primarily driven by a decline in cross-border volumes due to the effects of border restrictions and social distancing measures partially offset by growth in GDV switched transactions and continued growth in services. Our previously mentioned -- as previously mentioned, acquisitions contributed approximately 1 ppt to net revenue growth. As a reminder, the transaction with Nets did not close this quarter as previously expected.", "Looking quickly at the individual revenue line items. Domestic assessments were up 5% while worldwide GDV grew 1%. The 4 ppt difference is primarily due to favorable mix. Cross-border volume fees decreased 48% while cross-border volume decreased 36%.", "The 12 ppt difference is due to adverse cross-border mix mainly driven by a slower recovery in non-intra-Europe cross-border volumes that are high yielding than intra-Europe cross-border volumes. Transaction processing fees were up 1% while switched transactions were up 5%. The 4 ppt difference is primarily driven by the adverse cross-border mix I just mentioned. Other revenues were up 6% including a 2 ppt contribution from acquisitions.", "The remaining growth was driven by our Cyber & Intelligence and Data & Services solutions. Also just as a reminder, growth in other revenues was impacted by a difficult year-ago comp. Finally, rebates and incentives were up 2%. Moving on to Page 7.", "You can see that on a currency-neutral basis, total operating expenses decreased 5%. This includes a 3 ppt increase related to acquisitions which was lower than expected primarily due to a delay in the closing of the transaction with Nets. Excluding acquisitions, expenses decreased 8% which was also better than expectations primarily related to actions taken to reduce advertising and marketing, travel, personnel costs and professional fee-related expenses. Turning to Page 8.", "Let's discuss what we've seen through the first 3 weeks of October. One point to note, while the week ending October 21 shows higher growth metrics relative to the prior week, this is being primarily driven by the timing of significant promotional activity by an e-com merchant and their competitors. Through the first 3 weeks of October, each of the metrics are in line with recent trends, adjusting for this e-com promotional activity. Commenting on the specific metrics, starting with switched volumes.", "We believe that most markets are in the normalization phase domestically, with some approaching growth. When you look at how people are spending, card-present growth rates remain steady, with strength in retail categories such as groceries, offset by some declines in T&E. Card-not-present growth rates remain healthy. Trends in switched transactions remain steady, benefiting from increased contactless penetration.", "In terms of cross-border, intra-Europe continues to outpace other cross-border volumes. As previously mentioned, intra-Europe yields are lower than those of other cross-border volumes. So now turning to Page 9. I'd like to provide you additional color on the cross-border trends across card-present and card-not-present.", "You can see the trends that we laid out through the course of the quarter continue. The e-com promotional activity I referenced also impacted cross-border growth for the week ending October 21. In total, if you look at the gray line, total cross-border continues in a similar band. If you look at the orange line, card-present spend has declined slightly, following an uptick in travel over the summer holiday season.", "Card-not-present growth which is the yellow line on the chart, continues to be resilient and has held up well. The green line represents card-not-present excluding online travel-related spend and remains positive. We continue to see strong growth across retail categories, particularly in discretionary areas like clothing and home improvement as well as in non-discretionary categories such as groceries. This line was particularly impacted by the e-com promotional activity.", "One final point regarding all metrics. Given the recent increase in COVID-19 cases, we are closely monitoring the impact on spending of additional mitigation measures that are being put in place particularly in Europe. Turning to Page 10. I wanted to share our thoughts on the upcoming quarter.", "As we previously established, given the ongoing uncertainty, we will not be providing a forward view for net revenues at this time. We do intend however to continue to provide periodic updates to our operating metrics to help you understand the trends we are seeing. First, I'd like to make a few comments on how I see our business shaping up in light of the pandemic. The story in non-T&E domestic volumes is quite encouraging.", "Specifically, as Ajay mentioned, we are seeing volume growth rates ex-T&E in September, similar to what we were seeing pre-COVID in Q4 2019. The impact of the pandemic on travel, and in particular, on non-intra-Europe cross-border travel, remain significant. While we believe that cross-border will ultimately recover, it will take time for people to build their confidence in the safety of travel. And we believe that is tied to the broad availability of vaccines and therapeutics likely toward the latter part of next year.", "As a reminder, we will see improved growth rates due to lapping the effects of the pandemic before that starting in late March next year. All of this being said, we have always been well-positioned in the cross-border travel space, and we continue to build on this position of strength through various initiatives with existing and new partners as Michael commented on. This will enable us to capitalize on the recovery in cross-border when it does occur. With that as background, I'd like to make a couple of comments to help you with your modeling of revenues for the quarter.", "First, as you have seen, non-intra-Europe cross-border travel has seen minimal recovery since the onset of the pandemic. Given that these volumes are significantly higher yielding than intra-Europe cross-border, this has resulted in a slower recovery in our cross-border revenues. As a reminder, this negative mix impacts both our cross-border volume fees and transaction processing fees as you have seen in Q3. This will continue to be a factor so long as this mix persists.", "Secondly, we expect rebates and incentives as a percentage of gross revenues to increase by 2 to 3 ppt sequentially reflecting normal seasonal trends and increased deal activity as Michael mentioned. Now, let's turn to operating expenses. Consistent with our four phased framework for managing through the pandemic and given that we are in the normalization phase, we continue to carefully manage our priorities in order to preserve our ability to invest in our key long-term growth drivers: digital, cyber, data analytics, B2B and multi-rail solutions. For Q4, we expect operating expenses to be down low single digits versus a year ago on a currency-neutral basis excluding acquisitions.", "This reflects our continued focus on expense management as well as sequentially higher advertising and marketing spend related to promotional campaigns. With respect to M&A, we are pleased with the progress we made toward securing regulatory approval for the transaction with Nets and now expect that transaction to close in the first quarter of 2021. Based on this timing and the planned closing of the Finicity acquisition this quarter, we expect acquisitions to contribute a 0.5 ppt to revenue and approximately 4 to 5 ppt to operating expenses in the fourth quarter. Other items to keep in mind for Q4.", "Foreign exchange is expected to be a 1 ppt headwind to revenues and 0 to 1 ppt headwind to operating expenses. On the other income and expense line, we are at an expense run rate of approximately $100 million per quarter given the prevailing interest rates. This excludes gains and losses on our equity investments which are excluded from non-GAAP metrics. And finally, we expect a tax rate of approximately 20% for the quarter based on the current geographic mix of our business.", "And with that, I will turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you Sachin. Casey, we're now ready for the Q&A session." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] And your first question comes from the line of Craig Maurer with Autonomous Research. Please go ahead. Your line is now open." ] }, { "name": "Craig Maurer", "speech": [ "Yeah. Good morning. Thanks for taking the questions. So synthesizing everything you're saying and piecing together what you said on cross-border, it sounds like, effectively, we should be modeling an extended period here of depressed yields perhaps through the start of 2022.", "Is that how you're thinking about things?" ] }, { "name": "Sachin Mehra", "speech": [ "Hey Craig. It's Sachin. So let me take that one. I think the thing to actually focus on is the following.", "When you think about cross-border, you should think about intra-Europe cross-border and non-intra-Europe cross-border. But the other dimension you should think about is personal travel relative to business travel. And I think what you should -- or our expectation in terms of how we think things will evolve is going to be tied to the availability of vaccines and therapeutics. Our view is personal travel comes back quicker than business travel does.", "Personal travel for Mastercard represents a substantial portion of our total cross-border. So the way I would think about that is to think about in the context of, as travel starts to come back, we'll see personal travel which is a substantial portion of our total cross-border come back sooner than business travel. And that should be tied to how we see the evolution of the COVID vaccine and the therapeutics taking place. That's the way I would think about it." ] }, { "name": "Craig Maurer", "speech": [ "OK. Considering the other commentary you had, refresh our memory in terms of the yield dynamic in card-not-present/e-com versus card-present, considering it seems that obviously the direction is favoring e-com at this point." ] }, { "name": "Michael Miebach", "speech": [ "Look, I mean, here's what I tell you. In terms of the opportunity for yields on card-present versus card-not-present as the way you should think about it, generally, at the baseline the yields are pretty consistent. Clearly, when you have card-not-present transactions, you have the opportunity to leverage the strong capabilities we at Mastercard have from a services standpoint, such as our fraud and analytics capabilities which, when layered on and are more relevant in the card-not-present environment, calls for the yields to be higher in card-not-present over card-present." ] }, { "name": "Craig Maurer", "speech": [ "OK, thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Ramsey El-Assal from Barclays. Please go ahead. Your line is now open." ] }, { "name": "Warren Kneeshaw", "speech": [ "Ramsey, you may be on mute." ] }, { "name": "Operator", "speech": [ "Once again, Ramsey El-Assal from Barclays. Please go ahead. Your line is now open." ] }, { "name": "Warren Kneeshaw", "speech": [ "All right. Let's go over the next one please, Casey." ] }, { "name": "Operator", "speech": [ "Certainly. Your next question comes from the line of Lisa Ellis with MoffettNathanson. Please go ahead. Your line is now open." ] }, { "name": "Lisa Ellis", "speech": [ "Good morning. Thanks for taking my question. You mentioned on the call that tokenization -- I think this is the first time you've disclosed some of these metrics. So digging into them, tokenization doubled -- tokenized transactions I guess doubled year on year, and it's now 8% of the total.", "Can you elaborate a little bit on what's going on with tokenization? Specifically, how is the implementation of SCA in Europe impacting the rollout of tokenization? And then what kind of tools are you using to drive this rollout? So for example, at some point, would you implement a liability shift or something like that similar to what you did with EMV or kind of how was this expected to roll out over the next couple of years, especially in light of this dramatic shift into e-com. Thank you." ] }, { "name": "Ajay Banga", "speech": [ "Lisa, it's Ajay. I'm going to kick it off, and I'm going to let Michael -- he's the European expert, right? He's German. But here's the deal, first, tokenization to us is building the foundation for safe, secure and frictionless online contactless kind of commerce. But think of tokenization as being extendable also to card-present transactions eventually.", "So that wherever card data exchanges hands, in any form, the actual data that exchanges hands is not the data that can be reused without unlocking cryptograms. That's the objective. That also therefore provides us with a terrific realm to see more transactions than we used to in the past which by the way is one of the reasons why our transaction percentage that we see is growing up from -- over the last decade from 40-something percent to 55-plus percent today. And that enables our data and services business to power itself on a higher level of growth.", "That's the logic of tokenization. That's the investment in it. The fact that it's now 8% which is doubling over last year in terms of number of transactions, you should view that as a continuing trend that we are going to push as hard as we can with every ounce of energy in our selling system. That's the first part of the answer.", "Does it connect to Europe? Yes. Not yet any differently from others because secure customer authentication, SCA, is still not fully implemented, as you know, in Europe because there was an extension granted on how and well that will go through. Will that be very much helped by tokenization? Yes, but not yet in those numbers. So what you're seeing is really efforts across the board, across markets, across geographies for us to build foundation for this safe, simple smart product of the future." ] }, { "name": "Michael Miebach", "speech": [ "Despite the fact that Ajay isn't European, I think he told the European story. The only thing I would add is, as we did the foundational work over the last two, 3 years around tokenization, particularly the merchant tokenization, our interim product, we've made the implementation so much easier. We're talking about a very light lift for merchants which is driving some of this acceleration here." ] }, { "name": "Ajay Banga", "speech": [ "And by the way, Lisa, this is useful for merchants, as Michael said. It's useful for fintech. It's useful for banks. It's useful from a point of view of government because it adds to security in the system.", "This is a good thing, and it's standardized across the industry which makes it get to scale." ] }, { "name": "Lisa Ellis", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Darrin Peller with Wolfe Research. Please go ahead. Your line is now open." ] }, { "name": "Darrin Peller", "speech": [ "Hey. Thanks guys. When we look at the other revenue line, it just was -- it came a little more than we had expected. If you could just give a little more detail into what went into that and really the investments you're making in that category which I know is sort of a catch-all for a lot of the newer services you have.", "What should we expect from that over the next year or two in terms of opportunities for further investment in growth in that area? Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Sure. So Darrin. So in other revenue, as we kind of previously discussed, it's got -- a large part of our services revenue sits there. There are several other revenue items related to acquisitions which we've done in the services area which kind of again sit in that.", "So there's a bunch of stuff which goes in the other revenue line item. I think the way you should think about it is the following. Our services capability and the revenue we generate from our services capabilities continue to be in great demand in the marketplace, and they're growing well. Bottom line, point number one, really important for us to get out there, because there is a lot of demand coming from our customers on that.", "What you are seeing in terms of other revenue growth in Q3 is -- and the reason it's -- we grew at 6% ex acquisitions. That grew at about 4%. We had a tough year-over-year comp. Last year, that other revenue line item was growing at 30% ex acquisitions.", "And so look, at the end of the day, last year, the growth rate we had was driven by some really strong demand in the third quarter for our consulting capabilities which came through there. And really, what I would say is longer term, the way you should think about services in general and other revenue as well is they continue to grow faster than the core. They're in good demand in the marketplace including those which we've developed organically as well as the acquisitions we've done including things like Ethoca, RiskRecon, all of which, candidly in the current prevailing environment with increased digitalization, are even in more in mand. So that's the way I think about it." ] }, { "name": "Ajay Banga", "speech": [ "The only thing I'll add to that -- this is Ajay, is at the services in other revenue is a number of different businesses. It's not one thing. So there's data analytics, there's loyalty, there's cybersecurity. So several lump -- it can create lumpiness across quarters.", "But those that we started out 10 years ago that were 4%, 5% of our revenue, it is currently running -- Sachin, at what level?" ] }, { "name": "Sachin Mehra", "speech": [ "Services is north of 25%. It's 25%. Yup." ] }, { "name": "Ajay Banga", "speech": [ "So somewhere between 25% and 30% of our revenue, depending on the quarter. So you can imagine the focus that Michael and Tim are putting into it. You should expect to see more activity in that space in data analytics, in AI, in cybersecurity. You should expect Michael to be continually driving new differentiation in that space." ] }, { "name": "Darrin Peller", "speech": [ "All right. That's helpful. Thanks guys." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Bob Napoli from William Blair. Please go ahead. Your line is now open." ] }, { "name": "Bob Napoli", "speech": [ "Thank you and good morning. Just a question on the M&A side. It seems like there's a lot more regulatory overview of acquisitions by large tech companies like -- including Visa and Mastercard. You sound very optimistic about closing Finicity and Nets.", "Obviously, Visa getting a lot of overview on Plaid. Are you seeing a lot more -- a lot heavier regulatory review of acquisitions? And does that change your M&A strategy at all?" ] }, { "name": "Michael Miebach", "speech": [ "Hey Bob. Michael here. So we're actively engaging on the two that you mentioned. That's Nets and that's Finicity.", "As Sachin pointed out earlier, we are confident that Nets will close into the first quarter. We're very happy that we get the intrinsical approval from the EU Commission there. We're working through the remedy. So that is a process that's well-understood and on track for us, so a high level of confidence there.", "When it comes to Finicity, we continue to be quite optimistic as we work this through and will close in the fourth quarter. Now the level of oversight and engagement around antitrust topics, we're obviously aware of that. And we're following a news as everybody else does. Now when we look at Finicity, where -- the confidence that I've just talked about there really relates to why we like Finicity.", "We like Finicity because they have really strong data management practices. We like them because they have an in-light-of-the-day set of relationships with banks and with fintechs on both sides, so very transparent business model. We like them particularly because of the approach that they took to create a world of open banking that really favors the consumer to use their data with their consent and only with their consent. They created the Financial Data Exchange around it which is now the emerging standard globally on how to do open banking in a corporate way.", "So we feel really quite good about that. Other acquisitions, as they come, we'll continue to work that within the respective regulatory environment, so not any change to our M&A strategy." ] }, { "name": "Bob Napoli", "speech": [ "Thank you. Appreciate it." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Jason Kupferberg with Bank of America. Please go ahead. Your line is now open." ] }, { "name": "Jason Kupferberg", "speech": [ "Hey. Thanks guys. I just wanted to ask two things. First, just the delta between switched transaction growth and transaction processing revenue growth.", "I think there was about a four point spread there. And then just a number of issuers have talked about improved U.S. credit volumes in September and October. Wondering if you guys saw that as well as you deconstruct the domestic volume numbers.", "Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Hi Jason. It's Sachin. On transaction processing fees and the delta between transaction processing fees and the growth in switched transactions, it is primarily being driven by the adverse cross-border mix. As you know, there is a component of our cross-border revenues which come in transaction processing fees.", "And when the proportionate share of intra-Europe versus non-intra-Europe is tilting toward in favor of intra-Europe transactions, it has the adverse impact which is what you're seeing come through there. And in Q3, that's exactly what's kind of driving that delta. On your second question on performance of credit. We do have actually seen an improvement in credit performance quarter over quarter, much in line with what you're learning from the issuer side.", "In fact I would say across all regions, there's been good improvement in our volume metrics. And the reality is, as we are starting to see strength come through relative to the second quarter in terms of domestic volumes and transactions, that's manifesting itself in the debit improvements we've seen as well as on the credit side. So it's very consistent with what we're hearing from the issuance." ] }, { "name": "Jason Kupferberg", "speech": [ "OK, thanks." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Tien-Tsin Huang with JP Morgan. Please go ahead. Your line is now open." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey. Thank you so much. I know a lot of questions on yields, and I understand that geography matters on cross-border. I think Craig asked about card-present versus card-not-present.", "But just in general, any comments or anything -- any call-outs on product mix and how that impacts your yields as well as maybe even client mix if more spending is going to bigger merchants and marketplaces? Any call-outs there?" ] }, { "name": "Sachin Mehra", "speech": [ "Hi Tien-Tsin. So the call-out which, in addition to the commentary which we've just shared around yields in general as well as the mix shift which is taking place between intra-Europe cross-border and non-intra-Europe cross-border is -- travel, by and large, happens to be more credit-oriented. And recovery of travel ties closely to how the metrics show up on credit as well. And then so the only point I can make is that as we start to see travel come back which we very well expect to come back, and like I said, personal travel probably before business travel.", "I think from a product standpoint, what you can expect to see is that the credit volumes start to come back in a more meaningful manner just because that's the more prominent product used there. The other piece is certainly prepaid well in the travel business. As you know, we've got a bunch of prepaid products which are very focused on travel-oriented business. And that too, we'll start to see that come through once travel comes back." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Gotcha. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of James Faucette with Morgan Stanley. Please go ahead. Your line is now open." ] }, { "name": "James Faucette", "speech": [ "Great. Thanks. Just a quick question for me on taxes. They came in a little bit higher than we had modeled.", "Is that attributable once again to geographic mix and we should expect to see that normalize as overall trends and volumes normalize? And I guess, just a quick question there. And then looking a little bit longer and at new products, can you talk a little bit about how we should think about the buy-now-pay-later road map and the MCI platform? I know that earlier this quarter, you announced an agreement with Global Payments, TSYS. How should we think about the economics of that platform developing and impacting Mastercard's business overall?" ] }, { "name": "Sachin Mehra", "speech": [ "Hey. On taxes, the -- the tax rate question which you had is being driven by a shift in the mix of our earnings -- geographical mix of our earnings. And really what I've shared with you in terms of our outlook for taxes for Q4 reflects the current mix as we see it. Look, longer term, what I would tell you is, as things revert back to the mean, and I perfectly well expect that over time, things will revert back to the mean, one would expect to see that come through in the nature of our tax rate as well as the mix starts to readjust back to what we used to see in the pre-COVID days." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. On the buy-now-pay-later space obviously, this is -- it's a hot space. We're very active in this area. The whole range partnerships that you recall over the last couple of quarters, Jifiti, Divido, our Pine Labs investment, our Vyze acquisition and now TSYS, so different regionally oriented ways to go to market.", "Afterpay, not to forget those guys. Different regional models to go to market. In terms of the economic questions that you asked related to that, it does play out in markets differently. But broadly speaking, the way we get involved in buy-now-and-pay-later is not to get involved in the credit side of it, but get out in -- get involved in the side of connecting merchants as well as lenders.", "So here that -- you should think about that as fee-driven. We don't see the credit impact on our P&L, but it's a nice transaction business that relates -- or links directly to the payment. And therefore, it puts us in an ideal position to benefit from that." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Bryan Keane with Deutsche Bank. Please go ahead. Your line is now open." ] }, { "name": "Bryan Keane", "speech": [ "Hi. Good morning. I was going to kind of ask a follow-up on that. And I understand credit's being impacted by travel.", "Just trying to think post pandemic, is it possible that we see credit continuing to lag versus norms because of these new models, new lines of credit like BNPL and maybe the growth in debit, the outsized growth continues. Just trying to think about some of the changes post pandemic and how you guys think about that. Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Well, let me start on that. First of all, I theorized -- picking up on Sachin's earlier comment, credit and travel. no There's a high degree of correlation. As travel comes back, you'll see that reflected in credit.", "I think, generally, the point about us providing choice in payments to consumers is the key point. So we'll see credit, we'll see debit, QR push payments. That's why we have a multi-rail strategy benefit from all that regardless of what the mix is. But I do expect credit to come back while we saw a significant growth in debit on the shorter term.", "So that would be my outlook on the short-term future." ] }, { "name": "Ajay Banga", "speech": [ "And think about -- this is Ajay. I think about whether you say credit or a credit product or credit on a buy-now-pay-later product, it's still credit. It's pay later. You're either paying now, paying later or paying in advance.", "There is no third way to pay. Paying in advance is prepaid, paying now is debit or pay by account which is again our multi-rail approach or credit which is credit cards or buy-now-pay-later. We are not going to shoehorn consumers into one place or the other. Our job is to offer choice to our partners, merchants, fintechs, banks, and then let them play the right approach with their consumer base.", "So our kind of approach to this is that the need for some degree of a pay later product commence, whether it's one rail way or the other happens to be just two options that we would offer both of." ] }, { "name": "Bryan Keane", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Chris Donat with Piper Sandler. Please go ahead. Your line is now open." ] }, { "name": "Chris Donat", "speech": [ "Good morning. I want to ask one follow-up question on the spending trends and your commentary about October and having one large e-commerce merchant. Do you have any thoughts on if that might be affecting -- like pulling forward some of the traditional holiday spending or is that not really a factor? And then also if you could comment on how much travel might typically contribute to a fourth-quarter increase relative to the third quarter in spending activity." ] }, { "name": "Michael Miebach", "speech": [ "All right. Chris, it's Michael here. So let me start with that. So when we look ahead from this October week into the rest of the year and the holiday spending season, I think we can already tell this is going to be a holiday spending season that's a little bit different in terms of when and how and where consumers spend.", "In fact, it is our view that it has actually started. So it started earlier than what we've seen in previous years, really with that particular e-com merchant promotions. So as we look ahead, our SpendingPulse is actually forecasting, if you take out automotive and gas, a growth in U.S. retail sales of 2.4% throughout this holiday spending season.", "And the categories, we talked about them earlier, where we see some that spend will go predominantly, continued trend of home furnishing, anything that happens around the kind of diameter of your home. Athleisure, clothing and electronics, that's what we expect to outperform. And what will help all this is some of the shift to omnichannel on the merchant side. So we'll see the continued rise of digital.", "But at the same time, wherever possible, in light of social distancing measures, we also look out for shopping local trends in your community, in your city. So both of that will play out, but that's our view on next months to come." ] }, { "name": "Chris Donat", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Sanjay Sakhrani with KBW. Please go ahead. Your line is now open." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. Michael, I know you mentioned the results of surveys you conducted on the usage of electronic payments. But I'm curious if you have a view as to whether or not consumers are likely to travel more in 2021 versus 2020, all else equal.", "I know there's a lapping effect. But do you think that you could see a better magnitude of improvement in cross-border, all else equal, as people are getting vaccinated? And then second question is just on the nontravel cross-border spending volume growth. Do you think you could still grow 20-plus percent in 2021 and beyond? Thanks." ] }, { "name": "Michael Miebach", "speech": [ "All right. Hey Sanjay. So first on, I wish I had a crystal ball on what's going to happen. But it is currently our view that the sort of personal travel -- first of all, domestic, but generally, personal travel is coming back first.", "People want to see their families. There's like pent-up demand. You've been locked up for months. So we do look for that as to come back faster.", "And I just booked a holiday, interestingly enough, so -- and other people do the same. So that is -- it's a somewhat uninformed view. But when you look at our mix, as Sachin earlier said, predominantly, our exposure on the travel side is toward domestic to start with and then business travel. So we see that increasing.", "And it's not going to be kind of a light switch moment sometime next year. It's going to start to build out as coordination on travel corridors gets better, as testing protocols of airlines and then airports gets better. There will be these various steps that get us back to travel -- return of travel with personal travel to start with. On the second part of your question, I'll hand it over to Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. So I'll just comment, Sanjay, on what Michael just said as well. As it relates to personal travel, I think it's instructive to also see what's going on in domestic travel right now. So you are starting to see domestic travel start to return.", "And if you see the mix of how domestic travels returning, you're seeing personal travel come around quicker. Not to say that business travel is not coming around. We're starting to see a little bit of business travel coming on the domestic side. So if I would extend that over to start to think about what the patterns look like on cross-border, and particularly the long-haul cross-border, we expect that the pent-up demand that Michael talked about, that personal travel will come back sooner than business, that business will come back as well in cross-border.", "It will tie closely to the vaccines and the therapeutics. Very important for us to kind of keep line of sight on that because at the end of the day, consumer confidence is going to be a very key determinant of how people feel about getting on planes for 12, 13, 14 hours. So I think that's important as to how we think about this from a framework standpoint. On the second part of your question on nontravel cross-border.", "Look, I mean, the secular trends are under way. You're seeing the amount of digitization which is taking place of payment flows. You're seeing the capabilities that we are building in that space to enable that secular trend and the acceleration of that secular trend. And we don't see the cross-border space as being too different in terms of how we see the e-commerce and cross-border playing out over the longer term.", "More and more merchants are going omnichannel, and that's really important. In the past, there were smaller merchants who felt like it was OK just to be -- having acceptance at the physical point of sale. They're moving more to an omnichannel environment. We're doing a bunch to enable that.", "We're doing a bunch on -- doing things from a card-on-file standpoint, tokenization, as Ajay mentioned. So I think those are all the things which we've got to kind of keep pushing on to capitalize on these trends from a secular standpoint. And we expect that the nontravel card-not-present components will continue to grow nicely going forward." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Ramsey El-Assal from Barclays. Please go ahead. Your line is now open." ] }, { "name": "Ramsey El-Assal", "speech": [ "I wanted to ask you about central bank-backed digital currencies. And it seems like that's becoming a much more a real option that's being explored by central bank. Can you give us your thoughts about the sort of the opportunities or challenges for Mastercard when it comes to central banks kind of getting directly involved with issuing more digital coins? And then just a quick bolt-on there. Any update on Click To Pay? And apologies if you already addressed it, but just any update there in terms of how it's progressing in the context of the environment we're trying to source in.", "Thanks." ] }, { "name": "Michael Miebach", "speech": [ "All right, Ramsey, Michael here. Let me take the second part of your question. First, get that out of the way. So Click To Pay, I'm making good progress in consumer rollout as well as in adding merchants.", "We're looking at 10,000 merchants here in the U.S. As far as consumer rollout goes, we talked to you in previous quarters about push provisioning through some large banks, particularly Citi here. So this is growing at double-digit rates in terms of adding consumers. That's very, very encouraging.", "And what I thought is a very interesting data point, if you start to look at consumers that have used the Click To Pay experience, this is a very slick experience. We started to see that about a third of transactions that's happening from returning users. So you start to see habit building here which is really quite encouraging. We're planning right now with some of the other EMV copartners to look at international expansion.", "The plans are getting ready. Just to mention 3 countries that are slated for next year, ABC. Australia, you see Canada. Here, you see Brazil.", "So some massive countries on the docket for next year. So that's moving ahead. Central bank digital currency, big topic. Particularly in the light of COVID, you see a lot of governments that have even increased interest in modernizing their payment stack.", "They're looking at various tools on how to do that. Before the crisis, there was a whole range of governments looking at central bank digital currencies. And I think with the crisis, more are even considering that as a tool. We're engaged with a very significant number of governments around the world, all regions, major regions around the world in terms of a dialogue on what is the best answer to what a government is trying to do.", "If you look at some of the more prominent examples that are out there, if you look at Sweden, the Riksbank, there is a thought behind the central bank digital currency approach to deal with a world where there is no cash left. In the Bahamas, they're looking at the cost of cash. In South Africa, they're looking at financial inclusion. So there's a whole range of different motivations, and we're trying to work with those governments to understand what those motivations might be.", "And the central bank digital currency is the best answer possibly. In some other instances, it might be real-time payments or it might be something else that we haven't even thought about. So that's the first part of the dialogue. We have come to the conclusion that the construct of a central bank digital currency is an important aspect.", "This is in ENC currency. So the central bank as in mining the currency is ensuring the resilience of the infrastructure. It's critical. While the private sector has a really important role to play in terms of innovation on top of that infrastructure.", "You think smart contracts. You think all sorts of solutions that make the lives of consumers and businesses easier. Now why are we a relevant partner in all of this? How does this affect all of us? First of all, we have invested years in cryptocurrency assets. We are the leading payment player when it comes to patents around crypto.", "So that is -- that puts us in a good position. We have a long track record in consulting with governments. If you look at some of the more prominent examples, we are having a seat at the table to see where this goes. I'll give you one particularly important aspect of intellectual property that matters here.", "Once you have a central bank digital currency, it's going to make a difference to the consumers. And so how do you actually spend it? So the link into an acceptance network is critical. So we hold some patents in that space that link these transactions right back into our network where it can be used. And this is how we can bring value, and it brings value to us.", "So Ramsey, a big topic. We're supportive whenever it makes sense, and we're engaging governments around the world." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Michael. I see we're getting close to the top of the hour. Just to wrap up, do you have any comments?" ] }, { "name": "Michael Miebach", "speech": [ "All right. I do have comments because it's that one call that is a very special call here. So -- and I'll tell you why. First of all, thanks for your questions.", "And before I hand it back to Ajay, I do want to acknowledge that Ajay will be taking on his new role as the Executive chairman at the start of the next year. So it will actually be his last earnings call as CEO. So I want to thank Ajay for his tremendous leadership all throughout. He's making gestures right now.", "You should see him. I know he has built close relationships with many of you, and I look forward to doing the exact same and continue to provide you straightforward information about Mastercard, about our business and what we do. On a personal note to you, Ajay, I'd like to thank you for all your help during the transition period, and I look forward to continuing to work with you in our new roles. Ajay, over to you." ] }, { "name": "Ajay Banga", "speech": [ "Thank you, Michael. And I actually was counting back during this call, and this is my 44th earnings call. And I hope you, Michael, have a similar run. I do want to thank all of you who have been so supportive of our company during my time over the last decade and for taking the long-term view and for trusting us to make the right investment choices to drive growth for this company over that long term.", "You've seen the results. We've grown our suite of core products. We've developed world-class digital capabilities that have resulted in significant share growth over time with banks, with fintechs, with merchants. We've developed a rich set of services that both support those core payment products.", "They also have to diversify our revenues. And we are a true multi-rail payments provider. We have positioned ourselves for growth in new payment flows like B2B as well as in areas beyond payments such as open banking and digital identity. From '09 to 2019, revenues have grown over three times from $5.1 billion to $16.9 billion.", "Adjusted net income has grown almost five times from $1.5 billion to $7.9 billion. And the share price has reflected this performance, this morning's performance notwithstanding. Michael has an awesome company with a wide array of assets and capabilities in an industry with secular tailwinds. Yes, we have to continue to execute while investing for the next decade.", "And I have no doubt, challenges will lie ahead like the pandemic that is still with us, economic and societal challenges as well as nationalistic tendencies. But I also have no doubt whatsoever in Michael's skills as a leader and in the quality of the wonderful people in this company as we look ahead. Thank you. Have a great day." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2023-01-26	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "AllianceBernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Tsin Huang -- JPMorgan Chase and Company -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Will Nance", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Ashwin Shirvaikar", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Ken Suchoski", "position": "Analyst" }, { "description": "Robert W. Baird and Company -- Analyst", "name": "Dave Koning", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mastercard Incorporated Q4 and full year 2022 conference call. All lines have been placed on mute to prevent any background noise.", "After the speakers' remarks, there will be a question-and-answer session. [Operator instructions] Mr. Warren Kneeshaw, head of investor relations, you may begin your conference." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Audra. Good morning, everyone, and thank you for joining us for our fourth quarter 2022 earnings call. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. Following comments from Michael and Sachin, we'll open up the call for the Q&A session.", "You can access our earnings release, supplemental performance data, and the slide deck that accompany this call in the investor relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted. Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts.", "Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days.", "With that, I'll now turn the call over to our chief executive officer, Michael Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren. Good morning, everyone. Let's get right into it. So, starting with the big picture.", "Consumer spending has remained resilient, and we are very well-positioned to capitalize on the growth opportunities ahead. We closed out the year with strong financial results and several notable wins. Quarter 4 net revenues were up 17% and adjusted operating income up 19%, both versus a year ago, as always, on a non-GAAP currency-neutral basis excluding special items. While the macroeconomic and geopolitical environment remains uncertain, we are keeping a close eye on a variety of positive and negative factors.", "The broadly resilient labor market with low unemployment and rising wages, coupled with elevated consumer savings levels, are key drivers of consumer spending. We're also tracking efforts by the central banks to curb inflation, along with moderating energy prices and the reopening of China. So still, lots of moving pieces. From an overall consumer spending standpoint, we expect the consumer to be relatively resilient.", "Spending patterns have largely normalized relative to the effects of the pandemic with the notable exception of China. In terms of switched volumes, domestic volumes in the fourth quarter remained steady relative to 2019 levels with some slight moderation in the U.S. related to lower gas prices recently. Cross-border travel continued to recover in Quarter 4, with inbound travel either flat or up in every region sequentially relative to 2019 levels.", "As of the first three weeks of January, inbound cross-border travel to all regions is now above 2019 levels. We will continue to monitor the economic environment closely. And should the outlook change, we're prepared to move quickly to adjust our spending levels as we have done in the past. In the meantime, we continue to focus on the things we can control.", "That starts with our three strategic priorities: expanding payments, extending our services, and embracing new networks. And here are some examples of how we're progressing against each of these. Starting with payments. We won substantial new business this quarter.", "Our innovative products, differentiated services, and partnership approach enabled us to secure major portfolio flips, extend relationships and launch new programs with banks, co-brand partners and transit systems around the world. I am very excited about our expanded partnership with Citizens to become their exclusive payments provider across all product portfolios in the United States. They will shift their debit portfolio to Mastercard, and we will maintain exclusivity on credit and commercial. Citizens selected Mastercard based on our digital assets, open banking capabilities, and safety and security tools.", "We have also extended and enhanced our long-term partnership with Citi. It solidifies Mastercard as Citi's exclusive global partner for Citi-branded consumer credit, debit, and small business cards. We look forward to continuing to partner to deliver digital initiatives, new technologies, and innovative payment solutions together. We've extended our long-standing relationship with Bank of America across their consumer and small business debit and credit lines of business.", "They're great partners. We're especially proud to continue as the lead brand for all newly issued small business cards. And our positive momentum with Chase continued this quarter as well. Building up on our recent co-brand, commercial, and paper bank partnership announcements, we are excited to announce that we have renewed the Chase Freedom Flex portfolio.", "Turning to the U.K. We recently extended our credit deal with NatWest Group for consumer and commercial. So, partnering with Belbim, a Istanbul transportation, to convert over 17 million closed-loop cards, Mastercards, and add 24,000 new acceptance locations across the city. We've partnered with QNB Finansbank and Trendyol, a large e-commerce marketplace in Turkey, over 30 million customers, to launch a new Mastercard co-brand credit product.", "Now an important driver of our success in core payments is our ability to deliver innovation and thought leadership. We are designing and deploying innovation solutions at scale, as a result, are the clear partner of choice for our customers. Three recent examples include our book in installments, tokenization, and Click to Pay. Starting off with installments.", "SoFi launched Pay in 4, becoming the first bank in the U.S. to launch within the Mastercard Installments program. SoFi valued the broad acceptance, strong consumer protections, and commission-based open banking capabilities that all make Mastercard Installments unique. We've got a strong pipeline for Mastercard Installments and plan to add several additional programs across multiple regions throughout the year.", "Turning to tokenization. We surpassed 2 billion tokenized transactions per month. And for the year, we are up 38%. We're currently enabling digital transactions in over 110 countries.", "Tokenization helps keep the ecosystem safe and secure across a wide range of use cases. One example that I think is particularly cool is the work we are doing with in-car payment. We're working with car manufacturers and fintechs to integrate payments using our tokenization platform and biometric authentication capabilities. Think about the simplicity it brings to paying for gas, tolls, charging, or entertainment right from your car.", "This is a great example of Mastercard working with partners to drive the convergence of the Internet of Things, 5G and addressing consumer demand for cool digital experiences. It also highlights how we're expanding the reach and the value of our acceptance network through new channels to support new use cases. This is just the beginning. Watch for more to come in this space.", "And on Click to Pay, we partnered with Adyen to launch Click to Pay on their global payment platform, recognizing the value that it brings to guest checkouts and millions of online shoppers. Adyen joins more than 20 other payment service providers around the world, bringing Click to Pay to thousands of merchants globally. Now the focus on innovation and partnership is also a critical part of our strategy to penetrate the prioritized set of new flows that we outlined at our 2021 Investor Day. We continue to make solid progress.", "Here are some of the examples of how we're driving growth in each area. First, disbursements and remittances. Mastercard Send and our cross-border services capabilities are solving an expanding set of use cases across multiple geographies. For example, we partnered with social marketplace platform, Poshmark, to enable seller payouts.", "And for cross-border payments, we've teamed up with Pay Send to broaden our global reach and expand the ability to send international payments across card brands. Second, we're deploying digital capabilities to displace cash- and check-based commercial payments at the point of sale, huge opportunity. In France, we signed an agreement with Societe General to develop their corporate card book. And in South Korea, we partnered with Kakao Bank and Samsung Cards to launch new debit and credit co-brand offerings for small businesses.", "The third flow is B2B accounts payable payments. Our virtual card capabilities provide an effective digital solution to address the working capital, process efficiency, and data challenges that are prevalent in B2B. We are the global leader in virtual card. We're seeing rapid growth in this space.", "We're bolstering our position through new partnerships and capabilities. For example, we announced plans to partner with Sabre and Conferma Pay to accelerate the use of virtual cards for B2B travel payments. We also signed an agreement with fintech partner, Extend, to offer virtual mobile corporate cards in the U.S. and Canada.", "And finally, on the consumer bill payment front, we are focused on deploying market-specific solutions to meet unique needs of consumers and businesses. For example, in Norway, we are powering the eFaktura service, which is used by the vast majority of citizens to pay their bills. In 2022, we hit a milestone as over 200 million digital invoices were sent using eFaktura. As you can see, we're making significant progress expanding in payments, and we are excited about the opportunity in front of us.", "Now turning to the second of our three strategic priorities, services. Services provide differentiation and diversification for Mastercard. Our strategy is to leverage our services to drive growth at the core and to expand into new segments and use cases. We're making steady progress on both and have significant opportunity for future growth.", "Our services continue to drive growth in the core as evidenced by our wins and extensions with Citizens, Citi, NatWest, and others, as I mentioned earlier. One example of a service that enhances the value of payments is Consumer Clarity. The service provides cardholders with merchant details in digital receipts to reduce disputes, low charge-back costs, and improve the consumer experience. We recently partnered with TSYS who will offer Consumer Clarity to over 25 million cardholders in the U.S.", "and the U.K. In 2022, we signed up over 50 financial institutions and merchant partners for Consumer Clarity, including large issuers like Itau in Brazil. We're also expanding our services to new segments and new use cases, including governments, retailers, digital partners, and financial institutions. This quarter, we partnered with research and consulting firms, including E-4 and CIMA in Germany, as well as the Barbados Ministry of Tourism and International Transport to provide governments with detailed insights into tourism and retail spending trends.", "We engage with retailers like Lowe's, who are leveraging our Test & Learn capabilities to conduct analytics on their core business. We partner with large fintechs like Monzo in the U.K. to advise on product development strategies. And we are deploying our personalization solutions, which we acquired through Dynamic Yield across a range of retail and financial institutions, including Carrefour Argentina, HYPE, [Inaudible] to enhance and scale their personalization efforts.", "I'm very encouraged by the continued momentum in our services growth strategy and the differentiation and diversification that these capabilities bring. I'll now move on to our third strategic priority, which is embracing new networks, namely open banking and digital identity. This quarter, I'd like to highlight an example of how our open banking capabilities have come together with our other strategic priorities to offer a new solution. As I mentioned earlier, in Quarter 4, JPMorgan Payments and Mastercard announced an innovative Pay by Bank solution.", "Solution utilizes the MasterCard open banking platform to modernize existing ACH payments and allow customers to pay bills from their bank account in a frictionless manner. Pay by Bank offers choice and provides a simple and secure experience of billers and merchants, as well as consumers by enhancing existing ACH transactions. This deal is a manifestation of our multi-rail strategy, expands our addressable market by our open banking capabilities and it deepens our relationship with JPMorgan Chase. We're actively working with them to take the solution to market this year.", "We also continue to make progress with open banking in Europe. Mastercard is connected to more than 3,000 banks and financial institutions across 18 markets to power their open banking efforts. This quarter, we partnered with Secure Trust Bank in the U.K., who will leverage our open banking capabilities to provide safe and convenient ways for their customers to repay retail loans directly from their bank account. In summary, we delivered another strong quarter of revenue and earnings growth, aided by a resilient consumer and the continued recovery in cross-border travel.", "In payments, we won substantial new business this quarter, including Citizens. We're expanding our differentiated services and embracing new networks, including leveraging our open banking capabilities to power solutions like JPMorgan's Pay by Bank. With all that, we're well-positioned for the opportunities ahead. We will manage the business with agility should the macroeconomic outlook change.", "Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. Turning now to Page 3, which shows our financial performance for the quarter on a currency-neutral basis, excluding special items and the impact of gains and losses on our equity investments. Net revenue was up 17%, supported by a resilient consumer spending and the continued recovery of cross-border travel relative to 2019 levels. Acquisitions contributed 1 ppt to this growth.", "Operating expenses increased 13%, including a 3 ppt increase from acquisitions. Operating income was up 19%, which includes a 1 ppt decrease related to acquisitions. Net income was up 16%, which includes a 2 ppt decrease related to acquisitions. EPS was up 19% year over year to $2.65, which includes a $0.06 contribution from share repurchases.", "During the quarter, we repurchased $2.4 billion worth of stock and an additional $590 million through January '23 -- 2023. So let's turn to Page 4, where you can see the operational metrics for the fourth quarter. Worldwide gross dollar volume, or GDV, increased by 8% year over year on a local currency basis. On the same basis, if you exclude Russia from the prior period, GDV [Inaudible] by 14%.", "In the U.S., GDV increased by 7% with credit growth of 14%, reflecting in part the recovery of spending on travel. Debit increased 1%. Excluding the impact of the roll-off of a previously discussed customer agreement, debit increased approximately 5%. Outside of the U.S., volume increased 8% with credit growth of 9% and debit growth of 7%.", "Cross-border volume was up 31% globally for the quarter, reflecting continued improvement in travel-related cross-border spending. Turning now to Page 5. Switched transactions grew 8% year over year in Q4. Excluding Russia from the prior year, switched transactions grew 18% year over year in Q4.", "Card-present and card-not-present growth rates remain strong. Card-present growth was aided in part by increases in contactless penetration in all regions when excluding Russia. Contactless now represents 56% of all in-person switched purchase transactions. In addition, card growth was 5% or 9% if we exclude cards issued by Russian banks from the prior-year card count.", "Globally, there are 3.1 billion Mastercard- and Maestro-branded cards issued. Now let's turn to Page 6 for highlights on the revenue line items, again, described on a currency-neutral basis unless otherwise noted. The increase in net revenue of 17% was primarily driven by domestic cross-border transaction and volume growth, as well as growth in services, partially offset by growth in rebates and incentives. Acquisitions contributed 1 ppt to this growth.", "Looking quickly at the individual revenue line items. Domestic assessments were up 6%, while worldwide gross dollar volume grew 8%. The difference is primarily driven by mix. Cross-border volume fees increased 40%, while cross-border volumes increased 31%.", "The 9 ppt difference is primarily due to favorable mix as higher-yielding ex intra-Europe cross-border volumes grew faster than intra-Europe cross-border volumes this quarter. Transaction processing fees were up 16%, while switched transactions grew 8%. The 8 ppt difference is primarily due to favorable mix, FX-related revenues, and pricing. Other revenues were up 16%, including a 1 ppt contribution from acquisitions.", "The remaining growth was driven primarily by our cyber and intelligence and data and services solutions. Finally, rebates and incentives were up 18%, reflecting the strong growth in volumes and transactions and new and renewed deal activity. Moving on to Page 7. You can see that on a non-GAAP currency-neutral basis, excluding special items, total adjusted operating expenses increased 13%, including a 3 ppt impact from acquisitions.", "Excluding acquisitions, the remaining increase was primarily due to higher personnel costs to support the continued execution of our strategic initiatives, partially offset by lower advertising and marketing costs. Turning to Page 8. Let's discuss the operating metrics for the first three weeks of January compared to Q4 2022. Each of these metrics, with the exception of cross-border card-not-present excluding travel, were favorably impacted by the lapping of the slower growth that occurred in January 2022 related to the Omicron variant.", "Switched volumes grew 21% year over year, up 7 ppt versus Q4. Switched transactions grew 12% year over year, up 4 ppt versus Q4. Overall, cross-border volumes grew 42% year over year, up 11 ppt versus Q4, driven by cross-border travel growth of 84% year over year, up 25 ppt versus Q4. Cross-border card-not-present, excluding travel, grew 10% year over year, up 2 ppt from Q4.", "A couple of administrative notes for your reference to help you understand the trends in the business ex Russia, we have suspended -- where we suspended operations in March 2022, we have included an appendix later in this deck to show all the data points from this schedule if you excluded activity from Russian-issued cards from prior periods. Additionally, as the impacts of the pandemic recede, going forward, we will no longer provide operating metric levels as a percentage of 2019. Turning now to Page 9. I want to share our thoughts on the upcoming year.", "Let me start by saying that I believe that we are well-positioned to address the significant growth opportunities at hand. We have established a clear set of strategic priorities and are making steady progress against each of them. This is evidenced by the many wins across the products and services Michael has discussed on this call and over time. On the macroeconomic front, as Michael laid out, we are monitoring a number of both positive and negative factors.", "We do expect consumer spending to hold up relatively well in this environment driven in part by the strong labor market. It is important to remember that we are coming off a year of strong growth as we lap the effects of the pandemic, and we expect our go-forward growth rates to moderate accordingly. From a cross-border travel standpoint, most regions have recovered and are well above 2019 levels in Q4. The exception is Asia, where there is still room to improve with the China reopening.", "Just a little further context here. China represented about 1% of inbound cross-border travel volumes pre-pandemic in 2019. In Q4, this volume was at approximately 20% of Q4 2019 levels. Similarly, China represented about 2% of outbound cross-border travel volumes pre-pandemic in 2019.", "In Q4, this volume was at about 50% of Q4 2019 levels. With this in mind, our base case scenario for the full year 2023 is for net revenues to grow at the high end of a low double-digit rate on a currency-neutral basis, excluding acquisitions and special items. This growth rate would be higher by approximately 1.5 ppt if you exclude Russia-related revenues from 2022. Acquisitions are forecasted to have a minimal impact to this growth rate, while foreign exchange is expected to be a tailwind of approximately 1 ppt for the year primarily due to the recent strengthening of the euro relative to U.S.", "dollar. In terms of operating expenses, we will continue to carefully manage our expenses as we invest in our payments, services and new network priorities to drive short- and long-term growth. For the year, we expect operating expenses to grow at the high end of a high single-digit rate on a currency-neutral basis, excluding acquisitions and special items. Acquisitions are forecast to add about 0.5 ppt to this growth, while foreign exchange is expected to be a 1 ppt headwind for the year.", "Turning now to the first quarter. Year-over-year net revenue growth is expected to be at the low end of a low double-digit rate, again, on a currency-neutral basis excluding acquisitions and special items and reflects generally resilient consumer spending. A couple of points to note. Q1 will be the last quarter in which we experienced the lapping effect of our decision to suspend operations in Russia in Q1 of 2022.", "And we expect cross-border volume growth in Q1 2023 to be elevated as a result of the effects of Omicron in Q1 2022. Acquisitions are forecast to add about 0.5 ppt to this growth, while foreign exchange is expected to be a headwind of 2 ppt for the quarter. From an operating expense standpoint, we expect Q1 operating expense growth to be at the low end of a high single-digit rate versus a year ago on a currency-neutral basis, excluding acquisitions and special items. Acquisitions are forecast to add about 2 ppt to this growth, while foreign exchange is expected to be a tailwind of approximately 1 ppt for the quarter.", "Other items to keep in mind. On the other income and expense line, we are at an expense run rate of approximately $100 million per quarter given the prevailing interest rates and debt levels. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics. And finally, we expect a non-GAAP tax rate of approximately 18% in Q1 and 18% to 18.5% for the year based on the current geographic mix of our business.", "And with that, I will turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Sachin. Audra, we're now ready for the Q&A session." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] We'll go first to Harshita Rawat at Bernstein." ] }, { "name": "Harshita Rawat", "speech": [ "Thank you. Good morning. So, Michael, Sachin, I want to ask about Pay by Bank. Over the years, you've developed and acquired capabilities for Pay by Bank in different countries.", "You've talked about this new partnership with JPMorgan. But a skeptic could also argue that Pay by Bank is a risk in regards longer term, and there's some precedence in certain countries. So, can you talk about the push and pull for severe and also maybe touch upon where does Pay by Bank being used versus card? Has Mastercard been able to participate in those transactions? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Right. Harshita, let me start off on that. So, the way we think about this is, in the end, it is about delivering choice to consumers, choice to merchants, choice to banks, and we are therefore in all relevant ways to pay. But it's also true that the card ecosystem over the years has driven tremendous value.", "So it is a prevalent way to pay for many, many use cases. But on the side, we have alternative payment methods emerging. And we look at those as options to go after new use cases, and that's exactly what happened here in the context of our partnership with JPMorgan. This is focused on existing ACH payments, which are not bringing the value to the biller or the consumer that they are looking for.", "Frankly, though, very specifically, what we're doing here, the issue with some of these account-to-account payments is you never really know what balance is on the account. And our open banking capabilities are really providing a payment success factor here that tells the biller this is a good time to debit this particular account. So true value brought that somebody is willing to pay for, in this case, the biller/the merchant. So, a good example of where there can be value created an alternative payment tools while this doesn't take away from the power the cards are bringing to consumers and merchants.", "So, we see this as coexistence. Where this is going over time, we don't quite know, but our multirail strategy positions us well to play in either field." ] }, { "name": "Harshita Rawat", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll move next to Darrin Peller at Wolfe Research." ] }, { "name": "Darrin Peller", "speech": [ "Hey, guys. Thanks. Nice job on the quarter and the year. When we look ahead, and we're looking at the trends you're showing us for January, even despite easier comps on omicron, it does look like you have pretty conservative assumptions built into the guide for the year for top-line growth of low double digits.", "Just given the trends we're seeing even beyond for January, but ex Russia, you anniversary that after March and the numbers go materially higher growth rates. So can you just tell us if there's some building blocks like around what you're assuming on macro from today's macro activity going forward and maybe rebates incentives? Is that a factor here? Thanks again, guys." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Darrin. Good morning. So let me provide you a little bit of color here. Look, I mean, what we've generally assumed in our base assumptions that I mentioned when I was delivering my prepared remarks is resilient consumer spending through 2023.", "I mean we see a resilient consumer today, and we're seeing a generally resilient consumer spending pattern going forward in our base case. The other thing which we've contemplated, as we mentioned, from a cross-border standpoint and particularly cross-border travel standpoint, the vast majority of the regions have now reached that state where they are kind of growing and growing at a healthy pace, but they're not growing at an accelerating pace. So, they've reached that level of stability. So let me give you a little bit of color here.", "You'll remember as we are coming out of COVID, right, intra-Europe came back first cross-border standpoint. After that, we saw several inter-markets come back from a cross-border standpoint, U.S., U.K., Canada, Latin America, all of those. All of those are growing at a healthy pace, and we're assuming they'll continue to grow at a healthy pace but not at an accelerating pace. The one area where we are assuming an increase in terms of growth is around Asia Pacific.", "I mean Asia Pacific has been a lagger in terms of recovery of cross-border travel. And we're expecting that there will be -- with the borders recently opening in several markets in AP that there will be some level of recovery, which will come through there when you index back to 2019. So that's kind of generally been the base case we've kind of assumed. Look, I mean, to be perfectly honest with you, I think that the reality is we've got things which are helping us from a share-win standpoint.", "We've got strong consumer spending. Our services capabilities continue to grow at a healthy pace. All of that is built into our guide as we go forward. Also remember that in 2022, we did have elevated levels of FX volatility, which were there in the market, which actually supported the growth rate which we had in 2022.", "It's hard to predict, but that looks like on a going-forward basis. We do our best assumptions on that from an FX volatility standpoint. But that's kind of the building blocks as to how we've gone about building our business. The last point I'll make is around rebates and incentives, you asked the question.", "As you can see, quarter on quarter, we talk about how we are delivering wins. We are winning with new customers. We are expanding our business with existing customers. So, we are building in assumptions from a rebates and incentive standpoint, which will be consistent with what you're seeing in our track record from a winning standpoint as it relates to us." ] }, { "name": "Darrin Peller", "speech": [ "OK. Thanks a lot, Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "We'll go next to Lisa Ellis at SVB MoffetNathanson." ] }, { "name": "Lisa Ellis", "speech": [ "Hey, good morning. Thanks for taking my question. Michael, I wanted to follow up, in your prepared remarks related to new flows, you highlighted the B2B POS payments as a notable opportunity area and highlighted a few new SMB co-brand wins there. Can you just talk a little bit more holistically about this opportunity? Remind us, a, how big it is; and then b, what's different about it.", "What do you have to do differently as Mastercard to capture this opportunity relative to the consumer side? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Right, Lisa. So, the opportunity here lies really in taking our existing set of tools, namely from the card ecosystem, very specifically the virtual card capability, which came through an acquisition many, many years ago that we've now built out ourselves into the leader here. So this existing set of tools and a huge opportunity in terms of flows to be addressed and make them more efficient, we're looking at $14 trillion from an opportunity perspective. If you recall what we laid out across the four flows, new flows, this is the -- one of the large ones here that we quoted.", "And the way to go about this is really to say, all right, who are the different players that we already have in our ecosystem? We bring VCNs into. There's a lot of deals with financial institutions, but there's also a lot of deals with partners out in the travel space, and the travel space is really the one that's been most promising for us, and that is coming back right now. So, this is a near-term opportunity. Cash and checks dominated existing tools, existing partners.", "This is right for us to go after it, and we're leaning in." ] }, { "name": "Sachin Mehra", "speech": [ "And Lisa, maybe I can just add a little bit out here, particularly as you think about the virtual card opportunity, which Michael just talked about. The differentiation, which is provided by technology, which is what Michael talked about by virtue of the acquisition, which we had with our virtual card capabilities, but there's also differentiation in terms of our approach from a go-to-market standpoint. And specifically, when you target flows from a go-to-market standpoint, you go on a vertical-by-vertical basis. So as you know, we've been very successful in the travel vertical.", "Part of the reason we've been successful in the travel vertical is having a deep understanding of what it takes at the travel integrator level to be able to embed your technology there so that you are the payment choice, which people will exercise when they have to make those payments. Similarly, as we look at that opportunity going forward, there are several other verticals we're making the similar kinds of advances in. So that's specific as it relates to the VCN piece. But you also asked about small business and the commercial point-of-sale opportunity, which is there.", "And the reality is we've been winning significant new deals in that small business opportunity. And we see, candidly, a very sizable market opportunity in commercial point of sale. A large part of that is still in cash and check. And the reality is, just like we did in B2M where we displace cash and check utilizing digital technologies and innovation, that's kind of the advances we're making also in commercial point of sale.", "So that's how we kind of see and frame the opportunity set across both of these areas." ] }, { "name": "Michael Miebach", "speech": [ "You can hear it. It helps you have a CFO that used to be the head of our commercial products." ] }, { "name": "Lisa Ellis", "speech": [ "Terrific. Thank you." ] }, { "name": "Operator", "speech": [ "We'll go next to Tien-Tsin Huang at J.P. Morgan." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hi. Thank you. Good morning to everyone. I wanted to ask just big picture, if you would characterize visibility here for us on revenue versus, I guess, you can go back to pandemic or pre-pandemic.", "Just curious on visibility given you mentioned lots of moving pieces. And then same thing on expenses, you said in the prepared remarks here that you're prepared to adjust investments, if necessary. If the base case and the outlook here is to show some operating leverage, can we assume the same operating leverage if revenue weakens relative to expectations? Sorry for the long question." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Tien-Tsin. So, on your question around revenue, it's like I laid out, right? I mean, at the end of the day, we put our base case together. We've kind of laid out what our assumptions are from a base case standpoint. And at the end of the day, we don't have the crystal ball to actually suggest that that is the way things are going to play out.", "But based on everything we're seeing in the nature of current trends, as well as leading indicators, particularly as it relates to the overall strength of the labor market, we feel pretty good about what we're seeing from a base case standpoint as it relates to the outlook for revenues. As it relates to one component of revenues, which we oftentimes think about is around -- on an as-reported basis versus what it is on a currency-neutral basis, very hard to predict where foreign exchange markets go. But again, we've seen recent strengthening of the euro take place, and that's what we've kind of shared with you in terms of our assumptions from an FX standpoint. And then you asked about operating leverage.", "Look, I mean, the reality is we've always operated with the philosophy of delivering positive operating leverage over the long term. We look at the top line. We look at how our expenses up also against that top line. We have, in the past, demonstrated our capability to modulate our expenses to the extent we start to see adverse impacts take place on the top line and vice versa.", "And the reality is what we don't want to do is impact the long-term growth potential of our business. So, we will continue to invest in our business with our eye on the long term. We will be prudent about not going into spaces from an opex standpoint, which are not in demand. Obviously, I'm kind of stating the obvious here.", "But the reality is the philosophy remains unchanged. We will look to deliver positive operating leverage as a company. And we have the tools and the ability to actually modulate expenses if top line -- if we feel like the top line growth is going to get impacted over the long term." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Perfect. Thank you." ] }, { "name": "Operator", "speech": [ "We'll go next to Sanjay Sakhrani at KBW." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. First off, I'm glad we're getting rid of the relative to 2019 metric for good reason. Just a question on cross-border and sort of the operating assumption this year.", "I know there's a number of different trends that you guys talked about. But there's still a decent amount of pent-up demand. I guess, how do you think cross-border travel behaves in a backdrop where macro might get worse from here? Maybe you could use some historical precedent here. Maybe just give us sort of how you're thinking about it.", "Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So, Sanjay, let me share a few thoughts on how we think about cross-border, right? So at the end of the day, there are numerous things which impact how people travel and spend in the cross-border environment. But at the outset, what I want to say is that the fundamentals around the cross-border proposition as delivered by Mastercard actually stand to be very sound just like they were in the pre-pandemic days. We said this through the pandemic, and it's played out in that manner.", "Now let me get a little bit more specific as it relates to pent-up demand -- your question around pent-up demand. Look, the reality is we all know from what we hear on the earnings calls of airlines that capacity is constrained from an airline standpoint. And with that constrained capacity and elevated prices, you're seeing that impacts come through when you do P times Q, which is price multiplied by quantity. You get kind of what the results and impact from a spend standpoint is.", "Fast forward, as capacity comes back online, one would expect that people will -- there will be some level of adjustment in prices because the demand-supply equation gets a little bit more in equilibrium. And so overall, we're not assuming that that necessarily results in a tailwind because capacity comes back online, right, because there's going to be an adjustment which takes place from a price standpoint. Our view -- again, we hope we're wrong, and we hope cross-border spending kind of goes with more capacity, prices remain elevated and people continue to spend, but we've got to take a point of view on that, and that's what we're taking. The other point I'll make is as it relates to what the impact of FX rates is on cross-border and cross-border travel.", "Well, the reality is what we've seen historically is that when exchange rates move, for example, with the dollar strengthening, with the lag effect, you would tend to see inbound into the U.S. get impacted. That's only natural. It gets more expensive for people coming from different parts of the globe to come into the U.S.", "But what we've also seen is individual extend to then redirect their cross-border spend to other parts of the globe where they don't feel the impact of that come through. So, movements in foreign exchange rates does have an impact on how we think about cross-border going forward." ] }, { "name": "Michael Miebach", "speech": [ "And just to add one point here, Sanjay, that is, over the last two years, we've been winning portfolios in the space. We've really focused on the space, expecting to come back. If you recall, let me just remind everybody here, across airlines, across travel -- online travel agencies, across lodging, across other forms of transports like trains, Marriott, Virgin Atlantic, Amtrak, JetBlue, Cathay Pacific, British Airways and so forth, we have won portfolios. And we've bolstered that in terms of market access through these partners with additional products.", "So, there's Mastercard Travel Rewards out there, which is now in 80 countries. So, we believe into the macroeconomic environment that Sachin just laid out, we have the better proposition. So, it remains an exciting space. The pace in which we'll grow, we'll have to see that as characterized by what Sachin just said, but we certainly have a differentiated proposition in that.", "And one last comment I want to make, Sanjay, I'm happy you're excited about metrics and how we're changing the metrics. From a metrics perspective, I want to complete -- back to Lisa's question earlier. I mentioned the $14 trillion on commercial POS, but there's also $24 trillion on accounts payable, which makes the total opportunity in this combined space, $38 trillion. So that conversation earlier was an important one and a very big part of our priorities." ] }, { "name": "Operator", "speech": [ "We'll go next to Jason Kupferberg at Bank of America." ] }, { "name": "Jason Kupferberg", "speech": [ "Hey, thanks, guys. I really appreciate the China cross-border data you gave there for both inbound and outbound. I think you said that inbound is running at about 20% of 2019 levels in the fourth quarter and outbound at about 50% of 2019 levels in the fourth quarter. Can you give us a sense of how much improvement you're expecting in those metrics in 2023 as the reopening progresses? And then separately, can you just make any high-level comments on growth for each of your three strategic pillars in '23? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So first, Jason, I'm not going to share specifics as it relates to how we built our model up for the full year. What I will share with you is as it relates to the recovery of both inbound and outbound for China, we have built in some level of recovery as the year progresses. It's our best estimate as to what we expect to happen by virtue of the borders opening and the quantity and requirements being lifted.", "But suffice it to say that the opportunity is pretty sizable. The fact that we were in Q4 at 20% of 2019 levels from an inbound travel standpoint -- cross-border travel standpoint is just suggestive of the fact that if you just think about what's going on in the regions and how they've recovered and bounced right back and gone well above 2019 levels, there's a significant opportunity both on inbound and outbound as it relates to China. And sorry, the second part of your question, Jason?" ] }, { "name": "Jason Kupferberg", "speech": [ "Just the three strategic pillars, what you're modeling for revenue growth on those in '23?" ] }, { "name": "Sachin Mehra", "speech": [ "Again, I mean, when you -- the strategic priorities, we've got payment services and new networks, as Michael has talked about. I mean I'll give you a general sense. I mean you know about -- from a payment standpoint, we've been doing this, and we've been doing this for many decades. And that is the substantive part of how we deliver our revenue growth.", "Over the last decade, we've shown you how services have grown and still growing at a healthy pace. In my view, the demand for our services capability still remains very strong. You've seen that we've been growing at a faster pace in services relative to the overall growth of our business. And I don't think we should assume anything different on a going-forward basis.", "And new networks is relatively nascent really. So again, I would put that into the space of it's growing. It's growing on a small base at a very healthy clip. But the reality is on the overall Mastercard, it's still to have a meaningful impact.", "So that's kind of the best I can share with you on that." ] }, { "name": "Michael Miebach", "speech": [ "Jason, I'd say that the model really is one not of separate pillars. This is an integrated business proposition where services differentiates payments. And payments is oftentimes a way to build out a further -- a broader set of services and so forth. So, it kind of goes in a circle, a virtuous circle, I have to say.", "When you look at it, the -- historically, we gave you a number a couple of years ago that service is a third of our quarter. It has been growing faster. I gave you an example earlier in my prepared remarks on Consumer Clarity, which is something that is transaction-related, and it's growing faster with 50 new issuers. So, there's just a lot of momentum in there.", "But there is also the kind of services that are not related to the underlying payments business. For example, what the example I gave you on Test & Learn, where we're working with a set of customers to work on their base core business as in Lowe's, the example that I gave you. So different sets of dynamics, but they go hand in hand, and that is the power of the differentiated and diversified business model that we have." ] }, { "name": "Jason Kupferberg", "speech": [ "I appreciate it. Thank you, guys." ] }, { "name": "Operator", "speech": [ "We'll move next to Rayna Kumar at UBS." ] }, { "name": "Warren Kneeshaw", "speech": [ "Rayna, are you on mute? Operator, let's go to the next and try to get Rayna back online. Operator, are you there?" ] }, { "name": "Operator", "speech": [ "Yes. We'll go next to Will Nance at Goldman Sachs." ] }, { "name": "Will Nance", "speech": [ "Hey, guys. Good morning. Maybe I'll squeeze one last 2019 -- versus 2019 question before the metrics go away. When we look at some of the kind of moving pieces in December, it seems like across some of the metrics, things seem to take a little bit of a step down on the 2019 stack.", "So just any color on what you're seeing on a regional basis between kind of e-commerce and travel and how those trends have kind of continued into January, maybe excluding some of the impacts of China that you're seeing. And then just a more numerical piece of that question as I -- appreciate the color you gave on the China metrics on inbound and outbound travel. Just wondering if you have any color on just the overall contribution of China to cross-border volumes." ] }, { "name": "Sachin Mehra", "speech": [ "All right, Will, so I'll take your questions in order out here. You talked about some color around how we're seeing things shape up in Q4 relative to 2019 levels. We're seeing pretty stable levels as it relates to switched volumes, switched transactions, and cross-border, in fact, marginally up on each one of them quarter over quarter. So, for example, in switched volumes in Q3 as a percentage of 2019, we were running at 154%.", "In Q4, we were running at 156%. And you can see this in the slide deck, which we shared with you. The one thing to just keep in mind is in the U.S. in Q4, we have seen a little bit of an impact come through from lower gas prices, and that's kind of being reflected in the numbers you see right here.", "You asked a question from a regional color standpoint. I'd say there's remarkably consistent growth that we're seeing in most regions. For example, in Europe, Europe continues to hold up pretty well. Latin America and EMEA are also actually holding up pretty well from a growth standpoint.", "In Q4, China was in the negative, particularly in its domestic volumes. And again, remember, our -- we don't generate a lot of revenue from the domestic side. But it was impacted negatively because of the flareup in the COVID situation, which took place there. So that's one piece to keep in mind.", "Another piece to keep in mind is that from an India standpoint, we are -- now that we're out of the embargo and we've started new issuance, you still have the tail effect of the embargo coming through. So said differently, the fact that you actually for a year, we're not issuing new cards in India has a result and impact of attrition of old cards which are taking place, which need to be more than compensated for by the issuance of new cards. And that takes time as issuers get ramped up and ready to go. So you've seen that come through in Q4 as well.", "But beyond that, I would say that we continue to see pretty good and consistent growth relative to 2019 levels across all our metrics here." ] }, { "name": "Michael Miebach", "speech": [ "And a stepdown compared to last year and the year before is, of course, there because you get the mathematics and the lapping effects and so forth. But to 2019, I think that's an instructive view here. It tells us that, yes, we're expecting a resilient consumer will continue to spend." ] }, { "name": "Sachin Mehra", "speech": [ "And, Will, you had asked the question about China. In my prepared remarks, I had shared with you that China inbound cross-border travel pre-pandemic was roughly 1% of our total corresponding volumes, and our outbound -- the similar metric from an outbound standpoint was about 2%. So, I know that was the second part of your question." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "We'll go next to David Togut at Evercore ISI." ] }, { "name": "David Togut", "speech": [ "Thank you. Good morning. Europe continues to be a driver of differentiated growth for Mastercard. For the year ahead, could you talk through some of your assumptions on the biggest opportunities in Europe, Germany, Poland, Italy, when you think about both economic outlook and cash digitization? We've seen mixed reports six, nine months ago, more concerned about Europe given high gas prices.", "Now it seems like the outlook has been a little better with lower gas prices and a more mild winter. But any insights would be greatly appreciated." ] }, { "name": "Michael Miebach", "speech": [ "David, let me start off on that. So, looking at Europe really in three categories, there's the U.K. on one hand, and there's emerging Europe and then there is Continental Central Europe. And slightly different picture on all of them.", "First of all, starting off with the continent here, the concern has been around for a while on rising gas prices and energy prices and the impact on the consumers' ability to spend. A combination of fiscal measures to provide cushions to consumers, along with energy-saving measures, along with the gas storage now reaching full capacity has really alleviated some of these concerns. So we continue to see a fairly resilient European consumer. That's our base assumption as we look forward.", "U.K. somewhat different economic outlook, and that might be a little more shaky there. But fundamentally, in this market, we are seeing a lot of tailwind for us from share gains over the last couple of years. So that works well for us.", "And emerging Europe continues to be a dramatic digitization opportunity as we've seen in markets like Russia, which unfortunately is not in our P&L any longer. But we have seen very high digitization rates, and we're pushing that in these emerging markets. Somewhere between, there's peculiarities like Germany where there was a significant digitization opportunity, and there still remains. But we caught up a lot in Germany over the last two years, particularly on the contactless side, which is now reaching half of the transactions there.", "So healthy mix in Europe and very strong share position with opportunities to come through from portfolio wins that we have shared with you over the last couple of years as they go into effect." ] }, { "name": "Sachin Mehra", "speech": [ "And I'll just add, David, to Michael's point around the deals which we've recently won and announced. Just to give you a little bit of perspective, we had talked about Santander historically. That migration is in progress. And we're through the bulk of a 9 million card migration there.", "We expect to be complete by early 2023 on that one. NatWest commenced the issuance of Mastercard debit cards in December of 2021. That's well underway, and we would expect some of that to continue to happen in 2023. And then the other one we had spoken about historically was Deutsche Bank, and we expect that the migration of that one will commence somewhere in the middle of 2023.", "So, just to give you a little bit of sense as to how we're kind of thinking about things." ] }, { "name": "David Togut", "speech": [ "Yeah. Thanks so much for all the great detail. Much appreciated." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "We'll move next to Ashwin Shirvaikar at Citi." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Thank you, Michael. Thank you, Sachin. I just wanted to drill into a couple of things now that we're getting rid of 2019 over the past few years. And looking forward, what has changed in terms of the growth algo? How should we think of that as we think of normalized growth visibility? And then this is a smaller question with regards to, specifically for '23, the spread between was and just how should one think of that?" ] }, { "name": "Sachin Mehra", "speech": [ "I'm going to need a little bit more clarity on the second part of your question, but we'll get to that. Let me take the first question first, which is as it relates to the growth algorithm. Just suffice it to say that the fundamentals of our business actually are very, very sound. The growth algorithm, which has actually enabled the strong growth we have delivered pre-pandemic, very much stands sound even today.", "So, the reality is, if you think about PCE growth, you think about the opportunity for the secular shift to electronic forms of payment, you think about the fact that we're growing market share, you think about how we're delivering on our services capabilities and driving growth from that. And now as we're doing new and different things around new payment flows, as well as new networks, that growth algorithm actually is very sound, very stable, very consistent with what we've historically had. And that's the way we think about the business for, call it, not only the near term but near medium to long term for Mastercard. Now, Ashwin, I'm not sure I got the second part of your question.", "Could you repeat that, please?" ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Yeah. I was asking about the cross-border volume spread. How should one think of that as we think of this year?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. Look, I mean, our cross-border proposition sound -- is very sound and stable. And I think at the end of the day, like I said, most of the regions are now back to what I would call the stable growth rates that we would normally have seen in the pre-pandemic phase. The one exception is Asia, and there's a little bit of opportunity which we have in Asia, which we've contemplated in our thoughts for 2023." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "We'll move next to Ken Suchoski at Autonomous Research." ] }, { "name": "Ken Suchoski", "speech": [ "Hi. Good morning, Michael and Sachin. Thanks for taking the question. I wanted to ask about the cross-border recovery.", "We see the volumes for cross-border travel are well above 2019 levels. Where are you seeing the transactions versus 2019 levels on that same metric? Sachin, you made some interesting comments on price versus units. And I'm just trying to get a sense for how much the cross-border travel volumes are benefiting from inflation and spend per transaction. And how much recovery is still left from a number of transaction standpoint? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Ken. So, my comment is actually going to hold true for not only cross-border for -- largely for the business, if you think about it, right? You know our transactions or the growth in our transactions is impacted by our average ticket size. There are puts and takes on the average ticket size, not only in cross-border but even on domestic, which are influenced by numerous factors. One of which is inflation.", "The others are the mix between card-present and card-not-present. Because what happens is, typically, with more card-not-present, you tend to see a higher average ticket size, which results in lower transaction growth rate. Now that being said, also when you do more card-not-present, you have the opportunity to deliver more services. When you deliver more services, it allows you to actually have a compensating effect from a revenue standpoint.", "So, I think those are two important things to keep in mind. The third, I would say, from an average ticket size standpoint, which impacts both cross-border and domestic, is what is the regional mix because different countries have different average ticket sizes, which influences what the growth rates are. Specifically, on cross-border average ticket, it has been pretty stable year over year. And our assumption, as we kind of think about this is not knowing perfectly well where inflation is going to go.", "And the variables I kind of talked about, those are the things we factor into our assumptions as it relates to transaction growth on a going-forward basis." ] }, { "name": "Ken Suchoski", "speech": [ "OK. Thanks, Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Warren Kneeshaw", "speech": [ "We probably have time for one last question." ] }, { "name": "Operator", "speech": [ "We'll take that question from Dave Koning at Baird." ] }, { "name": "Dave Koning", "speech": [ "Yeah. Hey, guys. Thanks. Maybe just to go back a little bit to Q1 guidance.", "You talked a little bit about this, but I know revenue you've got on a non-GAAP basis, decelerating something like 5% or so. But every metric -- every core metric in January accelerated by kind of 4% to 11%. Is there just tougher comps coming on some of those key metrics? Or is it rebates? Or maybe talk through a little bit about the gap and kind of what's going to happen in the rest of the quarter." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Dave. A couple of thoughts. One, in Q1, acquisitions contribute less to our Q1 growth than they did to our Q4 growth because you're doing a sequential comparison between Q4 and Q1 in your question there. Number two, the suspension of operations in Russia has a greater impact in Q1 than it does in Q4.", "It's just the way the cadence of the revenues are. And then two other points I'd point out is Michael talked about the several wins we've got, active deal activity, which has been in play. We've got to contemplate all of that in our Q1 kind of thoughts. And then the last piece I'd mention is we did have elevated levels of FX volatility in Q4.", "I don't know where FX volatility is going to play out. We've done our best assumptions around that, but those would be the contributing factors." ] }, { "name": "Dave Koning", "speech": [ "Gotcha. Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Michael, any final comments?" ] }, { "name": "Michael Miebach", "speech": [ "Yes. So, thanks for your questions. Thanks for your trust. Rayna, we will figure out your questions offline.", "We can't get to those, unfortunately. The day will come when there's a call where there's more questions for me than for Sachin. I'm still hopeful we will get there at some point. But the story has been resilient consumer, and we still see some opportunity in cross-border for Asia.", "That's the base. We're winning. That feels good as we look ahead into 2023. And we have 28,000 excited people at Mastercard that are going to deliver on that opportunity.", "With that, thank you very much and speak to you next quarter." ] }, { "name": "Sachin Mehra", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2021-07-29	[ { "description": "", "name": "Warren Kneeshaw", "position": "Executive" }, { "description": "", "name": "Michael Miebach", "position": "Executive" }, { "description": "", "name": "Sachin Mehra", "position": "Executive" }, { "description": "Tsin Huang", "name": "Tien", "position": "Analyst" }, { "description": "", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "", "name": "Craig Maurer", "position": "Analyst" }, { "description": "", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "", "name": "Darrin Peller", "position": "Analyst" }, { "description": "", "name": "Dan Dolev", "position": "Analyst" }, { "description": "", "name": "Bryan Keane", "position": "Analyst" }, { "description": "", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Andrew Jeffrey", "position": "Analyst" }, { "description": "William Blair -- Analyst", "name": "Bob Napoli", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by and welcome to the Mastercard second-quarter 2021 earnings conference call. [Operator instructions] I would now like to hand the conference over to your speaker today, Warren Kneeshaw, head of investor relations. Thank you. You may begin." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Kristal and good morning, everyone and thank you for joining us for our second-quarter '21 earnings call. We hope you are all safe and sound. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the investor relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website. With that, I'll now turn the call over to our chief executive officer, Michael Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren and good morning, everyone. So here are highlights of the quarter. The strong momentum we started the year with accelerated this quarter, with net revenue up 31% and EPS up 37% versus a year ago, all that on a non-GAAP currency-neutral basis. On that same basis, quarter 2 net revenues are now 10% over 2019 levels even though international travel is in the early stages of recovery, which is showing the strength of our diversified revenue streams.", "The domestic switched volumes are well above pre-pandemic levels with all the regions growing in a healthy rate. We're seeing improvements in both domestic and cross-border travel with significant upside potential. Within this context, we're making progress against our strategic objectives and have expanded our relationships with key partners like Citi, J.P. Morgan Chase, Barclays, Stripe and Verizon.", "Let's dive in, looking first at the broader economy. Domestic spending levels continue to show improved in-store sales and strength in e-commerce. According to our quarter 2 SpendingPulse report, which is based on all payment types, including cash and checks, U.S. retail sales at auto, ex gas, were up 14% versus a year ago and up 10% versus 2019, reflecting improved consumer mobility and some residual effects of fiscal stimulus.", "SpendingPulse also indicated that overall European retail sales in quarter 2 were up 13% versus a year ago and 6% versus 2019. The vaccine rollout has scaled in the U.S., U.K. and Germany and several other countries with over 35 countries now reporting that over 50% of their populations are at least partially vaccinated. Broadening this effort is critical and will of course take time.", "Turning to our business, specifically in the four phased framework we established for managing through the COVID environment. We believe that most markets are at a growth phase domestically as cross-border spend is now starting to normalize and border restrictions are being relaxed. Looking at Mastercard spending trends. Switched volumes continue to improve quarter over quarter, with strength across all products.", "Debit spend remains elevated, and we are seeing further recovery in credit, driven in part by the return of travel and increased discretionary spending. This recovery is led by consumer credit, but it's important to note that commercial credit is also improving and has now reached pre-pandemic levels as well. In terms of how people are spending, they are definitely getting out more as we're seeing improvement in card-present spending, particularly in the travel, retail and restaurant categories, while e-commerce continues to be strong. Now, turning to cross-border.", "Proforma card-not-present spending, excluding online travel spend, continues to be very strong. On the travel front itself, it is clear people want to travel and they do so where and when able to. We've seen this domestically and across borders where there are limited restrictions. For example, we're seeing strength between the U.S.", "and Latin America as well as an increase in travel within Europe. Our industry reports, there has been a recent increase in bookings for travel between the U.S. and Europe, and the quarantine requirements for entry into Canada are starting to be relaxed, so that's a further opportunity. Overall, we expect more borders to open in the second half of the year, depending, of course, on infection rates, including the recent variants and progress on the vaccination front.", "Against this improving backdrop, we are focusing on our strategic priorities. One, growing our core products supported by our services. Second, driving digital enablement, both in stores and online. Third, ensuring the ecosystem is safe and secure.", "And fourth, providing choice through our multi-rail capabilities. As always, we will do this with an eye toward driving top and bottom-line growth over the long term by continuing to manage our expenses carefully. We'll look at them one by one. First off, we're driving growth in our core products and are leveraging our comprehensive services to do so, working with new and existing customers solve their pain points, both in payments and beyond.", "We're well positioned to capitalize on the return of travel and remain focused on building on our strength in this area by expanding relationships with our travel partners. For example, we have renewed our exclusive co-brand with JetBlue Airlines in the U.S. We also entered into a long-term global partnership with Cathay Pacific and Asia Miles, who will migrate their existing co-brand portfolio to Mastercard. In the Middle East, we have expanded our British Airways co-brand and in Latin America, we are now the preferred brand for LATAM Airlines.", "It is important to note that our services played a critical role in enabling all these deals, including our data analytics, Test & Learn, loyalty, consulting and cybersecurity solutions. Of course, we also continue to drive growth in the core outside of travel. Here are a few examples. We're excited about our partnership with Citi to launch the new Citi Custom Cash Mastercard, offering card members cash back in the top eligible spend category.", "J.P. Morgan Chase, we've extended and deepened our agreement in the commercial space, and we have renewed our Maestro brand relationship with Chase in the U.S. We also continue to partner closely with community banks throughout the U.S., including a flip of First Southern National Bank's debit portfolio to become their exclusive network brand. On the digital front, we're well positioned to drive the acceleration of the secular shift with our digital capabilities no matter how consumers want to shop: in store, online or both.", "As consumers return to in-person shopping, adoption of contactless continues to grow. In the second quarter, contactless penetration represented 45% of in-person purchase transactions globally according to our switched transaction. That's up from 37% a year ago. At the same time, e-commerce continues its strong growth, and we are providing consumers choice on how they want to pay online.", "For example, click to pay, to improve the guest checkout experience, it's now rolled out in over 10 markets, and we continue to launch significant new merchants such as the Canadian Tire group. On to the buy-now-pay-later space. In Australia, we're partnering with Citi and Commonwealth Bank of Australia to offer installments to consumers wherever Mastercard is accepted. And whether in store or online, we are securing and streamlining the consumer experience through our tokenization services.", "Tokenized transactions across in-store, online and in apps surpassed 1 billion per month throughout the second quarter. We continue to partner with major digital players to expand the reach of our digital capabilities. For example, we just entered a strategic partnership with Stripe to give business a small control of the how they spend their money by enabling Stripe users to create, manage and distribute virtual and physical cards for small business, commercial and consumer across credit, debit and prepaid. We've also entered a partnership with Verizon to bring 5G innovation to the global payments industry.", "Leveraging our services and insights in pairing Mastercard solution with Verizon's 5G connectivity will allow us to create better experiences from the checkout lines to being billed, even through how businesses are run. The increased capacity and reduced latency of 5G will enable us to take another step toward making every device a commerce device. Now, on to securing the ecosystem. As more merchants and consumers shift to digital, the importance of keeping the ecosystem safe and secure is paramount and is creating a strong demand for our cyber solutions.", "In addition to organic growth, a number of our acquisitions in the space continue to perform well. For example, Ethoca had strong deal momentum, including a fraud and dispute management agreement with EBANX, a payment solution provider operating across 15 countries in Latin America. RiskRecon, which monitors and then tests those customers' third-party cybersecurity risk, is now scanning millions of companies globally, up from thousands when we acquired them at the end of 2019. NuData is providing biometric fraud prevention tools to Major League Baseball and the neobank, Nickel.", "We're happy to advance our digital identity capabilities with the acquisition of Ekata that has now closed and off to a strong start on the deal front. Last but certainly not least, let's turn to our initiatives focused on addressing a broader set of payment flows with our multi-rail capabilities. The key here is to provide choice, essentially the right tool for the job. With our multi-rail approach, including our expertise and capabilities in cards, real-time payments and support for digital currencies, we are able to deploy the right combination of assets to meet our customers' needs.", "And more than just having this range of capabilities, we're making these solutions work together seamlessly. Let me give you a few examples. In B2B, we're making progress with Mastercard Track building out our global open-loop network by working with buyer agents and supplier agents such as banks, software companies and ERP vendors. On the bank side, we're very excited to have signed Box e-card payments who will use Track to connect their global business customers on both the buyer and the supplier side of the ecosystem across multiple rails.", "We also signed FreshBooks, a premier accounting software platform with customers in over 100 countries. In the Bill Pay space, we continue to scale the Mastercard Bill Pay Exchange, which leverages our real-time payment capabilities to provide a transformative mobile-first experience to bill payments with Citi Treasury and Trade Solutions now connecting into the platform. In Mastercard Send, we continue to penetrate a variety of new payment flows beyond traditional card payments. These enabled dozens of use cases and hundreds of programs across every region of the world.", "For example, we're partnering with innovative digital messaging platforms to offer P2P services to consumers. Today, uses of WhatsApp in Brazil can transfer money directly in-app, leveraging Mastercard Send. We're also partnering with MoneyGram and Checkout to enable near real-time cross-border P2P transfers across Europe. And on the B2C front, we continue to support the fast-growing gig economy, and I'm partnering with PayFair to enable instant earnings payout to some of the largest gig platforms in the U.S.", "Through open banking, Mastercard is empowering people and businesses across the globe to easily and securely gain access to their financial data to create new opportunities for themselves. In the U.S., our efforts with Finicity are running ahead of expectations as we continue to enhance direct API connectivity for banks and fintechs. For example, we're partnering with Jack Henry to enable consumers back up more than 400 community financial institutions to use its digital platform to access, use and benefit from their own financial data. The Navy Federal Credit Union vis-à-vis signed direct data access agreements with Finicity.", "Finicity is also leveraging best-in-class data connections to launch new products in new verticals, such as its Mortgage Verification Service. Finally, in terms of cryptocurrency, we're making it easier for cryptocurrency wallets to connect seamlessly to our network through a pilot with Paxos, Circle and Evolve Bank & Trust, which simplifies the conversion of crypto into fiat. Separately, we're partnering with ConsenSys, the Ethereum software engineering firm, to accelerate the development of crypto applications and services to our customers. Now, summing all this up.", "We delivered strong revenue and earnings growth this quarter, benefiting from our revenue diversification efforts. We believe that most markets are in the growth phase domestically and there's upside potential in cross-border travel. We're winning significant new deals, and we continue to focus on our strategic priorities to drive growth over the long term. Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. Now turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis, excluding special items and the impact of gains and losses on the company's equity investments. Net revenue was up 31%, reflecting the continued execution of our strategy amid the strong recovery in spending. Acquisitions contributed 3 ppt to this growth.", "Operating expenses increased 28%, including an 8 ppt increase from acquisitions. Operating income was up 34%, and net income was up 36%, both of which includes a 2 ppt decrease related to acquisitions. EPS was up 37% year over year to $1.95, which includes $0.03 of dilution related to our recent acquisitions, offset by a $0.02 contribution from share repurchases. During the quarter, we repurchased $1.7 billion worth of stock and an additional $398 million through July 26, 2021.", "So now let's turn to Page 4, where you can see the operational metrics for the second quarter. Worldwide gross dollar volume, or GDV, increased by 33% year over year on a local currency basis. We are seeing continued strength in debit and credit. U.S.", "GDV increased by 34% with debit growth of 23% and credit growth of 50%. Outside of the U.S., volume increased 32% with debit growth of 39% and a credit growth of 25%. Cross-border volume was up 58% globally for the quarter with intra-Europe volumes up 48% and other cross-border volumes up 71%, reflecting continued improvement and the lapping of the debts of the pandemic last year. In the second quarter, cross-border volume was 87% of 2019 levels, with intra-Europe almost back to even at 97% and other cross-border volume at 79% of 2019 levels.", "Turning to Page 5. Switched transactions grew 41% year over year in Q2 and were at 127% of 2019 levels. Card-not-present growth rates remain strong and card-present growth continued to improve, aided in part by increases in contactless penetration across every region. In addition, card growth was 8%.", "Globally, there are 2.9 billion Mastercard and Maestro-branded cards issued. Now, let's turn to Page 6 for highlights on a few of the revenue line items, again, described on a currency-neutral basis unless otherwise noted. The increase in net revenue of 31% was primarily driven by domestic and cross-border transaction and volume growth as well as strong growth in services, partially offset by higher rebates and incentives. As previously mentioned, acquisitions contributed approximately 3 ppt to net revenue growth.", "Looking quickly at the individual revenue line items. Domestic assessments were up 36%, while worldwide GDV growth was up 33%. The 3 ppt difference is mainly driven by pricing and mix. Cross-border volume fees increased 60%, while cross-border volumes increased 58%.", "The 2 ppt difference is primarily due to favorable mix as cross-border volumes, ex intra-Europe, grew faster than intra-Europe volumes this quarter, partially offset by the lapping of elevated levels of return activity a year ago. Transaction processing fees were up 33%, while switched transactions were up 41%. The 8 ppt difference is primarily driven by the lapping of elevated return activity a year ago and adverse mix. Other revenues were up 32%, including a 9 ppt contribution from acquisitions.", "The remaining growth was mostly driven by our cyber and intelligence and data and services solutions. Finally, rebates and incentives were up 49%, reflecting the strong growth in volumes and transactions and new and renewed deal activity. Moving on to Page 7. You can see that on a currency-neutral basis, total operating expenses increased 28%, including an 8 ppt impact from acquisitions.", "The remaining growth in operating expenses was primarily due to higher personnel costs as we invest in our strategic initiatives, increased spending on advertising and marketing and increased data processing costs. Turning now to Page 8. Let's discuss the specific metrics for the first three weeks of July. We are seeing significant improvements in the growth rates across our operating metrics versus 2020, in part due to the lapping effects related to the pandemic that began last year.", "To provide you better visibility into current spending levels, we thought it would be useful to once again present the 2021 volumes and transactions and the percentage of the 2019 amount when we were not experiencing the impact of the pandemic. So if you look at spending levels as a percentage of 2019 for switched volumes, the broad-based recovery continued through the second quarter and into July. Specifically, in the first three weeks of July, switched volume spend levels are at 130% of 2019 levels, which is a 9 ppt improvement over Q1. We are seeing a further recovery in card-present spending with improvements in travel-related categories, including lodging and restaurants.", "Also, in the U.S., we have seen consumer airline spend improve significantly since the early part of Q2, with volumes now back to pre-pandemic levels. Trends in switched transactions remain steady and are generally tracking the trends we are seeing a switched volumes. In terms of cross-border, spending levels as a percentage of 2019 show an improving travel trend. Cross-border travel, which includes both card-present and travel-related card-not-present volumes increased from 39% to 66% of 2019 levels from April to July, primarily driven by strength in Europe and between the U.S.", "and Latin America. Asia Pacific has been slower to recover. Cross-border card-not-present, ex travel, continues to grow at a healthy rate above pre-pandemic levels. This has moderated recently relative to 2019 levels in part due to a reduced contribution from the purchase of cryptocurrencies and the lapping of significant e-comm promotional activity in 2019.", "Turning now to Page 9. I wanted to share our current thoughts looking forward. First off, we continue to make strong progress against our strategic objectives and are well positioned to grow with the new and renewed deals we continue to sign. Domestic spending levels are showing healthy growth, and we are well positioned for the return of travel with travel-oriented portfolios.", "Further, our service lines continue to grow at a healthy rate. Turning to the third quarter. The spending levels continue to improve along their current trajectory. We would expect Q3 net revenues to grow at the high end of mid-20s growth rate year over year on a currency-neutral basis, excluding acquisitions.", "As a reminder, Q2 2020 marked the low point of the pandemic from a spending standpoint with some recovery in the following quarter. So we will be facing a more difficult comp of approximately 3 ppt in the third quarter. It is also important to point out that this is just one potential scenario as the level of uncertainty remains related to new COVID variant and the progress of vaccinations and therefore, the pace of recovery may not be linear. In terms of operating expenses, we will continue our disciplined approach to expense management while advancing our strategic objectives in key areas such as digital, cybersecurity, data analytics, B2B and our material solutions, including related brand and product marketing investments.", "For Q3, we expect operating expenses to grow at the high end of mid-teens rate versus the year ago on a currency-neutral basis, excluding acquisitions. As a reminder, we are lapping the spending actions we took last year as the pandemic developed. With respect to acquisitions, we are pleased to have closed on the transaction with Ekata earlier than expected and expect the acquisitions will contribute about 2 to 3 ppt to revenue in Q3 and Q4. Similarly, acquisitions will contribute approximately 9 to 10 ppt to operating expense growth in both Q3 and Q4 as we integrate several acquisitions in promising new growth areas such as open banking, digital identity and real-time payments.", "As a reminder, we discretely disclosed the impact of acquisitions for the year in which they closed and the subsequent year, after which time we do not split them out. Other items to keep in mind. Foreign exchange is expected to be a 0 to 1 ppt tailwind to net revenues and a 1 to 2 ppt headwind to operating expenses in Q3. On the other income and expense line, we are at an expense run rate of approximately $115 million per quarter given the prevailing interest rates.", "This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics. And finally, we expect the tax rate of approximately 17% to 18% for the year based on the current geographic mix of our business and improvement over previous expectation due to some discrete tax benefits realized in Q2. One last point, I wanted to let you know that we are planning an investment community meeting for the fall in New York. We are planning a cyber event on November 10, and we look forward to discussing our future plans with you at that time.", "And with that, I will turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Kristal, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Your first question comes from the line of Tien-Tsin Huang with J.P. Morgan." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey, good morning, everyone. Thanks for tall the details as usual. Just want to -- just going through, Sachin, some of the numbers you gave and just want to get your updated thinking here on operating leverage in the second half of the year, including the digestion of deals. Looks like there is some, but I'm just curious how aggressive some of the spending will be on the integrations given that there's a lot going on, a lot of good things going on there with some of the evolutions you've done and the focus on services if that makes sense." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. So Tien-Tsin, it's like I said in my comments, I think what we have line of sight on is the acquisitions which we have done, which we have announced, and that's what I've given you some level of guidance on as it relates to what contribution they're going to have from a revenue standpoint and an expense standpoint, all of which I just went through in my prepared remarks. Look, the reality is we're running the business for the long term. We're trying to drive long-term revenue growth and at the same time, long-term bottom-line growth.", "And we'll do this in a disciplined manner. We have demonstrated over the period of the pandemic that we have sufficient flexibility in our expense base to actually make sure that we continue to execute on our strategic growth objectives and at the same time, keep an eye on how we're seeing the top line come around. So I guess my point to you is the following, which is we will continue to do what's right for the business to drive long-term growth by investing in key strategic areas, both organic and inorganic. And that's kind of where we are.", "In terms of the specifics on the numbers, it's what I just shared with you. We expect that acquisitions will contribute between 2 and 3 points to revenue in the third and the fourth quarter and between 9 and 10 points of expense growth in the third and the fourth quarter." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. Just something to add, Tien-Tsin, here is if you look at the three big acquisitions that have come in over the last year or so, Nets, the largest one we have done is giving us a real advantage in real-time payments around the world. You have Finicity open banking. That's a trend that's very hot.", "We feel really good about that one. And then digital identity, Ekata is foundational to everything that we do online. So very critical acquisitions. To Sachin's point, we have to do what is right.", "But one thing that's not changing and that is -- that's very clearly that our discipline on execution. We stick to our 24-month nondilutive measure on all of these. So I just want to put that out there with you as well." ] }, { "name": "Tien-Tsin Huang", "speech": [ "All fair points. And those are all important areas. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Harshita Rawat with Bernstein." ] }, { "name": "Harshita Rawat", "speech": [ "Hi. Good morning. Thank you for taking my question. Michael, last week, you announced a card offering for a crypto company, which simplifies the crypto conversion to fiat and this fits within and the other announcements you've made in crypto.", "But taking a step back, can you talk about the value proposition Mastercard is bringing to the table for crypto companies, central banks or CBDC, stablecoins providers and the different ways you're engaging there? Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Right. Thanks, Harshita. Great question. Very important topic.", "It's obviously a vibrant space around digital currencies. Let me go back to what we discussed in the previous call, where we said there's broadly three different categories that are at play here, which is the Central Bank digital currencies and there's private sector stablecoins and there is a floating cryptos. So we told you that we want to be playing a role across all of them. We also said that -- in the first-quarter call that as far as stablecoins are concerned, we are getting ready to technologically enable our network to carry these stablecoins as settlement currencies provided they meet one of our -- all three of our criteria, which is regulatory compliance, consumer protection and stability.", "So none of that has changed. Let me just give you a view on what has happened since we had that conversation. So on the Central Bank digital currency front, things are definitely continuing to move forward. You see a lot of central banks engaged on the topic.", "The ECB has just recently announced that they will actually move forward with the digital euro after a period of industry consultation. The Bank of England is in its period of industry engagement at this point right now. So there is clear progress. What is our value proposition to central banks and the government in this space is, first of all, we bring a unique perspective to the market as -- to these players as a multi-rail provider because all these countries have to make the trade-off, what is my existing financial system delivering my existing financial infrastructure and what else is the Central Bank digital currency solving for.", "Everybody has different motivations ranging from financial inclusion to cross-border payments and hence, we're a sought-after party because we have experience in all of that. I think a particularly critical proposition here is our virtual test platform because all of these design choices that governments have to make and that we consult them on, we then have to live in the wild, so to say. They've got to work with the existing financial infrastructure, and that's what our virtual test platform does for them. So that's the proposition at this stage for central banks.", "On the private sector stablecoins, nothing much different other than us engaging with private sector players as well as regulators on what does good policy look like around private sector stablecoins because this question about regulatory compliance is still unresolved. The regulators do need to weigh in and we're a part of that dialogue. On floating cryptos, here, the point of currency stability is not solved. So we won't be enabling that as settlement currency on our network.", "But clearly, people want to invest in that. They don't want to sell their investments, and we're going to make this as easy as possible. So we have all these partnerships out there. Now, here's the thing with our announcement last week.", "And that is that in digital currency wallets out there oftentimes prefer to stay in crypto as these transactions are like selling and buying of investment. And here's where our partnerships, for example, with Paxos come in. It is our partner that allows these digital wallet to stay in crypto as they settle with Paxos and then Paxos settles with us in fiat. That's an interim step for us and when we reach the point that we might be enabling stablecoins on our network itself.", "So that's kind of where we are, playing a role across the board. This is a relevant technology. As a multi-rail player, we got to be in this space because people are looking for answers." ] }, { "name": "Harshita Rawat", "speech": [ "Perfect. Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Lisa Ellis with MoffettNathanson." ] }, { "name": "Lisa Ellis", "speech": [ "Good morning. Good stuff. Thank you for taking my question. I have one question on B2B payments.", "Michael, in your prepared remarks, you called out progress on Mastercard Track and Bill Pay Exchange. Taking a step back, can you just give us a sense right now of where you are in terms of scale and trajectory holistically in the digitization of B2B, especially as it seems like some of that digitization has gotten a bit of a jump start to the pandemic? Anything you can dimensionalize around volumes, growth rates, etc. Thank you." ] }, { "name": "Michael Miebach", "speech": [ "All right. Thanks, Lisa. B2B, a huge space, obviously, a TAM of $125 trillion. So how are we going about it? One bite at a time, I would say.", "So the first thing I should say is our commercial business is there. It's coming back. Commercial travel is coming back, as I noted earlier in my comments. So here the focus is on small business, virtual card.", "And in the B2B space, specifically virtual card solutions, for example, on online travel agencies. So all that is continuing, but it's worth noting, we gave you a number some time back and in 2020, this was 11% of our GDV and that is what we're happy about that. Now, when it comes to B2B very specifically, the multifaceted approach I talked you through earlier across Bill Pay, Track and the whole list that I talked about. Here, I see that if I take Bill Pay today, if you look at the fact that we have a quarter of all bills being paid addressable at a third of the billers, so that gives us real scale.", "So I think we have come to a point of scalability here with the right kind of players. Last quarter, we added Verizon as a biller to the mix. So that is encouraging. We haven't given specific numbers and we haven't done it this quarter yet, but we really see that's going in the right direction.", "And with Nets coming in, we have a significant footprint in Europe. They run a scaled Bill Pay business over there. So when the time is right, we will share some numbers around that. Now at B2B, specifically Track, the excitement around a large bank like Barclays joining the Track ecosystem is great.", "We've fine-tuned our go-to-market with ERP and software providers. So the rollout here is progressing well with the right -- with both sides, buyer and supplier and buyer and supplier agents. Again, we haven't given numbers yet, but it would be what you would expect when you build a two side network. We're starting to have players on both sides.", "We can start to connect the corridors. So the value proposition of Track, a data switch, a payment optimization engine and the choice in multi-rail payments is really starting to get a hold. We said to you a couple of times, this has been -- this is going to be a multi-rail journey. COVID, while there was a realization that B2B supply chains have been affected by COVID and there's a desire to digitize, it wasn't exactly top-of-mind through COVID.", "So we're starting to see this interest coming back. So that's kind of where we are. And Sachin, you have anything to add?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, sure. I'll just make one more point which is, as we think about B2B, we also think about it from a segment approach, right? What is the micro kind of business environment, small business environment, mid-market and then large corporates? And when you actually dissect along those lines, you will see that there's a significant amount of spend which takes place across the micro and small business space. And if you further break that down, you will see that there is a significant amount of that spend which takes place in cash. So the only point I'm kind of trying to make is that the value prop of the card rails in B2B still stands and stands pretty strong to displace cash, much like it has in the consumer space.", "And there's a tremendous opportunity for digitalization to continue down that path there as well. So I know we talked a lot about the accounts payable flow, and I think that's super important, but we certainly internally are not losing sight of the fact that a significant amount of cash spend, which still takes place where the value prop of card stands good." ] }, { "name": "Lisa Ellis", "speech": [ "Terrific. A lot of checks too. Awesome. Terrific color.", "Thanks a lot." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Craig Maurer with Autonomous Research." ] }, { "name": "Craig Maurer", "speech": [ "Yeah. Hi. Thanks for taking the question. Two questions for you.", "One, any thoughts on the reopening of the Durbin Amendment discussion? And second, are you planning to update your three year guide at the investor day later this year? And I know you just announced it, but figured I'd ask anyway. Thanks." ] }, { "name": "Michael Miebach", "speech": [ "OK. So let me take the last one with kind of like a bit of a cheeky response. I think you will just have to tune in, Craig, to find out if we're going to give a three year guidance or a longer-term guidance at the time. On interchange, so complex topic for sure and the new administration is looking at various regulatory and lawmaking initiatives.", "As we all know, we've just seen the news develop yesterday. Now from the outset, we've leaned in with the new administration. We built a really positive relationship. So that is very good.", "And we're continuing, obviously, the same kind of interaction and engagement on a topic as important as interchange to our industry with lawmakers on the Hill, House and Senate, both sides of the aisle. We're monitoring this very closely. There is chatter here and there on interchange. The topic that's always been focused by different parties.", "What I would say is we've had the benefit of now having many years of playing -- seeing the interchange regulation on debit play out. There's enough data for us out there to say that really what it was intended to do, we can't really see it. Cost for consumers have gone up and benefits have been reduced. We keep providing that data to lawmakers and other interested parties and figures what the facts are stating.", "Now, when it comes to interchange regulation applied to credit, you would expect the same in terms of cost impact, in terms of benefits impact, but there is another aspect here, that is the access to credit. You should assume that the access to credit for middle-class Americans is going to be impacted and not in a positive way if this interchange regulation comes in. So it is all something that needs to be thought through very carefully. What are the puts and takes? Why does this make sense? And that's the dialogue that we're leaning in.", "The good thing is we've seen this play out in many other markets around the world and have some experience with that and can then bring to the table as well. So that's kind of where we are, closely monitoring." ] }, { "name": "Craig Maurer", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Sanjay Sakhrani with KBW." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. Obviously, a lot of eyes on cross-border travel spending, and there were some constructive data points this quarter. Maybe two interrelated questions.", "Understanding the data variant sort of -- sorry, Delta variant adds complexity to a view, but do you think that we continue to see progress on travel spending going forward? And I think, Sachin, you mentioned in your third-quarter view, you expect continued spending trends. Is there a view on cross-border as well?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. Hey, Sanjay, sure. Why don't go ahead and take that question. So really, I will preface by saying the following which is again, it's -- the uncertainty in the environment prevails given all these variants, which are kind of showing up.", "But the reality is the following, which is it has been clearly demonstrated that people want to travel and they do so when they're able to travel. And that's been shown in the domestic environment, and that's being now shown in the cross-border environment. So one of the things which is something which we very closely track is how is it that booking levels are taking place? What's kind of that trajectory of spend looking like or that trajectory of kind of data looking like? And then which are the corridors which are opening up based on -- for example, earlier this week, there was some dialogue around how the U.K. is going to open up to vaccinated people coming from the U.S.", "and from other countries. So the reality is the following, which is the data as we've seen it is what we've shared with you through the first three weeks of July. We are positive in terms of our sentiment as we progress through the second half of the year that as people get more vaccinated, more corridors will open up. And as more corridors open up, people will exercise their ability to travel because they have the intent to travel.", "And this is really, really important because as I look at what's going on across the globe, you could see that the U.S. and Latin America, which has the ability to travel with more borders being opened, people are exercising that and they're showing that come through. Similarly, now we're hearing about Canada opening up, which will be, again, something, which is encouraging from our perspective in terms of how people play that out. Asia, on the other hand, is still, I would say, at a pretty kind of subdued level just because of the reality of the situation in Asia, being what it is with the variants now actually getting to higher levels in certain countries in Asia.", "So look, hard to predict. But longer term I guess when I kind of look through all of this, what we feel encouraged about is that the vibrancy of travel is something which will come back. And most importantly, we are very well positioned to capitalize on that and when it does come back." ] }, { "name": "Michael Miebach", "speech": [ "I just want to add one point. As I listen to Sachin, what I find very noteworthy here is, back to this comment about like 35 countries have now over 50% of vaccinations level, so this kind of sequence of you're vaccinated and you are willing to travel, which we have both seen as proof points, and then governments finding ways now to enable these corridors. As what we've seen with Canada and the U.K., there's a whole stack of people that are vaccinated and want to travel. And until you come to the point of who else is not vaccinated, there's a long runway for us for -- this to play out.", "But as Sachin said, very difficult to predict at this point, but those are facts that are on the table, at least that we're looking at and we've seen that over the last three weeks." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "The next question comes from the line of Darrin Peller with Wolfe Research." ] }, { "name": "Darrin Peller", "speech": [ "Hey. Thanks, guys. We're now a year and a quarter basically into the pandemic. And like when we think -- Michael, when we think about the structural and sustainable elements of what we're seeing in volume and even some of the other aspects of your revenue, like some of the value-added services, you've really been growing well, probably better than I think we would have expected pre pandemic.", "Can you give us a sense now if you revisited that what you see as now sustainably elevated, structurally better that could persist over the next few years beyond just stimulus and pent-up demand?" ] }, { "name": "Michael Miebach", "speech": [ "Yeah. So Darrin, the pent-up demand at some point in time is going to level out. I think you're right. Once you've caught up time and met everybody again, we're going to come to back of that.", "But there's still some more pent-up demand to go, particularly on commercial travel. We'll see how that will play out. It's interesting. When you look over the last two quarters, we see continued elevated levels of digital e-commerce spend, but we see in-store coming back.", "So there is not a net-zero game going on. I think this is actually really generally secular trend against cash and that is going to continue to run for a very long time. So it's good to have these two legs to stand on from our business model. I think that will remain.", "You'll see some of the e-commerce going to reduce over time, but I don't think we will go back to the levels that we had before the pandemic because people would have learned better experiences and they will like continue with that. I think every bit of consumer research that we do tells us that. And by the way, this is not just for online shopping, it's for digital banking and for contactless. It's for everything across the board.", "Generally, between 60% and 70% of people that we asked, and we ask them every month, say exactly that. With this push toward a more digital world, more data that needs to be kept safe, so I see that the path for our cybersecurity solutions is a very clear one and a very good one, and we will not see a reversion to something there before because you have the elevated driver of more digital just out there driving that business. And frankly, that's the same for data and analytics. Data analytics, again, more data, people want to understand it.", "But back to what Sachin was talking about on small business, here's a bunch of players that have traditionally maybe not used tools like that, understanding and managing their business through data and analytics. But now they can. So there's a whole new segment that's opening up that will -- we would like to serve through our partners in terms of real insights in how do you run a business online from whatever you might have been doing in the brick-and-mortar space before. So I think those are structural changes that are here to last.", "Cross-border, I don't think it's going to be something dramatically structurally changing. That's really the -- well, cross-border e-commerce. I think that is -- that's, again, people would have figured out that this does actually work. It couldn't go anywhere.", "They were using cross-border e-commerce platforms and tools, and I think that will continue. One more thing that comes to mind structurally is the heightened and elevated interest of governments and electronic payments and digital payments. That has started last year. Again, that was driven by the prices initially.", "How do I get my stimulus payments out to now a conversation, wow, this is an interesting space and I found that my infrastructure is dated. I need to partner with people. So that is something that I see fundamentally as an opportunity, but it's important to engage with government as a fair partner and see that local footprint, and things like that do matter and that is -- we are well positioned with our multi-rail infrastructure to do exactly that. So there's a few things that come to mind.", "Back to Lisa's earlier question on B2B, I think this continued interest in digitizing B2B supply chains and B2B payments, that will also play out and grow over time over the next two, three years." ] }, { "name": "Darrin Peller", "speech": [ "That's really helpful. Thanks, Michael." ] }, { "name": "Michael Miebach", "speech": [ "Thanks, Darrin." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Dan Dolev with Mizuho." ] }, { "name": "Dan Dolev", "speech": [ "Hey, guys. Thank you so much. I was very interested in the Stripe partnership and maybe some of the other partnerships. Can you maybe shed some more light on what you're doing with Stripe? It sounds very differentiated.", "Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Yeah, Dan. Hello and [Inaudible] The Stripe partnership, as you heard me say, this is really across the board a true strategic partnership. So this is enabling their customer set with basically every payment tool that is available and providing choice. That's in the end, what this is about.", "Verizon, an entirely different strategic partnership. But here's another network, but a 5G network. We said, what could we do? Back -- we've talked about SME on this call in a couple of occasions now. Think about an SME that today has a card terminal and how they're going to compete with the marketplace.", "This is a -- if you imagine for a moment, you have a full Internet connectivity with not much infrastructure that you need to bring in, and then you can provide a true omnichannel experience, even the smallest business can do that. That is what 5G can deliver at any endpoint, anywhere at any situation. And that is the vision that Verizon, Hans and his team and our folks that we have developed. This is very specific.", "We've been on it for a while and we're expecting to make a real difference there. So two different types of strategic partnerships. I think they both matter, come back to the point that it's -- for us, it's about providing choice and payments to and anyone out there that is transacting in payments." ] }, { "name": "Dan Dolev", "speech": [ "Yeah. It's done. Super." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Bryan Keane with Deutsche Bank." ] }, { "name": "Bryan Keane", "speech": [ "Hi, guys. Good morning. I know we talked about cross-border travel. Just thinking about cross-border card-not-present ex travel.", "I know that dropped a touch in June and then month to date in July. Just wondering what the outlook might be. Should we see further modernization or lower growth numbers there as we head into -- further through the year as you think about maybe more in-store activity, tougher comps, less e-comm promotional activity? Just trying to get a pulse on that number as we go forward. Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, Bryan. So a couple of things kind of to point out on that line item, really. At the end of the day, there are things which are, I would call, episodic, which took place in the months of April and June, and there's volatility in the price of crypto. There's more purchases which took place there.", "And then as the price came down, then you had the inverse effect of that taking place. So the reality is that, to us, kind of is one of those things which will remain volatile. And I say that only because I don't know where the price is going to go and how people are going to exercise their choice to purchase crypto on a going-forward basis. What I will tell you is we've seen a decent level of deceleration take place in how people are utilizing Mastercard products to purchase these digital currencies like crypto over the last three weeks as reflected in the numbers.", "So that's kind of one of the factors which influenced that. The second being just a tougher comp where the timing of that e-comm promotional activity which took place in 2019 happened to be in the first three weeks of July. So the comp is a tougher comp here. So that I don't view as something which is on a going-forward basis is going to be impacting what the so-called index growth rate is for this line item, 2021 versus 2019.", "Suffice it to say the following, which is the trend toward digital continues. It's true in domestic. It's true in cross-border. And the fact that, that is a positive feel, going back to what Michael just talked about in terms of structural changes is something we are well positioned to actually keep participating in as the economies evolve and things start to open up in different parts of the globe.", "So that's what I'd like to share with you on that one." ] }, { "name": "Bryan Keane", "speech": [ "Got it. Thanks for the color." ] }, { "name": "Michael Miebach", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Jason Kupferberg with Bank of America." ] }, { "name": "Jason Kupferberg", "speech": [ "Thanks, guys. Good morning. I just want to ask a follow-up on cross-border. In the second quarter, the cross-border volume growth ex intra-Europe was a really good proxy for your overall cross-border revenue growth.", "So I mean, just hypothetically, if July month-to-date trends hold for these volumes through the rest of Q3, it would seem like cross-border revenue growth could approach 60% this quarter. So I just wanted to see if that's a fair characterization or if there's any other moving parts we should be aware of? And then if you can just give us some quick comments on Q3, Q4 rebates, that would be great. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So on cross-border Jason, mentioning nicely that, look, you're aware about the fact that intra-Europe cross-border is low yielding than all other cross-border. And I think that's one thing to keep in mind because growth rates across those populations of spend will determine what revenue growth rate ultimately looks like. The reality is in the second quarter, we had a tougher comp from an elevated level of returns that we had seen in last year, which had the impact of subduing our cross-border volume fee growth rate some in this second quarter.", "And again, it's not like those returns and elevated revenues of returns only took place in the second quarter of last year. As the pandemic hit, people start to make cancellations in terms of their airline bookings, their hotel bookings, and that kind of -- while it tapered, it still occurred going into the third quarter as well. So just something to keep in mind as to what the puts and takes are when you're thinking about growth rates. On rebates and incentives, here's what I would tell you.", "I think you're very well aware about the focus of the company on making sure we are setting ourselves up to quickly win market share, and winning market share comes through creating fantastic value propositions and then delivering them at great value to our customers, which is where the rebates and incentives come into play. So we continue to do that, and we will continue to do new and renew deals, which will have an impact on rebates and incentives. So the one point -- the one more piece of information I'll share with you is that as it relates to Q3, we expect rebates and incentives as a percentage of growth to be generally in line with what we saw in Q2. That's the extent of what I'm going to share with you in terms of where I kind of see in term of this playing out.", "Obviously, the mix of volumes impact that line item as well." ] }, { "name": "Jason Kupferberg", "speech": [ "Thank you. Very helpful." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Andrew Jeffrey with Truist Securities." ] }, { "name": "Andrew Jeffrey", "speech": [ "Hi. Good morning. Appreciate you taking the question. Michael, lots of progress on risk, fraud, ID, etc.", "It sounds like value-added services generally are a pretty important growth driver. I wonder if you could compare and contrast what Mastercard is doing versus some of the sort of purpose-built risk and fraud products in the market. You have different channels, different capabilities, kind of how you coexist and compete with some of those independent providers. I'm thinking like a risk of five for example." ] }, { "name": "Michael Miebach", "speech": [ "Right. Right. Thanks, Andrew. Great question.", "So if you look at our services portfolio to start with, we try to seek an entry point as the sweet spot, leveraging our footprint and payments and our data and then have the technological capabilities and the talent and all of that coming together to a differentiated proposition. So you'll rarely see us compete with other services player on a pure play that has nothing to do with our position in payments. So that's the starting point of our strategy. And we're looking for adjacencies that just leverage our core competencies.", "Now when it comes to the cyber solutions, if I think about a product like Decision Intelligence, which basically helps our customers to make -- decide what's a good decision and what is not a good decision, it is exactly at the sweet spot of everything that I said. It's the transaction data. It's the availability of having this in real time in our system available and then using state-of-the-art AI to make the decisions for our customers. So here, I think we have -- from a competitive landscape perspective, a real leg up versus pure plays.", "Similarly in loyalty, we're one of the largest loyalty players in the world. They are pure plays, but the fact that we see all the transaction flow and we can look at aggregated anonymized data of look-alikes and what they are interested in and how their preferences go in terms of rewards, offers, managed programs and so forth, again, puts us in a differentiated proposition. You'd go -- but you see us building out our proposition in cyber coming back to that, looking at the whole value chain. Decision Intelligence about the transaction before the transaction, what we're now doing with Ekata and saying it's the foundational element.", "So here we go in. Ekata, in itself, has a set of data that allows us in real time to help a customer -- one of our customers decide if this account opening request is a good one or a bad one. There's a very high confidence score. That customer is obviously then interested in working with us on the downstream through the whole value chain of the transaction and other cybersecurity solutions, all the way to fulfillment, against, say, is that address actually a real address? So is this somebody that is just ordering something in somebody else's name.", "So that's how we're thinking about it holistically and leveraging our footprint in payments." ] }, { "name": "Warren Kneeshaw", "speech": [ "Kristal, I think we have time for one final question." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Bob Napoli with William Blair." ] }, { "name": "Bob Napoli", "speech": [ "Thank you and good morning. Andrew kind of stole my lead question there. But also a question on open banking. I think it has been suggested that it's performing.", "The Finicity is performing better than expected. So I was hoping to maybe get a little bit of more color on what's working better than expected and the longer-term open banking strategy for Mastercard." ] }, { "name": "Michael Miebach", "speech": [ "Right, Bob. Great point. So open banking, an important trend. What we really like is this whole concept of putting power into the hand of the individual using their own data to get a better choice in services, the financial services and other services eventually.", "So we like that. We've been active in Europe for three years now -- two years now. We went live in summer 2019 over there. Good momentum.", "You heard us talk about Tesco and Lloyd's in the U.K., set up use cases that are now live. So happy about that. Good footprint over there. And in here in Finicity, that was a real kick for us in closing that transaction in November last year.", "And the Finicity team, first of all, they're deep in permission API, in the invention of the FDX standards. So they live and breathe open banking, and that was really critical for us as a player here in the U.S., great incumbent in the market. Now what is going better than expectations? I see a lot of momentum in engaging with banks. They have best-in-class data, data connections and they had a best footprint in banks, but we're -- now that as everybody else is looking at that and said, let's connect with Finicity.", "But we also see progress on the fintech side because this is an ecosystem that works on both sides. So we're excited about that. They had an interesting set of solutions today, that account verification, credit decisioning assistance. And now with the mortgage verification service, we're starting to build out at the same time, although driving -- on the deal front, we're also expanding the product set by bringing our data together with their data and our tech talent with their tech talent.", "So on every dimension, really around Finicity, we're quite happy that we have a connection. All right. Good. I think that brings us to the end of our time.", "I gave you a summary of a quarter just earlier on, so I'm not just going to repeat that again. I just want to thank you for all your support all throughout and looking forward to speaking to you in a quarter from now. Thank you very much and goodbye." ] }, { "name": "Sachin Mehra", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2018-05-02	[ { "description": "-Head of Investor Relations -- Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Executive" }, { "description": "-President and Chief Executive Officer -- President and Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": " --Chief Financial Officer -- Chief Financial Officer", "name": "Martina Hund-Mejean", "position": "Executive" }, { "description": "-Deutsche Bank -- Analyst -- Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "-Evercore ISI -- Analyst -- Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "-Susquehanna Financial Group -- Analyst -- Susquehanna Financial Group -- Analyst", "name": "James Friedman", "position": "Analyst" }, { "description": "-RBC Capital Markets -- Analyst -- RBC Capital Markets -- Analyst", "name": "Daniel Perlin", "position": "Analyst" }, { "description": "-Wells Fargo Securities -- Analyst -- Wells Fargo Securities -- Analyst", "name": "Donald Fandetti", "position": "Analyst" }, { "description": "-Stephens -- Analyst -- Stephens -- Analyst", "name": "Brett Huff", "position": "Analyst" }, { "description": "-Goldman Sachs -- Analyst -- Goldman Sachs -- Analyst", "name": "Jim Schneider", "position": "Analyst" }, { "description": "-Bank of America Merrill Lynch -- Analyst -- Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Tsin Huang --J.P.Morgan -- Analyst -- J.P.Morgan -- Analyst", "name": "Tien", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Jamie, and I will be your conference operator today. At this time I would like to welcome everyone to the first-quarter 2018 Mastercard earnings call. All lines have been placed on mute to prevent any background noise.", "After the speakers' remarks, there will be a question-and-answer session. [Operator instructions].Warren Kneeshaw, head of investor relations, you may begin your conference." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Jamie, and good morning, everyone. Thank you for joining us for our first-quarter 2018 earnings call. With me today are Ajay Banga, our president and chief executive officer and Martina Hund-Mejean, our chief financial officer. Following comments from Ajay and Martina, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release supplemental performance data and the slide deck that accompanies this call in the Investor Relations section of our website mastercard.com. Additionally, the release was furnished with the SEC earlier this morning.Our comments today regarding our financial results will be on a currency-neutral basis and excludes special items unless otherwise noted. Both the release and the slide deck include reconciliations of non-GAAP measures to their GAAP equivalents.", "Please note that due to our decision to de-consolidate our Venezuelan entity starting this year, we're providing additional information regarding our switched transaction and card growth rates. The adjusted growth rates eliminate Venezuelan switched transactions and card counts from prior periods so that you can better understand the underlying growth rates of our business. Our comments on the call today will be on the basis of these adjusted growth rates. These are the only supplemental operational metrics which are significantly impacted by the deconsolidation.Finally, as set forth in more detail on our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance.", "Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance is summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days.With that, I'll now turn the call over to our president and chief executive officer, Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thank you, Warren. Good morning, everybody. We're off to a very strong start this year. Our first-quarter net revenue growth was 27% and EPS growth was 43% versus a year ago on a currency-neutral basis and excluding those special items but even if you exclude the impact of the accounting changes, the acquisitions, and a couple of other items that affect year over year growth comparisons, all of which Martina will explain to you in some more detail later, our underlying net revenue growth was up 20% and operating income was up 27%.", "All these results are driven by the focus of our folks, of our employees on execution and solid business fundamentals as we continue to invest for the long-term future of our company.Now on the macroeconomic front, we are continuing to see overall growth. We are, however, keeping a very close watch as central banks around the globe evaluate normalizing their monetary policies by reducing fiscal stimulus. The U.S. continues to perform well.", "Low employment, healthy consumer confidence, retail spending remain strong and our SpendingPulse estimates are increasing to 5.3% for the quarter versus a year ago. Now, remember that estimate is ex-auto, ex-gas and we believe that's the best way to look at the underlying trends in retail spending.Now, when looking at the rest of the world, we kind of see generally favorable conditions. Europe remains positive overall with retail sales growth the U.K. has picked up in the first quarter although showed some deceleration in March, again according to SpendingPulse in the U.K.", "We do remain concerned about the potential impacts of BREXIT. Latin America continues its recovery, lower unemployment, improved consumer confidence, and there we will continue to monitor for potential impacts from the elections, particularly in Brazil and in Mexico and of course the whole NAFTA renegotiation. Most of the economies in Asia continued trending positively and more stable oil prices and, I think, a number of government initiatives have driven some improvement in the Middle East and Africa region. If you put that together, we expect the global economy to remain positive, absent any significant impact from geopolitics or trade risks.Meanwhile, we are driving healthy double-digit volume and transaction growth for Mastercard across most of our markets.", "We're growing share and we're executing on our strategy as we move into 2018. And let me give you a few examples. In the U.S., we continue to see good progress in consumer credit. The Barclays Arrival Premier World Elite Mastercard, that's a mouthful, was just launched and includes premium benefits designed to attract and retain the traveling consumer such as an annual loyalty bonus and airport lounge access.", "This builds on the momentum from other recent U.S. affluent product wins like the Capital One Saver Card, the Bank of America Cash Rewards Card, for which, by the way, Mastercard issuance has now begun, and Bass Pro and Cabela's which we announced last quarter. Now turning to co-brands, we're making real progress this quarter again, including with Crate and Barrel, which is launching a new Mastercard consumer credit product and will be migrating some of their existing private label cards over time. We've also renewed a number of co-brand relationships including with Shell.", "And now Kroger has begun converting cards to Mastercard following the win that we announced last year. In addition, we're really pleased to be the exclusive network for PayPal's first consumer debit card in the U.S. which lets consumers and customers of theirs access funds in their PayPal accounts to shop online or in stores and to make withdrawals from ATMs worldwide. That's consistent with our broader PayPal partnership which currently includes all PayPal credit and debit co-brands around the world.In Europe, we continue to gain share in key markets and I'm very pleased to say we're expanding our relationship with the Santander Group.", "In the U.K., Santander will issue Mastercard debit cards for its more than 9 million consumer and commercial bank accounts, making this our largest debit slip in the U.K. to date. This extends Mastercard's existing relationship with Santander U.K. on consumer and commercial credit and leverages our capabilities in digital fraud solutions and some of our exclusive sponsorship assets.", "That's in addition to a credit and debit renewal, again, both consumer and commercial, that we just signed with Banco Santander in Spain. We're also pleased to announce a new deal for the U.K. Post Office Travel Money program, one of the largest consumer prepaid programs in the U.K., to be exclusively Mastercard branded. In Latin America, building on our strong underlying momentum, we've added the American Airlines co-brand in Brazil this quarter, we launched a new cashback consumer credit card with HSBC in Mexico and we're driving innovative consumer and commercial solutions with the largest digital bank in Brazil Banco Inter, and providing differentiated loyalty services for a number of customers in the region, including Banco Santander in Brazil.And we are strengthening our position in other markets as well.", "This quarter we extended our Commonwealth Bank of Australia credit and debt deal, which includes a portfolio flip. In India, we signed a comprehensive debit agreement with Bank of Baroda that includes advisors, consulting, data analytics, and managed services. As you know, our focus on India is on growing both the issuing side and merchant acceptance in a number of different ways, including with digital technology such as QR codes and we have talked about this in the past. Shifting to account-based faster [ph] payments, we are making progress with Vocalink and we're in the RFP response phase for a number of potential opportunities around the world but the PromptPay mobile payment system in Thailand is a good example of an international payment system powered by Vocalink gaining scale quickly.", "What PromptPay does is it enables bank transfers using a mobile number or a citizen ID and as of April, 40 million users in Thailand have signed up, generating more than 170 million transactions since its launch in January 2017 and the equivalent of about $16 billion in consumer, business, and government payments in the last six months alone.On digital, you heard us recently announce our support of the EMVCo standards for simple and unified payments. When people shop online and in-app, they expect the same convenience and security that they have in store. And just like the single acceptance terminal in a physical store, we believe there should be one common checkout button in the digital world. That will deliver tremendous benefits for consumers, for merchants, and for issuers.", "A common checkout button would give consumers a consistent, secure, low-friction checkout flow, making it far easier for merchants to implement secure digital payments and provide issuers with improved fraud detection and prevention capability. And that should result in lower abandonment rates and more sales, good for everybody in the ecosystem.Since these standards also build on our tokenization services and authentication services, I think that brings us closer to a secure token-based world. 75% of all our cards are already enabled to be tokenized and we see demand from merchants like Netflix and now Flipkart in India as well. And when you tokenize payment details at a merchant site, they essentially become useless if a fraudster steals them and tries to use them somewhere else.", "More importantly, it eliminates the need to manually update account numbers when cards are replaced. That happens automatically. It helps merchants and consumers by reducing declined transactions – again, good for everybody in the ecosystem.So what's the bottom line? The bottom line is the EMV framework will bring the benefits of standardization, openness, and interoperability to consumers, to merchants, to acquirers, to issuers in the digital space. Now, of course, we at Mastercard will continue to innovate and offer differentiated services for consumers and merchants in a whole range of ways, from loyalty and user experience to analytics with new kinds of security and authentication tools that we can provide, including with our recent acquisitions of NuData and Brighterion.Staying on our digital strategy, we are developing new ways for consumers to pay and for merchants to get paid through QR codes and particularly in emerging markets and a recent example is the partnership we announced with M-KOPA in East Africa to make it easier for people to access reliable energy sources to power their homes and businesses and the idea is to boost productivity and prosperity.", "Masterpass QR enables people to finance solar power through small daily payments by scanning a QR code with their smartphones or entering the merchant ID into their older feature phones. Distribution partnerships on social platforms like Facebook and mobile financial services platforms like Tigo Pesa in Tanzania further extend the availability of QR codes to millions of users at a time.And finally, we continue to expand our suite of differentiated services. As many of you know, the General Data Protection Regulation in Europe, known as GDPR, establishes new rules for the use of personal data and it puts consumers in greater control over how their data is used. Now we've always been committed to strong protection for consumer privacy.", "And you know, for example, that we only work with data in our analytics business on a fully anonymized and aggregated basis. We are very well-positioned, therefore, for compliance with GDPR by the late-May deadline across the full scope of the new requirements of this regulation.Having said that, one part of GDPR is related to how data must be anonymized for later use. And in this area, we've taken what I think is a particularly innovative approach. We have designed a compliant solution for this, founded an independent trust called Truata to offer this service commercially.", "Essentially, customers of Truata will remove personal identifiers from their data before sending that information to Truata, which further anonymizes it to protect an individual's identity. Customers will then receive analytics and aggregated insights back to use in their products and solutions. That way you ensure that the data and the resulting analytical capability and output can never be linked back to an individual. So that's a service that Truata's customers, including Mastercard, will use to further scale data and analytics services in a secure and compliant way.", "So with that, I will turn the call over to Martina for an update on our financial results and operational metrics. Martina?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Thanks, Ajay, and good morning, everyone. We are very pleased to deliver a strong start to the year, even when you exclude the 4 ppt tailwind from foreign exchange to net revenue and the 6 ppt to net income, which was primarily driven by the appreciation of the euro since last year.Here on Page 3, I will now highlight the numbers on a currency-neutral basis. And also I will exclude special items related to litigation commissions. Net revenue grew 27%, driven by strong underlying performance and it includes a 4 ppt benefit from the new revenue-recognition rules and a 2.5 ppt benefit from acquisitions.", "Excluding these items, underlying revenue growth was 20%. Operating expenses increased by 32% which includes 20 ppt of growth due to acquisitions our charitable contribution to the Center for Inclusive Growth and the impact of the new revenue-recognition rules. Underlying expense growth was 12%. Operating income grew by 23% or 27% on an underlying basis based on the adjustments to revenue and operating expense I just noted.", "Net income was up 39% reflecting strong operating results and the impact of the U.S. tax reform, which contributed approximately 8 ppt to this net income growth. EPS was $1.50 per share, up by 43% year over year with share repurchases contributing $0.03 per share. During the quarter, we repurchased about $1.4 billion worth of stock and an additional $608 million through April 27, 2018.So let me turn to Page 4, and here you can see the operational metrics for the first quarter.", "Worldwide gross dollar volume or GDV growth was 14% on a local-currency basis, and that's up 1 ppt from last quarter. We saw solid double-digit growth across most regions. U.S. GDV grew 10%, up 1 ppt from last quarter, and was made up of credit and debit growth of 9% and 12% respectively.", "And outside of the U.S. volume growth was 16%, up 2 ppt from last quarter, primarily due to Europe and Asia-Pacific. Cross-border volume grew at a healthy 21% on a local-currency basis, driven by growth in all regions, with the strongest growth contribution coming from Europe.Turning to Page 5, switched transactions continued to show strong growth at 17% globally, normalized to exclude Venezuelan transactions as we no longer consolidate that entity. We saw healthy double-digit growth in switched transactions across all regions.", "And transaction growth was also up sequentially, led by Europe and the U.S. In addition, global card growth was 6%, again normalized for Venezuela. Globally, there are 2.4 billion Mastercard and Maestro-branded cards issued.Now let me turn to Page 6 for highlights on a few of the revenue line items, again described on a currency-neutral basis unless otherwise noted. The 27% net revenue increase was primarily driven by strong volume and transaction growth as well as by growth in services.", "The new revenue-recognition rules contributed 4 ppt to the growth rate, higher than what we anticipate for the total year. Excluding this impact and acquisitions, underlying net revenue growth was 20%. This growth was stronger than expected due to the delay of new deals resulting in lower rebates and incentives for the quarter and higher growth in services and cross-border. Looking quickly at the individual revenue line items.", "Domestic assessments grew 20%, while worldwide GDV grew 14%. And the difference is primarily due to the impact of the new revenue-recognition rules. Cross-border volume fees grew 19%, while cross-border volume was up 21%. The 2 ppt gap is mostly due to the higher intra-Europe growth.", "Transaction processing fees grew 22%, primarily driven by the 17% normalized growth in switched transactions as well as revenues from our various service offerings and from Vocalink. Finally, other revenues grew 33% driven by increases in our advisors and safety and security services. As a reminder, most of the Vocalink revenues show up in this line which accounts for 10 ppt of this growth.Moving on to Page 7, you can see that total operating expenses increased 32% excluding special items on a currency-neutral basis. As I referenced earlier, this includes an 8 ppt impact from acquisitions, an 8 ppt impact from our charitable contribution of $100 million and a 3 ppt impact related to the new revenue-recognition rules.", "Excluding these items, underlying expense growth was 12%. This reflects our investment in strategic initiatives such as digital infrastructure, safety and security platforms, data analytics and geographic expansion as well as higher costs related to our increased revenues in certain areas such as loyalty.Turning to Slide 8, let's discuss what we have seen in April through the 28th, where all of our drivers are similar or a bit slower than our first-quarter drivers but in line with our expectations and comprehended in the outlook that I will talk about in a moment. The numbers through April 28 are as follows. Starting with switched volume, we saw global growth of 14%.", "That's down 2 ppt from what we saw in the first quarter with solid growth in all regions. In the U.S. our switched volume grew 8%, down three ppt from the first quarter with lower growth in both credit and debit programs. Switched volume outside of the U.S.", "grew 18%, down 2 ppt from the first quarter. And globally switched transaction growth was 17%, the same as what we saw in the first quarter with healthy growth in each region. And with respect to cross-border, our volumes grew 19% globally down 2 ppt sequentially in part due to the drop in crypto wallet funding.Turning to Slide 9 and our thoughts for the full year 2018, which I will describe on a currency-neutral basis and excluding special items, our business fundamentals remain strong as we continue to grow share across our core products and expand our service offerings. We continue to forecast a healthy economic environment.", "And with a solid first quarter, we now expect year over year revenue growth to be in the high teens percentage-wise, up from our previous expectations of mid-teens. As a reminder, this growth includes the impact of the new revenue-recognition rules in 2018 and the full year effect of acquisitions which we continue to estimate will contribute about 3 points to growth on a combined basis.As you can see on the orange bar at the bottom of the chart, our organic growth excluding these items would be in the mid-teens range, up from our prior expectations of the high end of low double digits. I would like to call out a few items related to the revenue profile for the year. First, we do expect deal closings and implementations to pick up from Q1 levels which will increase rebates and incentives in the following quarters.", "Second, we expect cross-border growth to moderate somewhat. This is due to the recent drop-off in crypto wallet funding. And in addition, cross-border will also face tougher comps for the balance of the year given the strengthening of the euro during 2017. You can see this a bit already in our April metrics.", "Thirdly, we do not expect to see as much revenue uplift in the next three quarters from the new revenue-recognition rules as we saw in Q1. And finally, just a reminder that we have lapped the Vocalink acquisition at the end of April.On expenses, we're accelerating our investments in strategic areas such as safety and security, digital and our B2B products. We're also seeing some increased operating costs related to our higher revenues, in particular, related to some of our services such as loyalty. As a result of these factors, we now expect year-over-year expense growth to be in the mid-teens, up from our previous expectations of low double digits.", "This growth includes the impact of the new revenue-recognition rules, the full year effect of acquisitions and impact of the contribution to our Center for Inclusive Growth. When combined, we continue to estimate that these three items will contribute about 8 points to growth. Again as you can see on the orange bar at the bottom of the chart, expense growth on an organic basis excluding these items would be in the range of high single digits, up from our prior expectations of mid-single digits. With respect to our quarterly expense profile, as usual, Q2 and Q3 will grow significantly more versus a year ago that the fourth quarter.A few other items of note.", "Foreign exchange is now expected to be a 2 ppt benefit to the top line and a 3 ppt benefit to net income for the year with the biggest uplift having already occurred in the first quarter given the profile of the year-ago exchange rates. And the estimated tax rate of approximately 19% to 20% for the year, based on our current expectations of a regional mix of earnings. Of note, the Q1 effective tax rate of 17.7% is lower than the expected full-year tax rate, as Q1 included discrete benefits of 2.3 percentage points.With that, let me turn the call back to Warren to begin the Q&A session. Warren?" ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Martina. Operator, we're now ready for the questions." ] } ]	[ { "name": "Operator", "speech": [ "And your first question comes from Bryan Keane with Deutsche Bank. Your line is open." ] }, { "name": "Bryan Keane", "speech": [ "Hi, guys. Congrats on the solid results. I want to ask about the strength you're seeing in Europe and Asia in particular. Are those share gains versus the competitors, or is that just the overall growth in the markets? It's probably a little bit of both I'm guessing." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Yes, we're seeing both, Bryan. Actually, in Europe, we're seeing domestic growth really showing up very nicely. Cross-border growth has actually improved from what the statistics that we have seen before, including what we're seeing, by the way, in the UK. So we are seeing very solid spend in the U.K.", "domestically. We see solid double-digit cross-border growth outbound of the U.K. as well as inbound into the UK. So we're seeing at the moment no clouds on the horizon, even though we are obviously worried about BREXIT.", "We see very solid growth in Eastern Europe showing up. In Asia-Pacific, what we're really seeing is that Australia is coming back a little bit. And we're also seeing some healthy growth, it's like in the high single-digit rate, from a cross-border perspective in China." ] }, { "name": "Bryan Keane", "speech": [ "OK. And just as a quick follow-up, on the rebates and incentives side, the pickup you expect, is there any way to think about the cadence throughout the rest of the year? Will it pick up each quarter going through, or is it just a little bit of a pickup here in the second quarter as some of the deal closes? Thanks so much." ] }, { "name": "Martina Hund-Mejean", "speech": [ "You're asking me the $100 question here because that is always what I'm asking our people in the business. It really depends in terms of when we are signing agreements and when we're implementing the agreement. The best outlook that I have at this point in time is that probably Q3 is the high-water mark in terms of rebates and incentives but again, once we close out Q2, we will let you know." ] }, { "name": "Bryan Keane", "speech": [ "OK, great. Thanks." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from David Togut with Evercore ISI. Your line is open." ] }, { "name": "David Togut", "speech": [ "Thank you, good morning. Could you comment on the pace of RFPs you're seeing in Europe for ACH-related offerings? Specifically, I'm asking about Vocalink's positioning on Continental Europe ahead of PSD2." ] }, { "name": "Ajay Banga", "speech": [ "So there are a number of RFPs out there, not just in Europe but around the world. We're participating in all of them. I don't think there's any change in the pace of RFPs based on the implementation dates of PSD2. A lot of the RFPs have to do with countries and locations trying to upgrade their clearinghouse systems over the years from what was built many years ago to what's more state of the art in terms of Fast ACH with better messaging and better data transmission capabilities connecting to directories and the like.", "That's what we are participating in." ] }, { "name": "David Togut", "speech": [ "Understood. And then as a follow-up, could you comment on any update with respect to your B2B hub?" ] }, { "name": "Ajay Banga", "speech": [ "Yes, so that work progresses, and we are in the process of rolling out with the first client early in the second half of this year. Meanwhile, we already had a number of our clients who had relationships with AvidXchange. This is the partner we have used to build the B2B hub with. And those volumes are doing really well.", "In fact, one of those, for example, is KeyBank. And we have seen not just great volumes coming through, we've seen an increased share shift from check to card. So we've got good momentum on that commercial business beyond the B2B hub, as well with growth across Bank of America Merrill Lynch, Capital One, Citibank, and a bunch of other partners in commercial." ] }, { "name": "David Togut", "speech": [ "Understood, congrats on the strong results." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from James Friedman with Susquehanna. Your line is open." ] }, { "name": "James Friedman", "speech": [ "Hi, it's Jamie at Susquehanna. Martina, I wanted a clarification, if I could. You were going quick there but when you were talking about other revenue growth and then you had called out advisors and safety and security. I think, and I apologize if I wrote this down wrong but you said there was 10 ppt of growth contribution from Vocalink.", "Is that – what's the antecedent? Are you referring to other revenue or services revenue or total revenue?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "So the other revenues, as you know, have most of our services business included, and it grew for the quarter by 33%. And 10 percentage points of that was related to the acquisition that we did of Vocalink, so the underlying growth actually was 23%. And of the 23%, the line items that drove it most was advisors as well as safety and security.The Vocalink acquisition, I just called it out because we still have not lapped the acquisition. Remember, we made the acquisition only on April 28, 2017, so it wasn't in there for the fourth quarter, so that's why we're calling it out for you.", "Of course, the impact in the second quarter will be much lower because you only have one month's worth of the Vocalink revenues coming in year over year." ] }, { "name": "James Friedman", "speech": [ "Got it, thank you for the clarification. And then I guess like a moth to the flame, I've got to ask about the crypto. Let's see how to ask this one. That's a bigger callout than we had anticipated on the crypto.", "I guess what corridors are you seeing that come through and where is it deteriorating from? And do you think it will ever come back?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "So the issue in this, first of all, in terms of the stacks, on the cross-border volume growth, the cryptocurrency funding or the crypto wallet funding really was 1 ppt. It was 1 ppt that we saw in the fourth quarter and it was 1 ppt that we saw in the first quarter. What the issue is that a number of the banks have decided, in particular in the United States, that they would not allow the usage of cards for this particular funding vehicle. And that's why we have already seen a relatively significant decrease of the volume related to that event.", "In terms of where the funding is coming from by country, we're seeing quite a bit coming out of the United States. We saw quite a bit coming out of Australia and some other select countries in Asia, and then a number of countries in Europe." ] }, { "name": "Ajay Banga", "speech": [ "The governments around the world – I was out in Asia recently. And Korea, for example, has pulled back on allowing some of these exchanges as well to operate. There's a lot of concerns even in Japan because one of their biggest exchanges got hacked into and has now been bought out by another company in an effort to bring that back to an even keel. In general, the in and out of buying currency – a normal fair currency to put into a crypto wallet, which is what we were involved using our cards with, it depends a little bit on the interest in cryptocurrency.", "And as you can see, right now there's a little less interest than there was in the latter part of the fourth quarter and the first quarter. So when we did our earnings call last time, we actually said that this is not something we count on because we just don't know how to predict it or we don't even want to count it." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from Dan Perlin with RBC Capital Markets. Your line is open." ] }, { "name": "Daniel Perlin", "speech": [ "Thanks, good morning. I had a question on the commentary around organic operating expense growth. So in the quarter, it was 12%. I think you're guiding to kind of high single digits for the remainder of the year.", "So that to me would imply a step-down but then there's the commentary about the significant ramp in investments or just continued advancement in investments. So I'm just trying to reconcile that statement a bit." ] }, { "name": "Martina Hund-Mejean", "speech": [ "It's really year-over-year comps, so you're going to have to look at where the operating expense numbers were in the second and the third and the fourth quarter of 2017. So it's just a reality of that. There's nothing really more to it, Dan." ] }, { "name": "Daniel Perlin", "speech": [ "OK." ] }, { "name": "Martina Hund-Mejean", "speech": [ "I can maybe add one more thing. So in the fourth quarter, often enough we go for lower A&M expenses. And you might see some of that too because we are trying to move some of that into the earlier quarters but that's really – it's not going to be very different than what you saw last year." ] }, { "name": "Daniel Perlin", "speech": [ "OK. And then can you just provide some commentary around the step-down in these April statistics? You've already mentioned obviously cross-border but switching in the global U.S., outside the U.S., they all kind of stepped down so. Thanks." ] }, { "name": "Martina Hund-Mejean", "speech": [ "OK. So, first of all, I just want to remind you that this is completely in line with our expectations. And I comprehended it totally in the stats for 2018 from a net revenue point of view but when you look at the U.S. where the switched volume is down, really predominantly it's because of the debit programs.", "And there it's a seasonality adjustment. You might remember that we are powering the Social Security benefits with Comerica for the United States. And depending on when they get paid, you have a little bit of an uptick in the first quarter. Secondly, we are also the provider for H&R Block in terms of tax reimbursements.", "And of course, in the first quarter, especially at the end of the quarter, there's actually quite a bit of an uptick which you don't expect to continue into the second quarter. So that's for the United States. In terms of the volume outside of the U.S., 18% down 2 ppt. Look, I mean this is like – if it's 1 or 2 ppt or even 3 ppt here or there, it's little upticks and downticks country by country.", "I'm not going to go through all of this but it's just what we see from time to time quarter over quarter." ] }, { "name": "Daniel Perlin", "speech": [ "Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from Don Fandetti with Wells Fargo. Your line is open." ] }, { "name": "Donald Fandetti", "speech": [ "Ajay, on the common checkout button, can you talk a little bit about sort of a realistic timeline when you think this could be up and running? And I guess my question is, do you think that this approach will be a little more successful in terms of merchant penetration? I think my sense is over the years that it's been a little bit of a struggle for the networks under digital wallets.And then, secondly, how important strategically is success here? Clearly, if you look at where volumes are going, e-commerce is the future. And can you talk a little bit about that?" ] }, { "name": "Ajay Banga", "speech": [ "Sure, Don. I mean, look, e-commerce is definitely growing. And but remember we participate in e-commerce as well through the funding of lots of different wallets and methods of paying over the Internet, whether you pay from a phone or you pay from your computer. So e-commerce is growing which typically takes out cash as well and also does take out retail brick-and-mortar in some ways.", "It's a good thing as far as we're concerned. It's all about digital payments. So I'm not fussed about that. And remember this that e-commerce at the end of the day is if that's what the consumer wants to do and that's how they want to interact, our job is to make sure the consumer can do that in a safe way, in a simple way, in a convenient way, in a way that meets their needs and gives them rewards and incentives and the like to do it.", "So I'm actually quite inclined to think that that's where a lot of effort will go and think about the Internet of Things and digital physical commerce coming together, so all that's important. Therefore, finding a way to also grow in the digital space, not only by relying on other wallet providers but also giving our issuers a chance to be able to be present on merchants' checkout locations in an appropriate way, in a brand-friendly way, in a simple way for consumers is also important.And for merchants, which is to me where it all started from as well, if you go to them with each network or each wallet attempting to create its own way to connect with a merchant, think through what that means. Forget big merchants. It's a nuisance for them.", "Think of the medium and smaller sized ones. It's a nightmare for them. So the right way to this is the way we did the physical card business, take away the issues of multiple terminals in merchants' locations. It becomes impossible, difficult, expensive and inconvenient and makes it simple for them with one terminal.", "That's what this is about. It's one checkout button.And then after that, it flows the way you would normally flow with all the offers that we can provide from rewards and incentives and loyalty and security and all those things. So do I believe this is important? I absolutely do. Not just for the networks or the banks, I actually think it's really important for merchants and consumers.", "That's what I'm really focused on and why I'm a big supporter of the single checkout button. I think it's transformative for the industry as a whole, for the ecosystem. I think our job is to execute it well.Now your first question is about timing. My belief is it that we better do this well.", "Somewhere over the course of the latter part of this year, you'll begin to see the first aspects of this coming out into the marketplace. You'll probably see a real push in the early part of next year. Remember merchants have got to gear up for getting into this. Banks have got to gear up for getting into this.", "Normally the banks have already signed up to network digital wallets but also how they then offer it seamlessly to their customers for online enrollment. There's a whole set of things to be done here if we're going to do it well for the merchant, the consumer and the issuer. That's what we're focused on." ] }, { "name": "Donald Fandetti", "speech": [ "Thank you." ] }, { "name": "Martina Hund-Mejean", "speech": [ "And I just want to add one step to what Ajay has been saying on how important the e-commerce business is to us. In this quarter, the e-commerce business grew 25% OK? So that's a very, very large growth. And by the way, these kinds of stats we have been seeing quarter after quarter. It's either in the lower 20s, mid-20s or high-20s depends on which quarter you're looking at.", "So it's obviously a huge focus for us." ] }, { "name": "Operator", "speech": [ "Your next question comes from Brett Huff with Stephens. Your line is open." ] }, { "name": "Brett Huff", "speech": [ "Good morning. Thanks for the time and congrats on a nice quarter. Can I dig in a little bit more on the B2B strategy that you have? It sounds like the investments are going to be accelerated there. Can you just be a little more specific on what specific strands of investment that you're going to accelerate there? Is it more partnerships? Is it more organic building of technology? Could you just be a little more detailed for us?" ] }, { "name": "Ajay Banga", "speech": [ "Sure, sure. So that's part of Martina's expense commentary that she was talking about, right? I mean look, we are taking advantage of two things. Let me put them in context. One is better revenue growth and two is the tax reforms that have allowed us to think in terms of accelerating some of our investments in strategic areas.", "Commercial B2B is one of them but there are safety and security. There's everything we're doing at digital and contactless. There's all the work we're doing on expanding acceptance with QR codes and the like. There's the matter of loyalty and rewards.", "And so there's a bunch of places the money is going into. Commercial and B2B is a very important part of that. That's why we called it out in a prior Investor Day. What are we doing? It's not just what we've done already which is commercial cards which, by the way, are growing well.Somebody asked me a question a little while back and I talked about good commercial growth in the U.S.", "with Bank of America and Capital One and Citi and elsewhere as well. That's typically inside the traditional card-based business, whether physical cards or virtual cards. And that basically aims at corporate T&E, at fleet cards, at purchasing cards, at B2B payments through Amadeus and the like. That's one part of it.", "That uses things like Smart Data. It uses In Control. Those are all, I would say, assets of ours that we are continually investing in to keep them state of the art, but they're there. We own them, we have them.What's interesting is we're all seeing interest beyond the typical bankcard issuers.", "The technology providers who embed commercial payment solutions into their software, into their platforms are getting interested in our ability to provide them with a full-service suite when they go and sell to small and medium merchants. As well as payment aggregators in verticals like construction and insurance where we haven't had great penetration over the years.Then there's the third aspect, which again somebody asked me about it, the B2B Hub and all the work in the accounts payable place. The idea there is to streamline accounts payable, which otherwise has over the years become more and more of a nightmare to most people. There are lots of people you're buying from, lots of people you're paying for.", "Trying to reconcile those two together and find a way to ensure that complicated payments are reconciled appropriately and don't leave you with enormous issues at the end of the cycle as well as providing access to easy credit. That kind of stuff is what the Mastercard B2B Hub can help with.We don't provide the credit but we can help enable the efficiency of the accounts payable space. And then the last one which we're actually quite focused on and which shouldn't be the last but it's just that way I'm talking about it is actually capturing cross-border B2B payments. That's where Mastercard Send and HomeSend on the one hand combined with Vocalink on the other is, to me, the killer app.", "So today I can go to the bank and go there and say I can meet your B2B needs. You want them through ACH and direct debit, talk to me. You want them through virtual cards, talk to me. You want them through commercial cards, talk to me.", "You want them through any aspect, I can help you. And I can help you Mr. Bank, and Mr. Medium and Small Merchant by making life easier for you, quicker for you, more efficient, easier to reconcile and streamline.", "That is our B2B strategy." ] }, { "name": "Brett Huff", "speech": [ "That's helpful. And then just any update on the economics of how you see the Vocalink business kind of being deployed, be it more network effects or network economics versus kind of being an arms dealer or a mix. I know that was something you talked about at your last Analyst Day. Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Arms dealer? I don't know if I used that. That's an interesting topic. So here's the deal. I'll start off and I'll give it to Martina.", "My view is that Vocalink will go in the marketplace, as I said, one, through RFPs where they are actually creating or participating in the infrastructure of fast payments in a country.The U.K. is where we not only participate in helping the infrastructure, we run it. In other countries like in the United States, it's our software that's powering the clearinghouse which is in the process of rolling out this instant ACH systems. Like that we are the participants, as I said, in Thailand.", "That's the example I gave you about that. One where we are more than just software and also helping them actually manage their capabilities. We do that in Sweden. We do that in Singapore.", "We do that in a number of countries. We're participating in RFPs for that kind of work in a number of markets around the world from Latin America to Asia.There is a second aspect, which is to be able to bring our knowledge and capabilities of this to banks as they attempt to make ACH become a bigger part of their payments but do it in a way that takes it from being a relatively blunt instrument where reconciliation and settlement is happening, sometimes one day later, sometimes two days later, to on-time, real-time instant. And what that changes in terms of the value-added services they can provide and therefore find a way to build loyalty with their customer base. That work is another space.", "We call that fondly the scheme kind of thinking.Then there's a third which is more application-built, which you read about us launching in the UK, the Pay by Bank app which is an ability for banks to pay at a merchant space and offer their consumer the choice of paying by card or by direct debit or with some kind of economics and value-added services that make sense for the consumer, the merchant, and the bank. All that is part of what Vocalink's up to. It's a different set of strategies for different markets. It's is not going to be one sort of fit of the code for every country." ] }, { "name": "Martina Hund-Mejean", "speech": [ "From an economic point of view, typically when we go to the infrastructure layer, it's either a license fee. That is not a lot of money we always tell to our investors, or there is a basic fee for people who are using the infrastructure. Where the money is really going to be made is what Ajay referenced, when you run the scheme or when you have an app. And typically transaction-based pricing, very similar to our core model, comes in at that point in time.", "And that's what we're already proving out in the U.K. with the Pay by Bank app. And then lastly, on top of that with the services that we're building, and we showed a number of those services in our last Investor Day in September, that is a normal pricing if it's a data analytics service or if it's a loyalty service or if it's a fraud service. That's kind of the normal pricing that we have established already from a core perspective.", "So those are the three layers in terms of what you should be watching out for us to develop. Having said all of this, this will take some time. This is not like we're turning the key and suddenly you're going to see this all coming in next year. It's going to take us a number of years to really prove the case." ] }, { "name": "Ajay Banga", "speech": [ "And the reason for that is we're dealing with clearinghouses in different countries. These are not individual one-on-one bank to us deals. These are deals where you're going to get either the government or a set of banks that own the clearinghouse together to be able to migrate to Fast ACH. There are lots of implications of this but it makes us the player that can offer choice to a country, to an issuer, to a merchant, and to a consumer.", "And the choice is what we are focused on." ] }, { "name": "Brett Huff", "speech": [ "Thank you so much." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from Jim Schneider with Goldman Sachs. Your line is open." ] }, { "name": "Jim Schneider", "speech": [ "Thanks for taking my question, good morning. I was wondering if you could maybe address two items on debit. One do you think that the – it seems like the trends are pretty strong globally. Anything to call out in terms of your debit share from an issuance perspective beyond the things that you noted in terms of Kroger and your confidence that can improve from here? And then the second one relates to the transactions processed on network or switched transactions.", "That seemed to step down a little bit. Was that purely an effect due to European mix, or was there something else going on there?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "So first of all, our debit performance is very strong in the United States and in Europe, really in the rest of the world too but that's the two questions that you asked. In the U.S., as you can see, we're winning some share. When you look at transactions in the U.S., it really depends which quarter you're looking at because the routing of the PIN transactions by the merchants can make a difference. And you might remember that we won quite a few of those routing RFPs quite some quarters ago, and some of those are lapping but also merchants make dynamic decisions from time to time.", "So I don't think you should be reading into that anything from a U.S. point of view other than that we continue to make good progress. From a European --" ] }, { "name": "Ajay Banga", "speech": [ "We also have the PayPal debit deal in the U.S., which will help us." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Which will help us. It hasn't rolled in, of course at this point in time. And then in Europe, I think we're very strong in debit in most countries in Europe. There's only one country where we had a little bit more of an issue, which is the U.K.", "And as you can see from a number of these announcements that we have been making over the last few quarters as well as what Ajay talked about this morning with Santander, we are really going back into that space and being able to compete effectively. You are not seeing some of those stats yet coming into our actual numbers. It will typically take a six- to 12-month period for the implementations to happen and for those portfolios to flip over." ] }, { "name": "Ajay Banga", "speech": [ "Last time we talked about Crédit Mutuel in France. We got a debit flip there. We've got ING Bank in Italy. I just talked about Bank of Baroda in India.", "You'll find that our growth rate on debit in India is strong. And over the next couple of quarters, you'll see us talking about the India debit share there. The debit, you're aiming at millennials. You're aiming at everyday spend.", "You're aiming at contactless, which really attacks cash. So you're also obviously aiming at ATM withdrawals and getting cash out of ATMs. Debit meets all those needs. And so debit is important to us, and that's where we're focused on.", "We're also doing a lot of work on converting some Maestro cards to Mastercard debit because that gives banks and consumers a better capability of using those cards. So there's a lot of building blocks to our strategy on debit." ] }, { "name": "Martina Hund-Mejean", "speech": [ "The one thing, Jim, I just want to point out because I'm not sure if you're getting confused because of that is, remember we are excluding the results of Venezuela starting the first quarter of 2018, which in particular impacts transactions. It doesn't really impact volume. And so you're not seeing – you're seeing the same 17% growth or so that we had in transactions but in fact, if you strip that out, then the transaction growth in the fourth quarter was 15% ex Venezuela, and in the first quarter is 17%. So you actually saw an acceleration from a transaction point of view." ] }, { "name": "Jim Schneider", "speech": [ "That's very helpful, thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Jason Kupferberg with Bank of America Merrill Lynch. Your line is open." ] }, { "name": "Jason Kupferberg", "speech": [ "Hey. Thanks, guys. I was just wondering if you could give us some rough sizing on your China outbound business as a percent of total cross-border. We just continue to get some questions around the expanded acceptance of Alipay and WeChat Pay.", "I know we've talked about this a little bit in the past but as the acceptance footprint in the U.S. and other Western countries expands and more Chinese citizens traveling in the West potentially use some of those services, is this something that's significant enough to ultimately move the needle on those outbound China cross-border volumes? Is it too small to really matter? Just any context there would be helpful." ] }, { "name": "Martina Hund-Mejean", "speech": [ "I'm going to start and then probably Ajay is going to add some comments on it. First of all, we're seeing from a cross-border volume growth point of view, outbound in China high single digits, OK? That's what we saw in the last quarter and then it went around that for the last few quarters. The Alipay, the Tenpay, that's not a big impact at this point in time. What is much more of an impact, what happened in China last year in terms of the dual-branded cards were actually not allowed to be issued or banks took the PBOC guidance not to issue dual-branded cards.", "And that got changed some quarters ago where the banks were willing to again go into the dual-brand card business. And dual-branded cards as you know both have a cup logo which is the card is being used domestically as well as Mastercard logo on it where the card is being used cross-border. And that actually did impact our growth when they were cut off and it does impact our growth positively as they're starting to come back into the market.In the meantime, we have issued quite a few what's called single-branded cards. So these are just Mastercards.", "There's no domestic logo on it. And those single-branded cards are used by customers only in the cross-border context. As you can appreciate, those cards have to work their way up to top of wallet, right, because a Chinese consumer is not going to be able to use it daily in China but we're going to have to make sure that they put out that card overseas and there are lots of loyalty programs and other things that we're doing actually with our issuers but those cards also carry less spend than the dual-branded cards because they're less top of wallet. That was much more of an impact than what you saw from the pays." ] }, { "name": "Ajay Banga", "speech": [ "The only thing I'd add to that is that you've got to realize that I think China is an interesting market going forward but today, total numbers, it's a relatively small part of what Mastercard is. So yes, some of the cross-border from China goes one way or the other, one quarter it's up, one quarter it's down. It's interesting but it doesn't transform our life. Yes, out some period of time, some years depending on how the strategy in China plays out, I believe there is a very interesting opportunity for our company there.", "And we are deeply thinking our way through that. And that's where our focus is. That, by the way, includes our ability to operate for domestic processing in China which, as you know, we've got our own effort to apply to get the ability to get a domestic processing license. We went in there with a joint venture structure, constructed in a way that brings a lot of local expertise with us into the system but enables us to offer value-added services from our technology overseas as well.", "So it's a very nice balance of allowing local business people to be helpful to our company while also helping us add value from our global constructed services.We're obviously waiting for clarity from the Chinese government and talking to them regularly. Clearly, the U.S. China trade circumstances will help or impede some of that movement but I don't measure this in three months and six months. I measure this over a few years.", "I've been here nine years and I've been working on this topic for nine years. So it's not going to change in a day. Meanwhile, Alipay and Tenpay are actually partners of ours in a number of ways. So I have a lot of respect for them.", "I admire their capability. I think we can do a lot together with them as well. There is a change on the ground in China as well with the regulator and the government beginning to put a more constructive playing field around what banks are doing and what digital players are doing. And I think you should kind of go and study that a little bit to get a sense of this isn't going forward, what it was looking back.", "It's just there's a whole new landscape working out in China and we believe that there's an opportunity for us as well as others in what's a very large marketplace." ] }, { "name": "Warren Kneeshaw", "speech": [ "Operator, I think we have time for one last question." ] }, { "name": "Operator", "speech": [ "And your final question comes from the line of Tien-Tsin Huang with J.P.Morgan. Your line is open." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Thank you, thank you. Good morning. Hi. Good morning.", "Good stuff. I don't have a lot of stuff. Just wanted to ask on the regulations side, because we've been getting this question. Just on the euro cross-border and dynamic currency conversion proposals.", "Any implications for Mastercard?" ] }, { "name": "Ajay Banga", "speech": [ "Not really. I mean, I think implications always in a sense is going to help get it implemented but I actually think it's consumer-friendly. And so if you do it the right way it actually helps consumers understand what they're paying, when they're paying, and how much they're paying. So I don't think it's – implications there to get it done but it's probably the right thing to do." ] }, { "name": "Tien-Tsin Huang", "speech": [ "OK. Good. And then just one quick one. Just on the services side.", "It sounds like very strong growth there. I'm curious, given all the focus and sensitivity on data sharing, does this change in any way your thinking on monetizing analytics and info services and things of that nature?" ] }, { "name": "Ajay Banga", "speech": [ "No. In fact, Tien-Tsin, I believe that we can set a bar on how GDPR kind of rules gets implemented in different parts of the world. We are ready for the GDPR work in Europe. We're are not really ready for our work.", "We're creating a commercial opportunity out of what most people think is a cost. And we believe if you do it the right way you can still protect consumer privacy. You could still protect their interests, as you and I want our interest provided but still provide you with good value-added services that include your ability to choose how your data is shared. I don't see that as conflicting.", "Remember that the majority of what we see as data today is essentially not consumer specific. The overwhelming majority is only of card number, the dollar value, or the euro value, the time of the transaction and the merchant code. So I don't think that's changing." ] }, { "name": "Tien-Tsin Huang", "speech": [ "All right. Great. Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Ajay, any final questions or any comments?" ] }, { "name": "Ajay Banga", "speech": [ "Thank you all for your question. We'll wrap up with some closing thoughts. We are off to a very good start of the year with record revenue and earnings growth this quarter. Martina actually has willingly raised our expectations for the year as well, which is a first.", "We're pleased with our deal momentum with wins like Santander in Europe. And that leverages our differentiated service offerings. That's what Tien-Tsin is also getting at just now. And to advance our digital strategy, we are executing on delivering the best digital experience across all channels, all devices, in both developed and emerging markets.", "So we believe that our investments in these and other key areas will continue to position us really well for long-term growth. And so, with that, thank you for your support of the company. Thank you for joining us today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] }, { "name": "Tien-Tsin Huang --J.P.Morgan -- Analyst", "speech": [ "More MA analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
MA	2020-04-29	[ { "description": "Executive Vice President of Investor Relations", "name": "Warren Kneeshaw", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": "President and Chief Executive Officer-Elect", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "Bernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Keefe, Bruyette & Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to the Mastercard's Q1 2020 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your presenter today, Executive Vice President of Investor Relations, Warren Kneeshaw. Please go ahead, sir." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, James. Good morning, everyone, and thank you for joining us for our first quarter 2020 earnings call. We hope you and your families and coworkers are all safe. With me today are Ajay Banga, our Chief Executive Officer; Michael Miebach, our President; and Sachin Mehra, our Chief Financial Officer. Following comments from Ajay, Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session. It is only then that the queue will open for questions. Due to the length of our prepared comments today, we plan to allow for an additional 15 minutes for questions if necessary.", "You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning.", "Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis, unless otherwise noted. Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts.", "Finally, as set forth in more detail in our earnings release, I'd like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website for 30 days. With that, I will now turn the call over to our Chief Executive Officer, Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thank you, Warren, and good morning, everybody. Our first quarter started off strong and kind of continuing to build off the solid trends and performance that we had in 2019. But as you all know, as the pandemic developed and spread, it impacted our first quarter performance. But the strength in our services-related revenue shows that the strategy we have pursued over the last decade to diversify our revenue streams is paying off.", "Now, this virus has created a truly extraordinary challenge that we need to address together. And like everyone else, we're trying to do our part. First, the execution of our grow, diversify and build strategy, which builds on the solid foundation of our technology, data, brand and our wonderful people, has put us in the fortunate position of being able to support our clients and partners throughout this difficult period. And you will hear me and Michael and Sachin talk more about this later.", "At its core, this is a health crisis, and therefore, the public health response is the most important policy response in the near term. It is the critical first step to getting the world's economies back on track. And as we've all been reading, coordinated efforts such as the sustained implementation of social distancing and the scaling of our healthcare capacity to address increasing needs are having a positive effect. Recovery over the medium and longer terms will be dependent on the implementation of successful testing processes and the development of effective prophylactic therapeutics and vaccines. Now, we are contributing through our investment in the Therapeutics Accelerator, together with the The Gates Foundation and Wellcome Trust.", "In the meantime, fiscal stimulus packages are being introduced across many markets, and this will be a critical effort to provide relief during the downturn for individuals, for small businesses and for others who are particularly hard hit. We're also seeing very strong efforts on monetary policy across a number of countries, which would be particularly supportive as the recovery takes hold. Ultimately, the shape and speed of the recovery will be determined by the effectiveness of these policy initiatives. But again, in the meantime, we are helping out. We have joined forces with OnwardUS, a coalition of tech partners and foundations that are addressing displaced workers across the United States. Separately, we are providing necessary resources to support the unique needs of small businesses with a commitment of $250 million in technology, product and insight assets, as well as philanthropic support.", "So now we'll shift gears for a moment to tell you how we are looking at this on the ground. We have spent some time together as a team on developing a framework that really helps the entire Company think about the progression through four distinct phases: containment, stabilization, normalization and growth. Containment of [Phonetic] mitigation initiatives like travel restrictions and social distancing and work from home orders are implemented by public authorities in an effort to bend the curve and contain the growth in new COVID cases. From our perspective, from a payment volume perspective, this phase is characterized by rapid contraction in spending levels.", "What follows is stabilization, when these mitigation initiatives are by and large complete and spending stabilizes around a new lower level due to mobility limitations with a focus on buying necessities, and of course, aided by e-commerce. We believe we are currently in the stabilization phase in most markets.", "The next phase is normalization where governments gradually relax mitigation practices as the environment becomes safer for the citizenry, enabled by the broader availability of testing and tracing and improved therapeutics even before the roll-out of an effective vaccine. This phase we think will be characterized by a gradual path to recovery in spending to pre-COVID levels. We anticipate spending will begin to rebound during this phase, but not necessarily evenly. We would expect some sectors, particularly where there's pent-up demand, like home improvement or clothing or healthcare or domestic and intra-regional travel to normalize earlier. Other areas like mass entertainment and long haul travel will probably take longer to recover. It's possible that we will see early signs of normalization in some sectors and geographies throughout the rest of this year.", "And the final phase is growth, where spending levels gradually trend higher than pre-COVID levels. We believe a widely available vaccine and proven therapeutics will help to bring this stage to fruition. So containment, stabilization, normalization and growth is the framework we are using. It's not necessarily linear as they have seen in Japan and Singapore recently. And frankly, it's impossible to say how long each phase will last. But we think this framework makes sense. We are running this business with this common lexicon across the Company. You will hear us talk about progress in these terms as we move forward.", "Now, bringing all this back to our business, it is clear that our metrics are being impacted. You've seen those. But our business drivers are rooted in more than just PCE trends. The secular shift from cash and check to electronic forms of payment is important, and we expect it to accelerate coming out of this crisis. We have worked hard to grow a balanced portfolio across credit, debit, prepaid and commercial payments with a focus on strengthening share in debit and prepaid, which tend to be more resilient in times like this.", "We've also diversified our business in terms of our customer base and geographies, as demonstrated with our presence around the globe, and our services lines, a significant portion of which are not linked to transaction levels. They help us to further diversify our revenue stream and they are very much in demand, all this on a foundation of a strong balance sheet and liquidity, which allows us to execute on our strategy to capture new payment flows and build new capabilities for the long term, organically, of course, but also importantly, inorganically. The near term will no doubt look different than we expected it to be just three months ago, but we're very well positioned to make the most of the significant opportunities that we see coming our way.", "So, now let me turn to what we're doing to address the situation today. Normally, and like every other time, we are focusing on the things that we can control, both inside our company, but also externally with our customers, governments and society at large. Let me start with the most important issue, the health and well-being of our employees.", "Our offices remain open wherever they have been allowed to do so. But the vast majority of our employees are working from home. Many people are dealing with new circumstances and unexpected challenges. So, we are helping our employees in every which way that we can. We're providing them with digital health benefits, paid time-off for those in need to care for themselves or their loved ones. We have assured our employees that there will be no COVID-19-related layoffs this year.", "Our network and systems remain fully operational, based on the resilient core infrastructure that we have built and that is regularly tested. We're helping our customers mitigate risk as well. We're engaging with them in scenario planning. We're leveraging AI tools in financial institutions and others to help them fortify their business continuity plans as they navigate the downturn to ensure that they can come out strong on the other side.", "And we're also reaching out beyond our four walls to support governments, much as we've worked with them in the past with an increased focus on their specific needs in light of today's pandemic crisis. We are uniquely positioned to help them provide emergency payments to both people and businesses through our multi-rail solutions. We are facilitating specific COVID-related social disbursement programs around the world, reaching millions of some of the hardest hit people, including in the United States, through the Direct Express prepaid program, or account-to-account rails which enable about 90% of payroll and support. Almost all state benefit payments in the UK are now also being leveraged to support payments to displaced workers and financial assistance to businesses in that market. And we're involved in work like this in markets as diverse as Israel and Chile.", "So there's a lot going on. But we are always thinking about what more we can do so. So, before we move on, let me just say, we will get through this. I have tremendous confidence in the ability of mankind to find innovative solutions in the face of difficult circumstances. And when confidence returns, and it well, we expect the fundamental growth trends that have driven the Company will return in force. We have a resilient business model that benefits from diversification, that benefits from our ability to optimize existing products and solutions, and benefits by the fact that we can introduce new value props, all of which contribute to our ability to grow over the longer term.", "So with that, I'm going to turn this call over to Michael, who as you know, has all the operating teams reporting to him. And I think I'm very fortunate to have him working side-by-side with me as we've navigated through this unique time together. So, Michael?" ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Ajay, likewise. Yes, these are clearly difficult times, which is why we're leaning in with our customer to be the best partner we can possibly be, especially now, as we work through the containment and stabilization phases together and prepare for normalization, and ultimately, growth. We're staying closely connected and anticipating the needs of banks, merchants, governments, fintechs, as well as the end consumers, while executing on our strategic priorities, driving a secular shift to electronic payments, building new revenue streams and capturing new payment flows, diversifying our customer base and geographic reach. All these have been critical parts of our strategy and they will continue to be key enablers driving our success coming out of this crisis, all of this while remaining agile on how we manage expenses to ensure long-term growth. So, let me take each of these three in turns to give you an idea on how we are doing this.", "First off, the secular shift. Now, with trillions of dollars of payments still being made by cash and check despite our best efforts, there's clearly an opportunity to drive new transactions to our products, both online and in-store. We've seen a dramatic increase in e-commerce in this time of low mobility, and we expect some of these behaviors to persist going forward.", "When we look at our switched volumes in April, card-not-present accounts for over 50% of volume, which is up from 40% last year. So, our drive to offer our customers expanded digital capabilities online and in app is increasingly important, and we are doubling down on these efforts. For example, by leveraging our payments gateway services, merchants are able to accept digital payments securely and easily. And our Simplify Commerce platform makes it easy for small and medium-size businesses to set e-commerce options up within just a few days, which of course matters more now than ever. Underlying these digital transactions are tokenization capabilities, which enable safe and secure purchases across every digital channel and bring benefits like improved approval rates, again really matters today. We have new commitments with FC [Phonetic] in the US and large e-commerce retailers such as JD.com from China to tokenize the cards on file.", "Now, in-store: contactless is the fastest, easiest and safest, and as of late, as announced by the WHO, the healthiest way to pay and is a key driver in the conversion of cash to electronic payments, especially now with consumers looking for a quick way to get in and out of stores without exchanging cash, touching terminals or anything else. We've seen over 40% growth in contactless transactions worldwide in the first quarter. Our recent consumer insights indicate that habits are being created today. It will last beyond the current situation. More than half of new tappers are saying they will continue to use contactless once this pandemic is over. And we are helping to enable this by increasing contactless limits around the globe. And in our conversations with banks, we see a renewed commitment to accelerate the issuance of new contactless cards.", "Now, moving on to the grow pillar, we continue to win important credit, debit, prepaid and commercial deals around the globe. Let me give you just a few recent examples, including our expanded partnership with Sberbank in Russia and expanded global commercial agreement with WEX, including new products and services. We've also extended our long-term relationship with Banco Inter in Brazil in the consumer and commercial credit space. And Afterpay has agreed to make Mastercard its preferred commercial prepaid and issuer processing partner. In the US, Dow [Phonetic] will be moving its commercial card business over to us, including T&E and purchasing cards, as well as a new virtual card program. And I'm really pleased to announce that we've won credit and debit programs with Live Oak Bank, a significant provider of small business loans in the US, again very important in these times.", "I'd like to come back to the debit trended that Ajay mentioned. We've increased our consumer debit share globally over time and are leaders in a number of markets such as Brazil, India and several markets in Continental Europe. We believe that this, along with our global leadership in prepaid, will serve us really well in the current environment and of course beyond. Further, we have products like digital debit, which enables issuers to offer their customers credentials that can be used online, even when their current cards don't have these capabilities. We have several examples this quarter. Most notably, the cooperative banks in Germany are working exclusively with Mastercard to enable more than 20 million customers with access to digital debit cards.", "Let's shift the focus to our diversification strategy. Now, we continue to make good progress in expanding our customer base, particularly with fintechs, where we moved early and we've developed a leadership position. Some examples of recent wins include a new prepaid co-brand program with Credit Sesame in the US, an expanded relationship with N26, otherwise known as N sechsundzwanzig, across 18 markets around the globe.", "Now, on to diversifying geographies. As you all know, we have been looking forward to switching domestic transactions in China. We're really pleased to have received the preliminary approval for our license application, which will allow us to set up our JV with our local partners, NUCC. We expect this process will play out over the next year.", "Now, this takes us to the build pillar of our strategy. As you know, we've made a concerted effort to invest through a combination of organic and inorganic means to build new revenue streams. This has not only accelerated our growth but also diversified our revenue, which is particularly valuable in these times and will continue to be important over the long run.", "First off, services: our services lines are holding up well despite the downturn, as a significant portion are not linked to transaction levels. So, let me bring this to life for you. For example, our customers are using our differentiated insights and analytics to help them assess, react and plan during the current crisis. Now, we have implemented our unique test and learn capabilities acquired through our APT acquisition a few years ago to address industry-specific needs. Here's an example. This could be engagements like working with grocers on inventory levels and promotions in real time and many more use cases. We're also working to address frauds, which is even more important as more transactions are moving online.", "The capabilities that we have acquired through companies like NuData, Brighterion, Ethoca, and most recently, RiskRecon help us bring significant value to the ecosystem and will continue to position us well as behaviors are likely to shift in the post COVID-19 world. With RiskRecon, we are providing cyber vulnerability assessments for small businesses and healthcare organizations. And Ethoca helps issuers and merchants prevent fraud before it even occurs. And it helps to reduce costs and the operational burden of chargeback resolution. This breadth of our cyber intelligence services allows us to assist even beyond payments as we're doing by creating a digital identity framework.", "Finally, here are a couple of updates on our progress in new payment flows and real-time payments in particular. Our real-time payments implementations are progressing as planned, including in the Philippines, Saudi Arabia and in the Nordics with P27. I do want to point out that our account-to-account rails are particularly resilient in times like these, given the breadth of use cases they address and the recurring nature of these payments. In the UK alone, we process more than 2 billion real-time transactions annually, which are growing at double-digits over our account-to-account rails. And as you know, we're involved in account-to-account rails in many more companies -- countries around the world.", "Now, as you would expect, the social distancing measures are pushing more day-to-day activities like person-to-person payments and home delivery services to digital platforms, which in turn use Mastercard Send. We continue to see very strong volume growth here. Even with the slowdown in some aspects of the economy like ride-sharing, strong growth persists. We're also seeing strong growth across our cross-border assets, including Transfast, as momentum in both, in P2P flows and in B2C flows disbursement use cases, including as of late, the First Abu Dhabi Bank, which has gone live with cross-border account-to-account remittances.", "And over to the open banking front, we continue to roll out a set of comprehensive solutions and services that we believe work for all players in the ecosystem. Further to our efforts in Europe that we launched last year, I'm very excited that we will be expanding our long-standing relationship with Tesco to work with them on open banking, which is particularly notable given that the UK is a leading market in this space. We see the ability to facilitate the exchange of real-time information, while protecting data privacy, is a significant opportunity for us, and as the landscape evolves and open banking makes its way around the world.", "With all of this as a backdrop, we are actively managing our expenses. As the situation developed, we quickly advanced the framework for prioritizing our spending with a focus on how to best support our customers and drive the long-term interest of the Company. We looked at each expense line and made adjustments based on factors such as market readiness and customer demand. At the same time, we have preserved our ability to invest in strategically important areas such as digital, services, geographic expansion and the enormous opportunities we see in real-time payments, and each are critical to our long-term growth. The flexibility in our model enables us to adapt quickly and adjust. As circumstances warrant, we will continue to manage this closely.", "For more detail on expense management and our financials overall, let me now turn the call over to Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks Michael. As Ajay and Michael mentioned, this truly is an unprecedented time for us all. Before I get into the numbers, I would like to take a moment to acknowledge the resiliency of the team here at Mastercard who have maintained their focus in supporting our business, our customers and partners, and each other during this challenging period. In light of the current circumstances, I will focus most of my comments today on the trends that we have seen recently, but I will start by walking you through our Q1 results.", "So turning to Page 3, here are a few highlights on a currency-neutral basis and excluding both special items and the impact of gains and losses on the Company's equity investments. Net revenue grew 5% with acquisitions contributing approximately 1 ppt to this growth. Total operating expenses increased 8%, which includes a 6 ppt increase related to acquisitions. Operating income grew by 2% and net income was up 3%, both of which included 3 ppt reduction due to acquisitions. EPS grew 6% year-over-year to $1.83, which includes $0.05 of dilution related to our recent acquisitions, offset by a $0.04 contribution from share repurchases. During the quarter, we repurchased about $1.4 billion worth of stock.", "Let's turn to Page 4 where you can see the operational metrics for the first quarter, each of which was impacted by the pandemic, starting in February and March. Worldwide gross dollar volume, or GDV, growth was 8% on a local currency basis and was favorably impacted by an additional processing day due to the leap year. This partially offset the declines due to the pandemic. US GDV grew 6%, down approximately 3 ppt from last quarter with credit and debit growth of 7% and 5% respectively. Outside of the US, volume growth was 9%, down by ppt from last quarter. Cross border volume growth was approximately 15% through January, driven by double-digit growth in most regions, but began to decline progressively through February and March as travel restrictions were put in place globally. This resulted in overall cross border volume decreasing by 1% for the quarter on a local currency basis. I will get into more detail on the trends we are seeing in a moment.", "Turning to Page 5, switched transaction growth was approximately 20% through February, reflecting the strong recent trends, supported in part by the ongoing adoption of contactless. We then saw declines in March as stay-at-home practices were implemented, which resulted in growth of 13% globally for the quarter. In addition, card growth was 5%. Globally, there are 2.6 billion MasterCard and Maestro branded cards issued.", "Now, let's turn to Page 6 for highlights on a few of the revenue line items, again, described on a currency-neutral basis, unless otherwise noted. The 5% net revenue increase was primarily driven by transaction and volume growth, as well as strong growth in our services offerings, partially offset by a decrease in cross-border volume and higher rebates and incentives. As previously mentioned, acquisitions contributed approximately 1 ppt to this growth. Looking quickly at the individual revenue line items, domestic assessments grew 8%, in line with the 8% growth in worldwide GDV. Cross-border volume fees decreased 2%, while cross-border volume decreased 1%. The 1 ppt difference is mainly driven by mix. Transaction processing fees grew 16%, while switched transactions grew 13%. The 3 ppt difference is primarily driven by the strength in services, partially offset by mix.", "Other revenues were up 28%, including a 6 ppt contribution from acquisitions. The remaining growth was primarily driven by our cyber and intelligence and data and services solutions, which held up well this quarter. Finally, rebates and incentives increased 26%, reflecting recent deal activity as anticipated. If you look at rebates and incentives as a percentage of gross revenues, you will see that they increased sequentially to 35% this quarter, reflecting recent deal activity and the impact of the amortization of fixed incentives over a smaller gross revenue base.", "Moving on to Page 7, you can see that on a currency-neutral non-GAAP basis, total operating expenses increased 8%. This includes a 6 ppt increase related to acquisitions, partially offset by a 3 ppt benefit related to the differential in hedging gains and losses versus the year-ago period. The remaining 5 ppt of growth related to our continued investment in strategic initiatives such as digital enablement, safety and security, geographic expansion, and new payment flows.", "Now turning to Page 8, and given the circumstances, I thought it would be worthwhile to update you on where we stand from a capital allocation standpoint. As you may recall, our capital allocation priorities are to maintain a strong balance sheet, invest for the long-term growth of our business, return excess capital to our shareholders, and migrate our capital structure toward a more normalized mix of debt and equity over time. And these priorities have not changed.", "Despite the impact of COVID-19, through the strength of our business model and prudent expense discipline, we have generated strong operating cash flows in Q1. This strong operating cash flow, the temporary suspension of our share repurchase program and the $4 billion of debt that we raised in the first quarter further strengthened our liquidity position. At the end of the first quarter, we had $10.7 billion in cash, cash equivalents and investments. We believe that maintaining a strong liquidity position is the prudent thing to do, given the current economic environment. It gives us tremendous flexibility to not only meet our obligations, but to also capitalize on new organic and inorganic opportunities that may present themselves in this environment. We have deals in the pipeline that we are examining actively as you would expect at a time like this.", "Lastly, as it relates to the share buyback program, we will reevaluate this as macroeconomic visibility improves and will opportunistically execute on the program as we have historically done.", "Now, turning to Page 9, let's discuss what we've seen through March and the first three weeks of April from an operating metrics standpoint. We are providing additional detail here to help you better understand the recent trends. Essentially, what you see is that through March, we were in the containment phase with cross-border volumes and domestic spending declining as travel restrictions were implemented, followed by social distancing measures being put in place across various jurisdictions. The rates of decline have recently stabilized as these restrictions have taken hold, indicating early signs of the stabilization phase.", "It's important to point out that social distancing measures have been implemented at different times and to different degrees around the globe and even within countries. So, not every location is in the same phase. Parts of Asia moved first, followed by much of the developed world in March, and the balance in the last few weeks. So, looking at this a little bit more closely, let's start with switched volumes where you can see the impact of the social distancing measures on overall spending, starting progressively in March. The impacts have varied by category with spending on essentials such as groceries, pharmaceuticals and utilities holding up pretty well. Spending on items that are either discretionary or require mobility are down significantly. This includes categories such as travel, restaurants, clothing, recreation and gas.", "We have also seen people defer healthcare services other than those related to COVID-19. Not surprisingly, the way in which people have been making purchases has shifted. Specifically, as Michael mentioned earlier, card-not-present spend now accounts for over 50% of switched volume in April, up from about 40% in 2019, as e-commerce spend excluding travel has actually grown. We have also seen merchants accelerate their omni-channel distribution efforts, most notably in restaurants and department stores, to accommodate the shift. In total, switched volumes have leveled and are down approximately 25% versus year ago in recent weeks, indicating early signs of the stabilization phase that Ajay alluded to. The 3rd week of April numbers have actually improved across all regions, perhaps in part due to the early impact of fiscal stimulus, but it's still early days.", "We are seeing the stabilization continue over the last several days as well. Looking forward as social distancing measures are relaxed, we expect that some of the sectors that have been hardest hit will begin to show signs of normalization. Early signals will include spending on gas as people return to work and spending on deferred needs such as health and personal care. We expect some sectors, particularly where there is pent-up demand such as clothing, home improvement, and domestic and intra-regional travel, to normalize earlier. Other areas will take longer to respond, for instance, long-haul travel spending and mass entertainment.", "Trends in switched transactions are similar to what we are seeing in switched volumes, as they are impacted by the same factors for the most part. We are seeing an increase in the use of contactless and card-present transactions, supported in part by the increased spending limits that we have facilitated around the world. We think this trend will continue.", "Turning now to Page 10, I would like to provide a little more color on the cross-border trends we have seen recently. In total, if you look at the gray line, cross-border volume appears to be leveling off, down approximately 50% year-over-year, again, indicating the early signs of the stabilization phase. However, to get a better understanding of these numbers, the best way to think about cross-border is to split it between card-present and card-not-present. Each accounted for about a half of our cross-border spend last year. Not surprisingly, if you look at the orange line, card-present spend dropped significantly, as the travel restrictions and social distancing measures were implemented, and has since bottomed at a minimal level. So, there is very little room left to see further deterioration.", "On the other hand, card-not-present, which is the yellow line on the chart, has been more resilient, down approximately 25% in April. However, you should note that this includes significant declines in online travel-related spend. So, looking at the green line, if you exclude online travel, you can see card-not-present spend is actually up approximately 20% in April, demonstrating the resiliency of this aspect of cross-border.", "So, in summary, the normalization of cross-border spend is dependent on the relaxation of travel restrictions, and returning to the growth phase is dependent on an improvement in consumer confidence that is in turn related to the availability of effective therapeutics and ultimately vaccines.", "Turning now to Page 11 and our outlook going forward, for net revenues, given current uncertainties, we will not be providing a forward view for either the second quarter or the year at this time. We do intend, however, to provide periodic updates to our operating metrics throughout the quarter to help you understand the trends we are seeing. Consistent with this approach, we are also withdrawing our 2019 through 2021 performance objectives at this time and will reconsider these as we have better visibility.", "I do, however, want to make a few additional comments to help you with your modeling. First, with respect to cross-border, inter-regional travel has been more significantly impacted than intra-regional travel in Europe. As a result, an increased percentage of cross-border volume is made up of intra-Europe transactions, which are lower yielding than inter-regional transactions. Second, while the some portion of our services revenue are linked to transaction levels, a significant portion of the revenue we generate from services is not. This helps our service lines diversify our company's revenues, something we expect to continue to benefit from over the longer term.", "Overall, we have seen strong demand for our data analytics and cyber solutions. In the second quarter, we expect services growth will continue to outperform our core products. You should, however, expect the growth rates to come down sequentially in the second quarter but to remain positive overall. These declines are due to the dependence of some of our cyber and intelligence services on switched transactions, which we expect to be lower sequentially, and the impact of social distancing measures on our ability to execute projects at customer sites, and will impact both the transaction processing and the other revenue lines. We would expect services-related revenues to accelerate as switched transactions begin to normalize and mobility restrictions are relaxed. Separately, we expect rebates and incentives as a percentage of gross revenues to continues to increase sequentially, reflecting deal activity and amortization of fixed incentives over a smaller gross revenue base.", "Now, turning to operating expenses, as Michael mentioned, we are managing expenses carefully to ensure we can invest strategic -- in strategically important initiatives. We have ramped up our efforts in this area and now expect operating expenses on a currency-neutral basis, excluding acquisitions, to decline at a low-single digit rate in Q2 versus a year ago. Other items to keep in mind, foreign exchange is expected to be a 1 ppt headwind to revenue for the quarter and the year. Foreign exchange will be a tailwind to operating expenses to a similar extent. Acquisitions will contribute about 1 ppt to revenue and 6 ppt to 8 ppt to operating expenses for both the second quarter and the year, assuming the transaction with Nets closes in the third quarter.", "In the other income and expense line, we will now be at a quarterly expense run rate of approximately $100 million, given our recent debt issuance and prevailing interest rates. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics. With respect to tax, you should assume a tax rate of approximately 17% to 18% for the year, assuming the geographic mix of the business does not change significantly.", "Ultimately, as Ajay said, we will get through this. We are seeing early signs of stabilization and the impacts of fiscal stimulus. We are in a very strong position to navigate through this period of uncertainty and emerge well positioned to address the significant opportunities that lie ahead.", "And with that, I will turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks Sachin. James, we're now ready for the question-and-answer session." ] } ]	[ { "name": "Operator", "speech": [ "[Operator Instructions] And our first question comes from the line of Craig Maurer with Autonomous. Go ahead please. Your line is open." ] }, { "name": "Craig Maurer", "speech": [ "Yeah, thanks for taking the questions and especially for the additional detail. Hope everyone is well. So, wanted to focus on two things. One, if you could talk about the exit rate at April 21 that saw a nice improvement, how much do you think is related to recent stimulus efforts and how sustainable do you think that is or dependent on continued stimulus efforts?", "And second, when we think about cross-border, I was hoping you could help us understand how much of that -- the card-not-present non-T&E cross-border spend is related to B2B versus consumer activity? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Craig, thanks. The first part, the part of our fiscal stimulus, while it's tough to exactly figure out what impact that's had, remember that only started to go out relatively recently. And remember, that's a fair amount of money in the United States. But outside of the United States, which is -- recall, 65% of our revenue, or 60 plus percent comes from outside of the US. And the trends when Sachin was speaking were that this current week of April and the continuing trend for the first few days of the next week are global and they're across every region. So I don't know that I could give you a clear answer, but I don't think you can assume that it's only the fiscal stimulus that's boring through the system." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. And Craig, it's Sachin. I'll just quickly add to that, back to what Ajay was just saying, so even beyond the weeks ending April 21, we've seen the same trends continue for the next few days coming into this week. Actually, if you look around the globe and you start to see, in various countries where there is a slight relaxation taking place in terms of social distancing measures which were put in place, as well as cross-border restrictions which were put in place, we're starting to see a little bit of that stabilization impact come through. For example, in markets like Italy, Germany, Poland, Australia -- Austria, we're seeing this come through. And so, the point really being that as people start to get out and are getting back to, I wouldn't call it the normal ways, but getting back to being able to move around, we're starting to see that level of spend coming through as well.", "On your second question around cross-border, this is what I'd tell you, that cross-border card-not-present excluding travel, that lift you you're seeing, which is taking place in the third week of April, there are a few factors which are contributing to this. And you should just kind of keep that in mind. One is, timing of Easter globally is having an impact. But equally, if not more important, what you're starting to see is, the omni-channel prevalence coming through at various merchants across the globe. So, with the crisis hitting, more and more merchants are coming to realize the importance of going into online channels. And as they're going to online channels, they enable themselves, and you're starting to see the impact of that come through.", "Other categories where you're seeing some level of spend come through is in areas like clothing, in general retail, I would tell you, in subscription services, in the marketplace activity you're seeing. So, you're seeing that come through in all of those metrics there. That's kind of the color I'd like to share with you as it relates to how we're seeing those cross-border trends -- card-not-present trends kind of play out." ] }, { "name": "Craig Maurer", "speech": [ "Thank you so much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Bryan Keane with Deutsche Bank. Go ahead please. Your line is open." ] }, { "name": "Bryan Keane", "speech": [ "Hi guys, good morning. I guess, I'm a little bit surprised there isn't more variability in the rebates and incentives line with the lower volumes. Why isn't there? I know there is -- the contracts are structured in the accounting, but I just want to make sure I understand why there isn't a little bit of -- more of an impact on reduction in the rebates and incentives as volumes decreased?", "And then secondly, just on cross-border in itself, a lot of concern about the higher yields there and how it impacts margins. Maybe you can just give us some thoughts on that as well. Thanks so much and stay sure." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So, Bryan, on rebates and incentives, you're well aware about how rebates and incentives are constructed, right? So there is a variable component. There is a fixed component. And the variable component, which is there, moves back and forth based on levels of volumes which are going through the system. The fixed incentives are fixed. They remain fixed. And so, to the extent you're going to see variability is going to be on that variable component. The fixed fees is going to be there. The reality is, in the first quarter, you can see from our volumes, we were still growing volumes in the first quarter, and you're going to see the impact of that come through.", "The other aspect you've got to keep in mind is the impact of, what I would call, new and renewed deals. We had mentioned to you in our prior earnings call that -- and you've heard about the various deals which we kind of entered into. You're seeing the impact of that comes through in the rebates and incentives line as well. Really, that's what you should kind of keep in mind as to what we're seeing there. Obviously, the variable component will change, depending on where volumes ultimately trend out for the rest of the year. The fixed will be what it is.", "The second question which you've got is around cross-border. We've tried to provide you as much transparency as we can as it relates to what we're seeing in terms of volume trends. I think the thing to keep in mind in cross-border is, there are three different kinds of categories of cross-borders. There's what you would think about in the nature of intra-Europe cross-border where -- which is generally lower yielding. Then there is the inter-regional cross-border. I would break that up into two buckets. The two buckets are, there's the long-haul inter-regional stuff and then there's the short-haul inter-regional stuff. And I bring that up only because even as you think about how we move from stabilization to normalization, you should think about intra-Europe and short-haul inter-regional to come back sooner than long-haul. And that's just kind of by definition. So for example, if you are in Europe and you can do ground transport between one country and the other country, that would happen more naturally as border restrictions are relaxed and you don't have to get on planes to go to the various locations. So that's the way you should think about it. From a yield standpoint, intra-Europe low yielding, inter-regional high yielding. So, as inter-regional starts to come back, you've got to factor that into the mix in terms of how you're modeling." ] }, { "name": "Ajay Banga", "speech": [ "One little comment of our margin. I know you asked about cross-border margin. But remember, our company has various aspects to its margin mix. And one of those, which is in -- was services. If you remember, a few years ago, when services were a smaller percentage of our revenue, their margin contribution was also lower than the average margin for our company. That is not the case today. Our services business, all the different lines in it, together, when you kind of [Indecipherable] and look at them, they're very profitable for us, and they should be because scale allows us to leverage the fixed cost that we've put into building those businesses over a larger volume. So, I think as a company, we feel relatively good about where we are on margins. We feel good about some of the revenue diversification. And, of course, cross-border is down today, and it will be to some extent, as Sachin said, until long-haul inter-regional kind of stuff picks up. That's obvious. And so, we're going to keep doing what we can to keep growing our business in the meanwhile." ] }, { "name": "Bryan Keane", "speech": [ "Okay. Thanks so much." ] }, { "name": "Operator", "speech": [ "Our question comes from the line of Tien-tsin Huang from J.P. Morgan. Go ahead please. Your line is open." ] }, { "name": "Tien-tsin Huang", "speech": [ "Thanks a lot. Really a thoughtful presentation. Just a follow-up to Bryan's questions. Within incentive line, would deal -- can we assume that deal activity, that side of it, could there be a pause there here as people sort through the pandemic? Or could it actually accelerate as we see some of your clients embrace contactless and some of your other products? And then, somewhat related on the M&A front, it sounds like your appetite is up. Have your priorities changed because of the pandemic? Or have valuations changed such that you might have more deals in the opportunity set that weren't there before? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks Tien-tsin. So on rebates and incentives, the point really is, we're running our business as would run our business. You know one of our imperatives is to grow market share. We're constantly interacting with our customers. We're going to do deals. We're going to renew deals. We're going to do new deals. That's just part of the course. And so, what you're going to see come through is that activity. And to the best I've got in the nature of visibility on pipeline and things which are going on, which is a pretty active pipeline, to be completely honest with you, we factor all of that in, in terms of how we share with you our kind of thoughts around where rebates and incentives will play out." ] }, { "name": "Ajay Banga", "speech": [ "On the M&A side, Tien-tsin -- and hi. It's -- let me put it this way. There are a couple of things which we were looking at even before the pandemic hit. Those conversations are continuing and developing, and that's a good thing. There are others that will come up, I'm sure, as we go along. I don't know that you should view us as jumping in just because valuations may go down. I think what's more interesting here is that the willingness of the other parties to be able to feel that they may be in a better home with a company like ours that gives them access to distribution capabilities, geography and capital and liquidity are what creates for a better conversation. I view the valuation comment as interesting. But if all you do is jump and the valuations are down, is that really the kind of acquirer you want to be? Or do you want to be an acquirer at the right time for the right reason? And I think you will find us trying to find the right balance there and get the deals done for what value they bring to us. So we're keeping our powder dry to be thoughtful at a time like this." ] }, { "name": "Michael Miebach", "speech": [ "And Tien-tsin, Michael here. The areas of focus haven't really changed. So we're staying true to the strategy. Data analytics, cyber, new payment flows, open banking, those are still top of mind for us as we engage in a manner that Ajay just described." ] }, { "name": "Tien-tsin Huang", "speech": [ "Terrific. Thanks so much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Lisa Ellis with MoffettNathanson. Go ahead please. Your line is open." ] }, { "name": "Lisa Ellis", "speech": [ "Sure. Good morning, guys. Good to hear all your voice. Glad everyone is well. Can you -- and maybe this is for Ajay or for Michael. Talk a little bit about -- this is related to cross-border and cross-border travel. As you're in dialog with governments, your major issuing partners, your major co-brand partners, etc., what does the path to long-term recovery in cross-border travel look like? So in your view, what conditions have to be in place under which you think you'll see both governments be willing to reopen the borders and then also people be willing to get back on planes and start traveling? Thank you." ] }, { "name": "Ajay Banga", "speech": [ "Yeah, hi. Lisa. Nice to hear you guys' voice too. I got a little lonely after this locked up thing. So, here is the thing. What you're asking is the crux of a crystal ball issue that's a little difficult to get into, but let me give you some thoughts that I've picked up over time. The first one is, I actually believe that what you will is what [Phonetic] seems is happening in China is you'll begin with -- China, I think, is in more of a normalization phase than, say, the United States and Europe that is more than a stabilization phase, although even there, if parts of the US begin to open up as we're hearing some Governors speak, you may see a change in that over the next three, four, five, five weeks. I just don't yet know how to predict that well. But let's stick the idea of with China being more in the normalization phase than the rest of us. There's a long journey for China through that phase. It's not done. It's just begun. But there, local travel has begun. Trains have got bookings. Trains locally have got bookings. Restaurants and bars are open in Shanghai and Beijing and Guangdong and places. Wuhan is still challenged. So that's -- we're learning a little bit from China's experience here. And now, you've got Australia and New Zealand beginning to think of opening up. So I think we'll get some more data from countries that are a little ahead of the curve than the rest of us.", "Talking about cross-border travel, China is beginning to talk about corridors of cross-border being opened up, which is -- to your question about does government feel comfortable about what kind of connections with certain countries they can reopen. So they're talking about reopening traffic obviously to Hong Kong and Taiwan and Singapore. But also at a point of time, they were thinking about Japan, which has since been a little more challenged. But Japan seems to be improving as well. So, I think what you find is cross-border travel in corridors or within Europe, which will open first, before you get the situation of longer haul going. There is the issue of planes having been grounded for quite a while, of crews and planes having to be reactivated. That will also take its own time to come through. The airlines are obviously watching this very carefully, and they're very keen to get back on stream, but they need to see some bookings. You know that in domestic in the United States, the TSA actually cleared more people through their security systems over the last day or two than they had for the previous couple of weeks. Now, that's kind of very low level compared to the peak that we saw prior to the crisis. But that's all indicators of how this will get back into shape. I don't know. My general view in life is that we will probably end up with a reliable therapeutic somewhere over the summer. Whether it's available in large enough quantities across the entire world, particularly for those who are disadvantaged, I don't yet know. But the work that we have seen with The Gates Foundation work and with a bunch of others seems to point in that direction. I suspect the availability of a therapeutic will be some kind of an inflection point on the curve. The fact is that without a real vaccine, can you actually get people confident about getting on to long-haul planes and can you get countries confident about letting people in from another country at that point of time without testing them and quarantining them in their entry point? I don't know. I don't think so. And so, to me, that probably is still some time next year, unless there's a miracle and we find a vaccine earlier, which I don't have good scientific reason to believe.", "So, we're kind of running the Company through this stabilization, normalization and growth phase, and we are preparing ourselves to have our expenses and our view of the medium and long-term very focused through these lenses. And I think that's what you will see us doing. We're pretty confident about what we are trying to do here. We're confident about our deal flow. We're confident about our competitive advantages to keep growing share and working well in debit and working with fintechs on real-time payments and open banking, and what we're doing with services and digital analytics and cyber security. So I've a lot faith in what we're up to. But I don't how to when cross-border will come back." ] }, { "name": "Lisa Ellis", "speech": [ "Okay, yes. Fair enough. On a related point, just for my follow-up, the non-T&E cross-border e-commerce, I think, is a little bit of a black box at least to us. Can you just comment, generally speaking, what the composition of that is like? Meaning, does it move and grow in similar ways to domestic e-commerce, like non-T&E e-commerce? Or are there aspects of it that are similar or difference like certain regions or certain -- is it more media heavy than retail heavy? Is there anything unique or comments that you can give about that? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Lisa. I'll take that question. Look, I think first, you should recognize that's not an insignificant portion of what the cross-border component is. So it's actually a pretty meaningful portion of the card-not-present component." ] }, { "name": "Ajay Banga", "speech": [ "We're trying to stay away from giving you a percentage [Indecipherable]. Good try but, a very good try. Very good." ] }, { "name": "Lisa Ellis", "speech": [ "We're already doing all the math on the little lines [Indecipherable]." ] }, { "name": "Sachin Mehra", "speech": [ "Let me give you a little bit of color what that comprises of. There's a whole bunch of stuff, as you would imagine, in that which relates to everything from subscription services to gaming, to purchases and clothing, appliances. There's all the stuff which kind of sits in that category. So, to your point about whether it's more akin to what you would see in card-not-present in the domestic environment, it's actually some very similar categories which sit in there. The one point I want to make sure that I kind of bring out is, we are starting to see a lot of the smaller merchants who were previously not present in the online environment activate themselves to get ready to participate and are actually participating in the online environment. We're starting to see that come through." ] }, { "name": "Ajay Banga", "speech": [ "And you see it in our daily life right now, right, Lisa? People who never provided food and grocery delivery online are all getting online in the last 3.5, five weeks in the United States alone. And that's a big change from before the crisis. That's true for cross-border as well." ] }, { "name": "Lisa Ellis", "speech": [ "Wonderful. Thanks guys. Glad everyone is healthy and safe." ] }, { "name": "Ajay Banga", "speech": [ "Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Darrin Peller with Wolfe Research. Go ahead please. Your line is open." ] }, { "name": "Darrin Peller", "speech": [ "Hey, thanks guys. Glad everyone is doing OK. Look, it's I think more than second quarter which -- or even recent trends, which a lot of investors are looking through. It seems clear there has been -- there's going to be impacts from this that have a more pronounced impact longer term structurally. And so, can you guys just talk through with us [Phonetic] -- if we think of the beneficial opportunities from coming out of this, which may include contactless being more accelerated or use of real-time payments versus the potential for things like cross-border to be maybe structurally changed, what are your thoughts of sort of netting it all out? If you just list off what you are seeing accelerating now and can structurally be something that could actually help the payments industry and you guys more pronounced near term, is it enough to offset some of the potential challenges of folks that may not travel as much?" ] }, { "name": "Ajay Banga", "speech": [ "As you can imagine, Michael is kind of devoting his attention to that. That's the future. So here he is. Michael, go ahead." ] }, { "name": "Michael Miebach", "speech": [ "Thanks Ajay. Hey, Darrin. So, when we look at what is changing in terms of, let's say, consumer behaviors or business, it's a little early. As we were saying, it's a little earlier to cast a vote on when and how travel is coming back. But we are engaging -- we're out there trying to understand, commissioning research, all of that. But there's is a few things that are pretty obvious, pretty clear and are coming through in the numbers already, at least on a relative basis. And the first is this push to e-commerce and digital. But here, people are getting used to, let's say, virtual entertainment, e-sports. People are getting used to consuming via delivery services, while they might have gone outside before. So, there is some behavior patterns moving toward digital, and we believe that will continue to persist. So, anything that we do that's related to our digital capabilities, bet it in the cyber space, be it in our underlying digital solutions, we should benefit from that. We look at that as a continuous tailwind, even for the displacement of cash. It's not only displacing existing electronic payments, it's a net increase that we expect versus cash.", "Now, talking about cash, one other thing that I expect coming out of this is that the attitude toward cash will be more negative than what it was before. So, even in the most holdout countries -- now, I gave you an example on the German cooperative banks earlier -- you start to see a shift to online and e-commerce away from cash even where you could use cash. And that is, to your question, Darrin, clearly contactless is going to be the way that will help us benefit from that trend. The numbers are astounding. In the last quarter, 40% [Phonetic] increase. That's really quite significant. The first rounds of consumer research tell us that people do want to spend less cash, are spending less cash actually right now. We've just done a study in the United States where 60% of people said exactly that. So anti-cash, more contactless is going to be something that we'll benefit from.", "Looking a little closer into our ecosystem, so directly [Phonetic] our customers. So these underlying trends will also change some of the behaviors there. We believe that our current exposure from our services portfolio into the world of data analytics -- it's a more complex world. There's going to be more change. Everything I just talked about might evolve in 10 different ways going forward. Understanding that and using our data points and data analytics will matter more. So we'll expect more demand there. And then, cyber and intelligence, this world, a world of more online, a world of more digital economy is only going to drive what we do in that space. The question in a world of more digital on who is actually transacting, the question of digital ID is a significant opportunity. We had an early start on that, and we perceive that to be something that is going to get a lot of our attention going forward.", "Ajay talked about the government role in getting through the crisis, stimuli packages and so forth. What we expect as a result of that is that the interest that we saw from governments over the last couple of years to look at payments as critical national infrastructure is going to only increase because if the economy is more digital, you will see more governments taking an active role. A multi-rail position will give us a seat at the table, and we already have that dialog going, and we'll see that coming strongly out of that.", "So, those are the top lines that I think are obvious, more granular consumer behaviors. We're staying close. We're running a bunch of research right now to get the latest on that." ] }, { "name": "Ajay Banga", "speech": [ "The only thing I'd add there is that if you -- in a time like this, it is clear that those who are suffering much worse than others -- everybody is suffering. Those who are suffering much worse are those who had less to start out. Getting the economy somehow working better for inclusion when we come out of this, I think, will become an even more important issue with governments and with thinkers around the world. It's not a coincidence that it's in the midst of all this that we've announced our commitment to go from 500 million included, which we've reached, to 1 billion over the next two years. 50 million small businesses in that and 25 million [Phonetic] women entrepreneurs is what we're going to try and reach as a company to facilitate their ability to participate in a better way in the economy as it comes out of COVID. That's the reason why this is a really good time to double down on thinking of that time. We've shown that we can do it because we've demonstrated the 500 million. We think we can do even more." ] }, { "name": "Michael Miebach", "speech": [ "Hey, Darrin, one last point. One last point, and I feel particularly passionate about it, and that's the B2B space. So we've been talking about B2B as a significant opportunity for a number of years now. So when you think about the impact on global supply chains and so forth, what we expect is that the drive toward digitization of supply chains and creating more flexibility is going to only increase. So, we believe there's going to be some tailwind in accelerating the -- our participation in B2B flows as well." ] }, { "name": "Darrin Peller", "speech": [ "All right. That's really helpful, guys. Thank you." ] }, { "name": "Operator", "speech": [ "And our next question comes from the line of Jason Kupferberg with Bank of America. Go ahead please. Your line is open." ] }, { "name": "Jason Kupferberg", "speech": [ "Hey, good morning, guys. Good to hear from you. Just wanted to talk a little bit about interchange rates and network fees. I think you had already announced plans that some of the interchange rate updates in the US were going to be delayed until July, if I'm not mistaken. Is that still the plan? Or should we assume the changes in either interchange or network fees, for that matter, are perhaps off the table this year just to help merchants from experiencing even more pressure amid the COVID environment?" ] }, { "name": "Ajay Banga", "speech": [ "Just to be clear, interchange rate changes, we're not just about increasing interchange. We're talking about categories of merchants would have different changes to their interchange, just to be clear. So the reason that those haven't gone through is because they were linked up with a whole bunch of technology releases. And right now, the real challenge for any merchant, any bank who is trying to navigate their way through this with most of their people working out of home or from home or with people struggling to meet the new business model, is they don't need new technology changes in the midst of this. So what we decided to do was to postpone all that. I have no idea when we'll will do it again, not fixed yet. It depends a little bit on how the environment goes, and that's how we'll manage through it." ] }, { "name": "Jason Kupferberg", "speech": [ "And then, Ajay, just wanted to get your quick thoughts, what you've got in terms of the shape of the US recovery?" ] }, { "name": "Ajay Banga", "speech": [ "My gut should not be expanding these [Indecipherable] so, not eating [Phonetic] too much ice cream. But US recovery, back to what I was telling Lisa a little bit, I think it all interconnects there. I actually believe that -- and this is just a guess. And I believe that in the next couple of quarters, you will begin to see the United States, as states open up, come a little bit out of this stabilization phase into the normalization phase. I do believe that the therapeutic will help enormously. I believe that Americans are actually quite resilient and their ability to sort of want to go back to being who they are, which is essentially social beings or like being with each other, will lead to a certain kind of behavior pattern. We need to do it carefully because the probability post summer -- if you believe, those are [Indecipherable] -- the profitability post summer of this having some kind of a recurrence, hopefully at a lower level, and we will be better prepared and we'll have the therapeutics and our hospitals would be in better shape and our reaction plans would be in better shape. I think that would probably be what happens. And so, you will see some such things come and go. And I think then, by the time the year-end comes around and people have been through phase, you'll probably see more confidence. And if by then, the news of the vaccine front is good, then you'll see a better improvement in the early part of next year, going into the middle and latter part of next year. That's the way I think about it. I don't think we're [Phonetic] in the short term. I think this is a medium term thing to plan for. I believe that's how you should build your business and manage your liquidity and think about your employees and clients and shareholders at this point. And that's how we are running our company, in those four phases. And we're all talking that language so that our budgeting, our expense thinking -- Michael's drive on prioritizing what we do and what we don't do is unbelievable. And I think that's part of what we're trying to focus on and stay focused with this four-phase thinking. It helps us all talk the same way. Otherwise, if you're a global company and China is in a different stage from the United States, you know what, it's very confusing to understand the underlying trends. But now, we're not confused. We call them in one stage and us in a different stage. We'll see how we go." ] }, { "name": "Jason Kupferberg", "speech": [ "Thank you. Stay safe." ] }, { "name": "Ajay Banga", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "And our next question comes from the line of Ramsey El-Assal from Barclays. Go ahead please. Your line is open." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi guys, and thanks for taking my question. I wanted to ask a question on China and your news that you're sort of -- things are progressing there in terms of your ability to get into the domestic market. Putting aside COVID impact, looking to sort of the future state maybe where things are more normalized, how crystallized are the kind of partnerships and infrastructure that you need to generate revenue in that market? Have you kind of put pen closer to paper in terms of your -- and can you comment on your kind of strategy and even tactics that you're going to need to kind of deploy to begin generating revenue in the market?" ] }, { "name": "Ajay Banga", "speech": [ "Well, first, we've already have a great business in China, and that's generating revenue today even though the..." ] }, { "name": "Ramsey El-Assal", "speech": [ "I meant domestic -- absolutely, yeah." ] }, { "name": "Ajay Banga", "speech": [ "Domestic, yeah? Okay. So -- because otherwise, we've -- I must current business, we're outperforming on new card growth and new cards per share. We are doing programs with a bunch of people. We've even done something with the Shanghai Metro, which is a little more oriented there, where the first transit deal actually in China is with the Metro. It's the world's third largest subway system, by the way, by passenger traffic volume, and that's rebuilt up over the last few days. Now, when going -- in the third quarter of this year, tens of millions of international travelers to Shanghai, which I hope there will be, will be able to pay at the fare gate with QR codes using their MasterCard in a Shanghai Metro app. That's the kind of work we're doing, not just bank issuance, but actually enabling a lot of the activity that enables us to be embedded in the payments ecosystem in China.", "The domestic one, we are deep in the process of this year -- post getting the license application in principle approval, over the course of a year, we will go through all kinds of things, including national security evaluation of the technology and the infrastructure on the ground. That work is progressing apace. We have not hit that. We are not cutting back on that. That's our medium and long-term future. And we are keeping on running with that. There is nothing new I can tell you on that because that's like, it will take its time. It will take the time to work its way through. It's still a year away. And Mike can probably add some more on that." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. And Ramsey, the conversations with our existing partner on cross-border obviously extending into domestic partnerships. And most importantly, one thing that we're using this time for while we do the technology development with our partners of NUCC is driving up the acceptance. So, currently, our team is out there in the market very actively, ensuring that our acceptance footprint is as good as it can be once we get approval from the PBOC to go live. So that's really the focus." ] }, { "name": "Ramsey El-Assal", "speech": [ "That's super helpful. I didn't know you could actually be in there selling the acceptance side. So that's good to know. Thanks for taking the questions." ] }, { "name": "Ajay Banga", "speech": [ "That work has been going on. That's exactly what we're focused on because remember, Mastercard acceptance in China used to be principally driven by the cross-border demand for it, which meant it was, by the nature of the beast, in certain markets, certain kinds of verticals. What we're doing is getting it out there into where it should be so that it can become a real payment system domestically as well." ] }, { "name": "Ramsey El-Assal", "speech": [ "That makes a lot of sense. Thanks." ] }, { "name": "Operator", "speech": [ "And our next question comes from the line of Harshita Rawat with Bernstein. Go ahead please. Your line is open." ] }, { "name": "Harshita Rawat", "speech": [ "Hi, thank you very much for taking my question. So can you please zoom in further on travel and provide some color on your area of exposure on tourism versus corporate travel? And also just very curious based on all of the research, etc. you're doing and what your customers are saying, what are the different scenarios we could be looking at here in terms of corporate travel being just very weak long term with tourism recovering a little bit faster? Thank you." ] }, { "name": "Ajay Banga", "speech": [ "Well, you get two kinds of points of view. Again, one point of view that says corporate travel will take a long time to bounce back and actually people will begin to travel on a personal basis at least intra-region and in those corridors I was referring to earlier. And the other point of view is that actually when businesses start interacting again, how do you rebuild supply chain? How do you rebuild business connectivity? You will need to have a degree of corporate travel recommence. And prior analytics don't serve well right now because prior analytics never had a shutdown of so long. Even 9/11 was a few days of impact to travel of this type, and then it came back. Even the financial recession that we went through in '08, '09 didn't have this kind of a shutdown. Oil demand in the world in the financial recession went down in the single digits. It's down 30% right now. So we're talking a very different scenario. So I'm loath to give you sort of an analytic view from prior times. Prior times, frankly, corporate travel back very quickly and personal travel came back a little slower. I don't know what will happen this time. Not sure yet." ] }, { "name": "Harshita Rawat", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Sanjay Sakhrani from KBW. Go ahead please. Your line is open." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thank you, and nice to hear that you guys are doing well. I guess I have one question and a follow-up for clarification. When we think about the scope of cost containment efforts, where exactly are you guys? I'm just trying to think about how we should think about the progression of cost saving opportunities if things get worse or things get better? And then I'll ask in the second question upfront -- or second now. In terms of the relationship wins that are affecting rebates, is there a revenue contribution that comes in this year? Or is that more spread out over multiple years? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, Sanjay, I'll take -- actually, I'll start with the second question first and then I'll get on to the expense piece. So, on your question around the relationships which we're either renewing and/or building new relationships with, look, you've got to think about it in the context of things which are existing customers. You probably will start to see the revenues -- we're already seeing the revenue of that come through. And to the extent that expanded deal, you will see the revenue of that come through on a sooner basis than you would see in the nature of new relationships where you're flipping portfolios or you're starting a de novo program or something of that sort. So I think it's a little bit of a mixed bag. So you'll see that kind of come through. I don't see the trend on that, by the way, being any different than what we've done historically. When we signed deals in the past, whether they're new deals or renewals, that pattern is pretty much what we're expecting on a going forward basis.", "As it relates to operating expenses, let me just give you a little line of sight as to what's going on from an operating expense standpoint. I know Michael will share a little bit more about the various areas we're focused on. First, specifically as it relates to the numbers, you can see based on my comments earlier that in the second quarter, we are sharing our thoughts around how we are looking to take a decline in our operating expenses in the low-single digit range, and that's a ramp-up from where we were obviously in the first quarter. I would tell you, longer term, the way you should think about expenses is the following. We have flexibility in our expense base. We're going to do the smart thing. We're going to do the prudent thing. What we don't want to do is jeopardize the long-term growth prospects of this company. We will remain nimble, depending on how the economic environment is playing out, and we'll exercise that prudence from an expense standpoint across the various line items as are appropriate as part of that process." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. And then, Sanjay, that was a pretty comprehensive answer. But just one thing I want to say, as I called it out earlier, the two guiding factors are not only the long-term growth and the strategic investments. It's also market readiness and customer demand. So we would not be going out right now with something that the market is not ready with because everybody is busy addressing COVID-19 and what they should do about it. So, there is a couple of initiatives like that that we are deferring basically, and we're keeping our [Indecipherable] to bring them back to market as and when needed.", "And customer demand is the other thing. Right now, we see huge demand for investments and improving -- further improving what can be done on cyber, so we can continue to double down there. But you can imagine like promotions in the travel space is just not what is a sensible thing to do right now. So that's kind of how we think about it, customer demand, market readiness and then keeping the strong -- the long-term stuff in mind, and I gave you the categories earlier." ] }, { "name": "Warren Kneeshaw", "speech": [ "All right. I think we've [Indecipherable] the end of allotted time. So, Ajay, any final comments?" ] }, { "name": "Ajay Banga", "speech": [ "Thank you all for your questions. I'm going to wrap up with a few closing thoughts. I know we kept you a little longer than usual. But there's no mistaking that COVID-19 has created a tough environment. But you can see that we are beginning to get to the early signs of stabilization. We believe our diversified business model will allow us to successfully navigate this and capitalize on opportunities as we come to normalization and ultimately back to growth.", "We are carefully managing our expenses. So we will continue to invest in the areas that differentiate our company and enable us to deliver on our grow, diversify and build strategy. So, you should see us doing things like in services such as data analytics and cyber and intelligence that we think drive real value for our customers to diversify our revenue base, to [Phonetic] enable us to win market share; or in digital solutions like our gateway and digital debit products that enable e-commerce; or in account-to-account capabilities, including most importantly our real-time payment rails that help us to address new payment flows; and some ideas in areas which we've have been investing in for a while, like open banking and digital identity. I don't have a crystal ball. You could see that I couldn't answer some of your questions about where this could go. But I do think we'll see certain trends will stand out. The world will it be more digital and the secular shift to electronic payments will accelerate. There will be a deeper focus on cyber security and data analytics. Cross-border activity will come back, but in phases over time. And importantly, governments will increasingly be open to partnering with the private sector in areas where we bring clear value. Real-time payments and cyber security and identity services are examples of that very open view of partnership. We are heavily invested in these. We're focused on these. And as Michael said a little while back and Sachin and I did before that, we have no doubt we will be well prepared to capitalize on these opportunities as they come our way.", "So thank you for your continued support of the Company. Be safe, be well. Thank you for joining us today. I'm looking forward to actually being able to see people and shake hands and give somebody a hug once in a while once we get past this. Thank you very much." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks everyone." ] }, { "name": "Michael Miebach", "speech": [ "Thank you. Bye-bye." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
MA	2019-01-29	[ { "description": "-Chairman, President and Chief Financial Officer -- Chairman, President and Chief Financial Officer", "name": "Michael Saylor", "position": "Executive" }, { "description": "-Chief Operating Officer and Chief Financial Officer -- Chief Operating Officer and Chief Financial Officer", "name": "Phong Le", "position": "Executive" }, { "description": "-Deutsche Bank -- Analyst -- Deutsche Bank -- Analyst", "name": "Austin Dietz", "position": "Analyst" }, { "description": "-Citi -- Analyst -- Citi -- Analyst", "name": "Tyler Radke", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good day, ladies and gentlemen, and welcome to the MicroStrategy fourth-quarter 2018 earnings conference call. [Operations instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Michael Saylor, chairman, president and CEO. Sir, you may begin." ] }, { "name": "Michael Saylor", "speech": [ "Hello. This is Michael Saylor. I'm chairman, president, and CEO of MicroStrategy. I'd like to welcome all of you to today's conference call regarding our 2018 fourth quarter financial results.", "I'm here with our Chief Operating Officer and CFO Phong Le. First, I'd like to pass the floor to Phone, who's going to read the safe harbor statement and make some comments on our results for the fourth quarter." ] }, { "name": "Phong Le", "speech": [ "Thank you, Michael. Good evening, everyone. Various remarks that we may make about our future expectations, plans, and prospects may constitute forward-looking statements for the purposes of the safe harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our most recent quarterly report on Form 10-Q filed with the SEC.", "These statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. We anticipate that subsequent events and developments may cause the company's views to change. While the company may elect to update these forward-looking statements at some point in the future the company, specifically disclaims any obligation to do so. Also, during the course of today's call, we will refer to certain non-GAAP financial measures.", "There is a reconciliation schedule showing GAAP versus non-GAAP results currently available in our press release issued after the close of market today, which is located on our website at www.microstrategy.com. We entered 2018 with a plan to invest across sales, marketing, customers, technology, and our people with the purpose of growing revenue across our business. We feel we executed well in our investment plan and are on a path to revenue growth. In sales, we strengthened our field resources, placing field marketing, business development, and global alliances, people around the world.", "We also added a new head of worldwide sales in April and head of international sales in December. In marketing, we launched a new campaign focus on three core product features: federated analytics, transformation mobility, and hyper intelligence; and three core concepts for the platform: modern analytics, open architecture, and an enterprise platform. We added a new Chief Marketing Officer in July and a new Head of Worldwide Demand Generation in October. With respect to our customers, we launched and are delivering an initiative to provide proactive outreach and support through an enterprise intelligence center assessment and follow-up advisory work.", "We also added a new Head of Worldwide Consulting in September. In technology, we launched our most significant MicroStrategy product released to date, MicroStrategy 2019, our first platform release since 2016. We have eorganized our technology leadership and added over a half dozen key leaders to our technology team. We also hired a new CIO, who started in November.", "Finally, with respect to our people, we invested in new facilities and systems and launched a new employer brand campaign inviting people to accept the challenge of MicroStrategy. Our worldwide recruiting initiatives are very successful as we added 312 MicroStrategists to the organization, ending 2018 with 2,528 employees, a 14% growth rate. And about of these people were added to our technology organization worldwide. We believe we now have the strongest leadership team and strongest set of employees ever in MicroStrategy.", "We're starting to see the benefits of these investments. Here are highlights of our Q4 2018 financials. First, we had a strong product license revenue quarter. Product license revenue was $31.2 million in Q4 2018, a $0.7 million or 2% increase year over year and a $10.9 million or 54% increase quarter over quarter.", "Foreign currency FX negatively impacted our product license revenues by $1.5 million or 5%. Domestic Product license revenues were very strong, contributing to 62% of our total product license revenue and increasing 122% year over year. Product Support revenue was $73.7 million in Q4 2018, a 2% decrease year over year with foreign currency FX negatively impacting such revenue by $1.6 million or 2%. We continue to see strong customer renewal rates, a ongoing reflection of our highly engaged customer base.", "Our deferred revenue balance was $183.0 million as of December 31, 2018. This represents a $22.1 million decrease from the same time a year ago. This was primarily driven by a decrease in deferred product support revenue, which was related to, one, foreign exchange changes negatively affecting our foreign currency valued deferred product support revenue; and two, system changes impacting our quoting and invoicing timelines. In the second half of 2018, we implemented a new customer quoting system.", "As a result of this implementation, we experienced delays in issuing product support renewal quotes and invoices in Q4 2018. This resulted in a reduced deferred product support revenue. We do not expect this delay to impact our ability to renew product support for our customers. We expect to return to our standard quoting timelines in the first half of 2019.", "Other services revenue was $20.0 million in Q4 2018, a 10% decrease year over year with foreign currency FX negatively impacting such revenue by $0.5 million or 2%. We're continuing to transition our consulting business from lower to higher rate services. Turning to cost, our strategy to investment, sales, marketing, technology, our customers, and our people is driving increases overall. Q4 2018 cost of revenues was $25.9 million, a $1.1 million or 5% increase year over year and a $2.5 million or 11% increase quarter over quarter.", "These increases the result of more proactive product support offerings and other services to our customers, which included services to prepare customers for an upgrade in MicroStrategy 2019. These upgrade services will continue to be a focus area in 2019. Sales and marketing expenses increased $6.0 million or 11% year over year and increased $12.4 million or 27% quarter over quarter. This quarter-over-quarter increase is primarily due to variable compensation due to improved product license revenue performance, marketing and translation fees and travel related to our launch of MicroStrategy 2019.", "Research and development expenses increased $6.6 million or 31% year over year and $2.2 million or 9% quarter over quarter. This was primarily due to additional hires, where we saw an increase of 157 people or 28% year over year and 28 people or 4% quarter over quarter. The quarter-over-quarter increase was largely due to a very successful campus recruiting effort in our Tysons Corner, Virginia headquarters location and our Hangzhou, China Technology Center. General and administrative expenses increased $1.1 million or 5% year over year and increased $2.1 million or 10% quarter over quarter.", "The increases were primarily due to increased recruiting headcount and associated costs. With an operating loss of $2.2 million in Q4 2018 as we invested in and ramped up our team for our MicroStrategy 2019 launch. For the full year 2018, we had operating income of $4.0 million, resulting in an operating margin of 1%. We had net income of $3.3 million in Q4 2018 and diluted earnings per share of $0.30.", "We had net interest income of $3.2 million. Other income of $1.0 million, which primarily consisted of foreign exchange gains and a benefit from income taxes of $1.3 million. I also want to provide a quick update on our stock repurchase program. During the fourth quarter of 2018, $111 million was used to purchase 880,667 shares of the company's common stock as part of our previously announced stock repurchase program.", "The repurchases resulted in an ending balance of cash, cash equivalents and short-term investments of approximately $576 million. We continue to have no debt. As mentioned previously, in the second half of 2018, we implemented a new quoting system on the Force.com platform. As we tested the general information technology controls and the implementation of the system, we identified deficiencies in the areas of user access, program change management, and project implementation over certain information technology systems that support the company's financial reporting process.", "As a result, we expect to report a material weakness in our internal control over financial reporting as of December 31, 2018 in our upcoming Annual Report on Form 10-K for the year ended 2018. I want to emphasize that no misstatements have been identified in the financial statements as a result of the material weakness and we expect to file our 10-K in a timely manner. While we are still completing our assessment of the effectiveness of internal controls over financial reporting, remediation efforts related to this identified material weakness have begun. However, this material weakness will not be considered fully remediated until the applicable controls operate for a sufficient period of time and management concludes through testing that these controls are operating effectively.", "We expect remediation to be completed prior to the end of this year. As we enter 2019, our objective is to grow revenue across all areas of our business and scale back the pace of investments, maintaining generally flat operating expenses to expand operating margin. We expect our MicroStrategy 2019 product to drive upgrade cycles across our customer base in the next 18 months. Customers are already showing enthusiasm for our new product, especially our hyper intelligence feature, which brings Zero-Click Intelligence to developers and data analysts as well as business users and executives across the enterprise.", "We also expect increased efficiency in our sales and marketing organization with increases in account executive productivity and marketing return on investment. A lower pace of hiring and lower employee turnover is expected to help decrease our general administrative [Inaudible] Technology recruits, especially campus hires arriving in the spring and fall as part of the very successful 2018 recruiting process, may cause incremental increases in technology costs. We believe our strategic investments in 2018 across the organization, new leadership and improved integration, and our new 2019 products set us up for a promising in 2019. Now I'd like to turn it back to Michael Saylor." ] }, { "name": "Michael Saylor", "speech": [ "Thank you, Phong. I would like to elaborate on Phong's comments with a few thoughts about 2018 and then speak about our plans for 2019. As I look back on 2018, I think we've made great progress strengthening the talent pool in MicroStrategy, adding hundreds of very, very talented professionals all around the world, including a large pool of talented engineers in the technology organization. I think that was a great success for the company.", "I'm also pleased with the way we strengthen our executive team in 2018. And then getting a new head of sales, a new head of marketing a new head of I.T., a new head of worldwide consulting, a new head of international sales, a new head of Latin America, and a new head of international enterprise support, and a new head of direct marketing and demand generation. They were all seminal achievements for the company. We're extraordinarily pleased with the talent that we've been able to attract and any engagement of these new executives and they're already making a big difference here at the firm.", "In 2018, we also made great strides strengthening our systems and although it's not without a few growing pains, I think the implementation of our CPQ system and a new quotation system in Salesforce was a big step forward in integrating all of our sales and marketing systems together in a common environment. And we also implemented Workday, which will lay down our very strong modern platform for all of our H.R. systems going forward. As Phong have mentioned, we delivered MicroStrategy 2019 at the end of the year and we dramatically strengthened our product offering, the biggest product release in three years.", "And and we returned $111 million of capital to the shareholders and that's also a material achievement. We're very pleased with that. As I look at 2019 and assess our prospects going forward and the plan, I just like to highlight to the shareholders, the 2019 product is the best platform we've ever created at MicroStrategy. It's a modern analytics, open architecture, enterprise platform.", "And that makes it quite interesting and quite valuable in the marketplace. MicroStrategy 2019 is going to appeal to a lot of people because there are many that have modern analytics but they don't have an open architecture. There are many with open architecture but they're not they're not modern in their analytic approach. And then oftentimes, there are desktop analytics or specialty tools but they're not enterprise-grade platform.", "So, to put together, the modern, the open, and the enterprise characteristics in a single offering gives us unique spot in the marketplace. We believe that there are some really unique solutions that we can deliver with the 2019 platform. Federated analytics is clearly one of the key ones, the ability to use the tools that you love but on a platform that you trust. Most organizations are interested in deploying a single version of the truth.", "Now with MicroStrategy 2019, we can offer them the ability to do that and yet keep their existing tools like Tableau or Power BI while they deploy MicroStrategy data sets, and we're really excited about the Federated Analytics' potential. Transformational mobility is another unique offering that we have because we're offering the ability to very rapidly deploy mobile applications that may also have custom functionality or transactional characteristics embedded in them. And that supports the digital transformation that most enterprises are seeking to go through. And then the third major unique selling point of the MicroStrategy 2019 platform is hyper intelligence.", "And hyper intelligence is more than just a feature. It's certainly more than just a unique attribute or a unique solution. Hyper intelligence represents the next wave of enterprise intelligence and indeed, it's truly a beginning of a paradigm shift. If we look back to the founding year of the company, 1989, it was the beginning of a wave of PC intelligence.", "And the exciting thing was using personal computers with graphical interfaces in order to deploy intelligence throughout enterprises. And for 10 years, we saw lots of lots of innovation and expansion and growth in the PCI intelligence era. And by about 1999 we moved into the Web intelligence era. And people started thinking about deploying intelligence apps using Web browsers, and that opened up a lot of new use cases and a lot of new constituencies and new projects and we saw another 10 years of very strong growth in the industry up until 2009.", "And 2009 was the beginning of the mobile intelligence era or the advent of iOS and Android and mobile devices starting to get embraced by enterprises. And now we are 2019, each of these previous errors has been about 10 years. Now we're moving in an era of hyper intelligence. And hyper intelligence is profound and very interesting because it's technology that gives you the answer to the question before you knew to ask the question.", "And it's technology that gives you the answer to the question within seconds instead of minutes, hours, days, or weeks. And so as you inject intelligence into much more routine operational business processes, you find new constituencies, new use cases, new executive sponsors, and new value propositions. I don't think this is going to be a simple feature. I don't think that's going to be a one or two-year fad.", "I think that the era of hyper intelligence is going to go on for the next decade, just like these previous waves. And MicroStrategy 2019 positions us uniquely positioned to take advantage of this trend. We're arriving to this stage of the marketplace early and with a mature product that's enterprise-grade. And so certainly Hyper Intelligence will be a big part of our marketing theme.", "And as the rest of the marketplace starts to realize just how powerful this is, I think this will be good for all of us. As we go into 2019, in addition to accentuating Federated analytics, transformational mobility, and hyper intelligence, we also have very powerful cloud offering on either AWS or Azure. And I think that the trend of the marketplace to embrace the public cloud sources like AWS and Azure is going to be a good one for us. We've really focused on an enterprise-grade open, flexible architecture for taking advantage of these public cloud sources, and we're getting good feedback from our customers, who -- and those of them that weren't enthusiastic in the early days of cloud or didn't want of a single source are a lot more interested now that they have choices and cloud offerings are more mature.", "As I look forward, my agenda for 2019 is, first and foremost, to market the MicroStrategy 2019 product offering to all of our customers and to all of our prospects and make sure they understand the kind of unique solutions that we can bring to bear. Our second agenda item is to aggressively move to upgrade our customers and pilot the new capabilities of MicroStrategy 2019 across the customer base and the prospect base so that people can can touch and feel and see with their own eyes the kind of value we can bring to bear with this new technology. The third agenda item is to sell new products services, and the MicroStrategy 2019 product offers some new product lines like the hyper -- high client that we believe we can begin to license to our existing customers and prospects and new application clients and new mobile clients and so -- and a new platform software and servers for the various public cloud platforms like AWS and Azure. So, we have new product to sell and we have new services to offer in conjunction with those products and we intend to sell both.", "And finally, when we take all of this in its entirety, the goal of course is to grow revenue and margin. And so, with that, I would like to go ahead and open up the floor for questions from the analysts." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] And our first question comes from the line of Karl Keirstead with Deutsche Bank. Your line is now open." ] }, { "name": "Austin Dietz", "speech": [ "Hey, guys. This is Austin Dietz on for Karl. Phong, I had a couple questions for you. Just first on the 2019 platform release, was there any pause in customer buying ahead of the 2019 platform release this quarter? And then second, how should we think about the revenue contribution or revenue lift from the 2019 platform release? Could it be a little bit more pronounced than the first half? Perhaps, if there is one, would it be a little more, kind of, gradual kind of throughout the year? And then I had a follow-up.", "Thanks." ] }, { "name": "Phong Le", "speech": [ "Hi, Austin. Thanks for the question. I think it's fair to say that in the second half of 2018, we saw some customers who may have taken a little time on their purchasing decision to see the 2019 platform and test it out. I don't know that I can quantify the amount that, that impacted our second half revenue in 2018.", "As far as 2019 goes, we started to aggressively market our 2019 product, starting on January 7th, which was our external launch. We have our MicroStrategy world event coming up next week in Phoenix, Arizona, which is another major milestone for us to be able to communicate to our customers about the 2019 platform. And so I'd expect over the course of the year, as we upgrade customers and we get our marketing message out, that we should see uplift in terms of our product license revenue." ] }, { "name": "Austin Dietz", "speech": [ "OK . Great. And then yes, the domestic product license business, I think it had been declining plus 20% in the past few quarters, but certainly it flipped this quarter. So, maybe just what seemed to change kind of in the quarter? What would you maybe call out there?" ] }, { "name": "Phong Le", "speech": [ "Yes, we had good large deal activity in North America. And it obviously was a positive for us to see that business start to rebound. I wouldn't call out anything specific about Q4. I think we're starting to see the team get their legs back underneath them and see some of the leadership hires and some of the management hires and account executives that we brought in, whether it'd be 12 or 24 months ago, start to see their traction take place.", "So overall, it was a positive quarter for North America for sure." ] }, { "name": "Austin Dietz", "speech": [ "OK. Great. Thanks." ] }, { "name": "Operator", "speech": [ "[Operator instructions]. And our next question comes from the line of Tyler Radke with Citi. Your line is now open." ] }, { "name": "Tyler Radke", "speech": [ "Hi. Thank you. Phong or Michael, I was wondering if you could comment on your outlook for 2019. Do you -- you've obviously made a lot of investments.", "Your headcount is up nicely. It sounds like you're getting things going in terms of execution here in North America and you have a major product release coming soon. So, what can we expect in terms of license revenue growth in 2019?" ] }, { "name": "Phong Le", "speech": [ "Yes, I think, Tyler, as I mentioned in my prepared remarks and Mike reiterated, we're very optimistic about the prospects for the year 2019 for some of the reasons you mentioned. 2018 was, as we had stated at the beginning of the year, our investment year. And you saw that both in our cost and our operating income. As I think we enter 2019, we're looking to grow product license revenue, frankly, revenue across all our major line items.", "I'm not going to comment specifically as to the magnitude of the growth. But we did mention we would like to see revenue grow for the overall business. And we'll start to see operating margin expansion as our investment activity and our investment acceleration that you saw in 2018 starts to scale back a little bit." ] }, { "name": "Tyler Radke", "speech": [ "Great. And a follow-up on maintenance revenue. I know you talked about some invoicing delays and changes based on the new system as well as some currency headwinds. I'm just curious from -- if we look at deferred maintenance revenue, it looks like that was down, on a year-over-year basis kind of for three quarters now.", "Is there any way you can, kind of, quantify what those impacts were? I mean, what would have maintenance revenue or maintenance deferred grown excess in tax? And do you expect maintenance revenue to return to a growth rate -- nice growth rate next year?" ] }, { "name": "Phong Le", "speech": [ "Yes, I think on a constant currency basis, Tyler, for the full year, we saw our maintenance revenues grow by about 2% year over year on a full-year basis. And any particular quarter, there's some ups and downs related to when we close large maintenance deals. So, I wouldn't read too much into the fact that we were, on a constant currency basis, flat year over year in Q4. On your question in terms of deferred product support revenue and deferred revenue overall, there are two main factors that I stated.", "One is a portion of that deferred revenue that's in foreign currency saw a depreciation just due to the strengthening of the dollar. And the second piece, as I mentioned, is related to a system that we put in place that caused us to delay a little bit our ability to send out quotes and invoice, and as a result, put deferred revenue on the balance. I don't expect that to be a long-term effect. So, I don't expect it to affect our ability to collect the maintenance from our customers and ultimately, recognize and receive product support revenue.", "But I think over the course of the first half of the year, 2019, you'll see that amount start to stabilize on a year-over-year basis again." ] }, { "name": "Tyler Radke", "speech": [ "OK. And last question for me, I know you addressed briefly the buyback in the quarter, but just curious what the motivation was behind that. I think in the past you've talked about potentially deploying capital as you get more confidence in the business and the business stabilizing. So curious what you're seeing there and what your outlook for buybacks going forward is?" ] }, { "name": "Phong Le", "speech": [ "It's a good question, Tyler. And I appreciate the curiosity. As you know, and we've talked about in the past, there's quite a few different factors that would address our decision making on the buyback, and I wouldn't point to any particular factor. I mean, the most important part is, we wanted to return capital to our investors.", "And so that's what we did and you'll see in our 10-K a more fulsome disclosure on that as we file that and in future SEC filings." ] }, { "name": "Tyler Radke", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. And, ladies and gentlemen, this concludes today's Q&A session. I would now like to turn the call back over to Mr. Saylor for any closing remarks." ] }, { "name": "Michael Saylor", "speech": [ "I'd like to thank everybody for being with us today and we appreciate your support. We look forward to speaking with you again in three months. All the best." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2019-04-30	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "President and Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": "Chief financial operations", "name": "Sachin Mehra", "position": "Executive" }, { "description": "KBW -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "William Blair -- Analyst", "name": "Robert Napoli", "position": "Analyst" }, { "description": "Mizuho -- Analyst", "name": "Tom McCrohan", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" }, { "description": "Mastercard Incorporated -- Analyst", "name": "Tim Murphy", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Eric Wasserstrom", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Donald Fandetti", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Tasha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mastercard Q1 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session (Operator Instructions) Thank you.", "I'd now like to turn the call over to your host Warren Kneeshaw, Head of Investor Relations. Please go ahead." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Tasha. Good morning, everyone, and thank you for joining us for our first quarter 2019 earnings call. With me today are Ajay Banga, our President and Chief Executive Officer; and Sachin Mehra, our Chief Financial Officer.", "Following comments from Ajay and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session. It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning.", "Our comments today regarding our financial results will be on a currency-neutral basis and exclude special items, unless otherwise noted. Both the release and the slide deck include reconciliations of non-GAAP measures to their GAAP equivalents.", "Please note that the growth rates we provide for switched volume, switched transactions and cross-border volume have been adjusted to normalize for the effects of differing switching days between periods. These adjustments have been made in current and prior quarters. This information is being provided so that you can better understand the underlying growth rates of these operating metrics. Our comments on the call today will be on the basis of these adjusted growth rates. We do not normalize GDV growth rates.", "Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days.", "With that, I'll now turn the call over to our President and Chief Executive Officer, Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thank you, Warren, and good morning, everybody. We are off to a solid start this year, revenues up 13%, EPS up 24% versus the year-ago. As Warren said, on a currency neutral basis and excluding special items. I think these results reflect our strong operational focus and our continued growth across each of our regions. And at the same time, we are continuing to invest in the business for the long term. As you probably noticed with some of our recent product and acquisition related announcements.", "Let me start with the macroeconomic environment as usual. You may recall that last quarter we said that the expected solid overall growth to continue in 2019 with some moderation. And our view has not changed from that. That said, we are still monitoring a number of items, this is ongoing trade negotiations and other economic and political factors that could affect growth over the medium to longer term.", "US economic growth remained strong, low unemployment, healthy consumer confidence, retail sales grew 3.5% versus a year ago ex-auto, ex gas, according to our SpendingPulse estimates. And that reflect some moderation as expected, as there are some impact from the shift in the timing of Easter this year.", "In Europe, we continue to see moderate growth, consumer confidence remains mixed with declines in places like the UK, Ireland and The Netherlands. But despite the uncertainty surrounding Brexit, UK retail spending remains healthy, again, according to what we see in SpendingPulse.", "Asia Pacific has been impacted by trade policy uncertainty, we continue to monitor the strength of the Chinese economy. But having said that, we're seeing modest GDP growth in the region overall, and that's kind of underpinned by favorable monetary policies and generally stable labor market conditions.", "In Latin America, the outlook is mixed. There is positive signs in Brazil and Chile and that's tempered by some weakness in Mexico. Similarly, in the Middle East and Africa region, we are seeing healthy growth in countries such as Egypt with some softness in the oil producing markets. Meanwhile, our business continues to drive healthy double-digit volume and transaction growth across most of our markets by successfully executing against our strategy.", "What I'm going to do is, give you few examples of how we're growing our core products, diversifying our customer base and building new areas for our business. Let me start with growing our core products, where I believe we continue to make good progress in providing people with simple and safe ways to pay with credit, debit, prepaid and commercial products. And it's not a card, the physical card is just one form factor as you've heard me say in the past, we are equally focused on seamlessly delivering our products digitally.", "Earlier this month Apple announced the Apple Card with Mastercard and Goldman Sachs. And available this summer, this is a credit product, it is designed for the iPhone that leverages Mastercard's tokenization technology of fraud tools and our chargeback KPIs. Customers can immediately access the digital version of the card in their Apple Wallet, they can also get a physical companion card. With attractive rewards and extensive security features the user experience is friction less.", "In addition, we look forward to collaborating further with Goldman's consumer business markets by bringing new products and services to market overtime. We are pleased to be the payment center for T-Mobile's new mobile first checking account, T-Mobile Money. Which consumers can open and manage online, all with an app on their smartphones and they can withdraw funds using a Mastercard debit card.", "Coming to markets outside of the US. I think we continue to make significant progress. We are pleased to announce the expansion of our partnership with Santander in Brazil to expand our share of the credit, debit and commercial portfolios of the fast growing customer (ph). We also extended our long-term agreement with Rogers Bank, which is a key strategic partner for us in Canada. Further expanding the services we provide on their card portfolios. And we are advancing our efforts to increase market share in Europe with BNP Paribas in France, flipping more than 4 million credit cards in a long-term deal that will be accompanied by a full suite of services, including spending controls and alerts, as well as identity check mobile security features.", "In addition, we have some great examples of customers with closed loop systems who continue to see value in open-loop Mastercard cards, because of broader acceptance and digital capabilities. One of these as example is Cred-System in Brazil, which is converting 7 million private label cards to Mastercard contactless co-branded cards to open up international acceptance to their cardholders.", "Now in the commercial side, we are pleased to be Citibank's chosen network for its cross-border B2B virtual card program in China. And the initial focus there is on enabling Chinese online travel agencies to make payments to hotels, hotel aggregators and airlines outside of China. That same vein (ph) to help our customers provide greater transparency and certainty in cross-border payments. As you know, we have announced an agreement to acquire Transfast, a global cross-border account-to-account money transfer network. We look forward to complementing and enhancing our solutions with their network reach, with their strong compliance capabilities, flexible technology and some very robust foreign exchange tools.", "By the way, we currently work with Transfast in support of our P2P and B2B capabilities through Mastercard Send. And why not Mastercard Send, just to give you a quick update. We continue to see healthy growth and we are continuing to develop a number of different use cases. Send currently powers seven of the major mobile P2P program in the United States, and we are working to grow our customer base. On the cross-border front, a number of our issuers are leveraging Send to provide faster and more cost effective and transparent cross-border payments to their customers. Bank of Montreal is the latest to announce that it will implement Send for it's Canadian business and commercial banking clients. And the initial focus there is on bank account transfers, and there are additional plans for payments to mobile wallets and cards internationally.", "So now from growing the core, turning to the second pillar of our strategy, the work we are doing on diversifying our customer base and strengthening our footprint in some of these new geographies. We are building relationships with merchant, processors, digital players, and a number of other partners to help drive their businesses forward.", "So I'm going to highlight a few specific examples on the core brand area, including our renewal with Target in the US, a new program with Japan Airlines, and with Falabella, which is the largest retailer in Chile. We also entered into an agreement with Mercado Libre, the largest e-commerce marketplace in Latin America to make their platform safer and more convenient with tokenization, seamless authentication tools and contactless prepaid card programs across Brazil, Argentina and Mexico.", "Now while doing all this, we are trying to find ways all the time to look for methods to improve our local presence, particularly in areas where there is low electronic payment penetration. That's why our partnerships with and the investments in Network International, which is a preeminent local processor in the Middle East and Africa region. And also Jumia, an e-commerce platform spanning 14 countries in Africa. We think these will accelerate our efforts to deliver a sustained shift from cash and checks to electronic payments in these markets.", "Mastercard will be Network International's preferred partner for processing, acceptance and value-added services with safety and security and data analytics. And our relationship with Jumia will include co-brand card issuance for consumers, as well as commercial payments on their platform and also the use of our payments gateway.", "And finally, the third pillar of our strategy is building new areas of our business. And we do this in a way that leverage at the core and differentiates our offerings, in particular, with services and new payment flow. So a few examples for you. Safety and security products remain a key area of focus, we recently announced the acquisition of Ethoca, a globally e-commerce fraud and dispute management network. What this does is, it enable the sharing of intelligence between merchants and insurers in over 40 countries. Wherever a fraudulent or disputed transaction is identified, near real-time information is sent to the merchant, so they can stop delivery and refund the cardholder and avoid the chargeback process.", "And as a result, both merchants and issuers benefit from reduced costs. With more than 5,000 merchants including top e-commerce brands, such as Google and Walmart and over 4,000 issuers already participating, we look forward to continuing to scale Ethoca's network.", "Now we are also looking for ways to help our partners improve their customers' user experiences. That's why we acquired Vyze, a platform that connects merchants with multiple lenders, opens up a wide range of financing options, including instalments for consumers online and in-store, and complements Mastercard's existing card and ACH-based solutions. While this merchant customers like Home Depot, Microsoft, Samsung, for them multiple lenders help to increase customer financing approval rates, decreased cart abandonment and ultimately therefore increase sales. At the same time, they benefit lenders by providing access to new customers through these channels. And just to be clear, we are not changing our model in taking credit risk, we are merely the platform provider here, connecting retailer and multiple lenders.", "Now with respect to our processing services. Pleased that Citibank will be using our Payments Gateway to support digital commerce enablement for their existing institutional clients. Now our gateways connection to numerous acquirers and digital wallets will provide a signal consolidated payments view for these large merchants who have a relationship with Citibank and make it simpler for them to accept payments on a global scale.", "And moving onto the work we are going to capture new payment flows, beyond traditional card rails. We have this quarter reached a number of significant milestones in expanding our real-time account-to-account capabilities with our Vocalink assets. First, you must have heard recently that we have been chosen to enhance the Instapay real-time retail payment system in the Philippines. Now this includes operating the infrastructure for and providing anti-money laundering tools to an institutional called BancNet, which is the national clearing switch in the Philippines. We will do this through a regional payments hub in Asia Pacific using leading edge ISO 20022 messaging, which streamlines communications and provides enhanced transaction data.", "Second, we are licensing our real-time payment software to the Saudi Arabian Monitoring Authority, SAMA, to upgrade their system, providing similar capabilities to what we already have in place in the United States, Thailand and Singapore. These wins build upon the announcements we made late last year about our partnership in Peru to modernize and operate the Peruvian Electronic Payments infrastructure and we remain involved in a number of similar RFPs around the globe.", "So, as you can see, we're making real progress in expanding our geographic footprint for real-time payments in Asia, in the Middle East, and Latin America, while adding value to governments and Central Banks to help their citizens and their economies.", "So before I turn the call over to Sachin, I'd like to thank Martina, who's not on this call, who's probably on a beach somewhere for both the years of dedication to Mastercard's growth, but also for ensuring that we were left in good hands upon her retirement with a very well prepared and chosen successor. And now it's my pleasure to introduce Sachin Mehra, our Chief Financial Officer. Sachin?" ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Ajay. And good morning, everyone. First, I would like to say that I'm very excited about the opportunity ahead. And I look forward to working with each of you and to meeting those of you I have not met yet.", "Turning to page three, we had a solid start to the year. Here are a few highlights on a currency-neutral basis and excluding special items related to certain tax and legal matters. Net revenue grew 13% driven by solid momentum in our core and was slightly ahead of our expectations due to services growth. Operating income grew by 20% and net income was up 21% reflecting our strong operating performance. EPS was $1.78, up 24% year-over-year, with share purchases contributing $0.04 per share. During the quarter, we repurchased $1.8 billion worth of stock and an additional $467 million through April 25 2019.", "So now let's turn to page four, where you can see the operational metrics for the first quarter. Just as a reminder, as Warren said, we don't normalize GDP growth rates. Worldwide gross dollar volume or GDV growth was 12% on a local currency basis, down 2 ppt from last quarter, in part due to the impact of the different number of processing days between periods, as well as some other factors such as the delay in the timing of Easter this year. This was much as expected.", "US GDV grew 8%, down approximately 2 ppt from last quarter with credit and debit growth of 9% and 6%, respectively. Outside of the US, volume growth was 13%, down 3 ppt from last quarter. Cross-border volume grew at 13% on a local currency basis, in line with expectations and driven by double-digit growth in several regions. This Q1 growth was down sequentially, due primarily to difficult year ago comps.", "Turning to page five, switched transactions continued to shows strong growth at 17% globally. We saw healthy growth in switched transactions across all regions, led by Europe and the US. In addition, card growth was 7%. Globally there are 2.5 billion Mastercard and Maestro branded cards issued.", "Now let's turn to page six for highlights on a few of the revenue line items. Again, described on a currency-neutral basis unless otherwise noted. The 13% net revenue increase was primarily driven by strong transaction and volume growth, as well as growth in our services offerings, partially offset by rebates and incentives. Looking quickly at the individual revenue line items: Domestic Assessments grew 16%,while worldwide GDV grew 12%. The difference is mainly due topricing and the differing number of processing days between periods, partially offset by mix.Cross-border volume fees grew 15%, while cross-border volume grew 13%. The 2 ppt difference is mainly driven by pricing, partially offset by mix. Transaction processing fees grew 16%, in line with the 17% growth in switched transactions. Finally, other revenues were up 14%, driven by growth in our Cyber and Intelligence and Data and Services solutions.", "Moving to page seven. You can see that on a currency-neutral basis and excluding special items total operating expenses increased 5%, primarily related to the company's continued investments in strategic initiatives. This was lower than expected due to the timing of certain marketing initiatives, which we now expect will mostly occur in the second quarter.", "Turning to slide eight, let's discuss what we've seen through the first three weeks of April where all of our drivers are up versus what we saw in Q1. Please remember that year-over-year comparisons across all drivers in April our aided by the timing of when Easter fell this year and that three weeks does not make a quarter. The numbers through April 21 are as follows: starting with switched volume, we saw global growth of 18%, an increase of 4 ppt to the first quarter. In the US, our switched volume grew 15%, a sequential increase of 5 PPT with strength in both credit and debit. Switched volume outside the US grew 21%, up 4 ppt from the first quarter, primarily driven by Europe. Globally, switched transaction growth was 20%, a sequential increase of 3 ppt, primarily driven by Europe and the US.", "With respect to cross-border, our volumes grew 17% globally a sequential increase of 4 ppt, in part due to the timing of Easter, as well as the tougher year-ago comps we saw in Q1. This was consistent with our expectations. For the year, we continue to expect cross-border volume growth to be about mid-teens and this is what is contemplated in our thoughts for revenue growth for the year.", "Turning to our thoughts for the year that I will describe on a currency-neutral basis, excluding special items and acquisitions. I will separately comment on acquisitions in a moment. Overall, not much has changed. We had a solid first quarter and our view on the economy is broadly similar with continued overall growth albeit with some moderation versus 2018.", "In terms of net revenue, we continue to expect growth at a low teens rate for the year, with second quarter growth consistent with or slightly better than what we saw in Q1. We expect FX to be a 2 ppt headwind to revenue for the year and about 3 ppt headwind for the quarter. On operating expenses, we are still planning to grow at a high-end of high single digits rate for the year. We expect Q2 operating expenses to grow at approximately twice the annual growth rate due to the lapping of a significant hedging gain a year ago and increased marketing spend. Year-over-year FX will be a tailwind to OpEx of about 1 ppt for both the year and Q2. In terms of the tax rate, we now expect to be closer to the bottom end of the 19% to 20% range for the year. Due to the higher-than-anticipated discrete tax benefits we saw in Q1.", "Now moving on to the impact of acquisitions. As Ajay mentioned, we announced a number of acquisitions that either have closed or expected to close this year. We estimate there will be about $0.06 to $0.08 dilutive for the year with the impact starting in Q2 and building progressively throughout the year, driven primarily by purchase accounting and integration related costs. One further item, as a reminder, as of January 2018 certain equity investments are required to be mark-to-market based on observable price movements. We have been following this new standard and it has had a relatively minor impact on our results since inception.", "In April, we made investments in two companies as Ajay mentioned, that have since become public. Valuation volatility will therefore increase as a result of the unpredictable nature of public equity markets. Accordingly, starting in Q2, we will be updating our non-GAAP methodology to exclude the impact of fair market value gains and losses on our equity investments. We are excluding these items as we believe this will facilitate a better understanding of our operating performance and provide a more meaningful comparison of our results between periods.", "Please note, that our long-term performance objectives and our thoughts for 2019 exclude such gains or losses. We will provide you full visibility to the impact of fair market value gains and losses on our equity investments as we do with the impact of special items and foreign currency, which we will continue to exclude from our non-GAAP measures.", "With that, let me turn the call back to Warren to begin the Q&A session." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Tasha, we're ready for the question-and-answer session." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. (Operator Instructions) And our first question comes from the line of Sanjay Sakhrani from KBW. Your line is open." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thank you. Good morning. I guess, I had a question unrelated to some of the stuff you talked about, which was TSB Bank's decision to stick with Visa after committing to you guys. Could you just talk about the observation there? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Sure. Hi, Sanjay. TSP is staying with us on credit and it's currently staying with Visa on debit. The reason is very simple. As you know, they had to focus their attention on their technology circumstances when they were doing a migration of their technology platform. And the bank is very focused on getting that done right and looking after their customers and meeting their responsibilities on that front. In the midst of that, to add the migration of a debit book would have added unnecessary risk as well as customer repetitional issues to them and therefore, what they have thought about is, hold on and we'll see later. And I think that's the right thing to do if I was in there place. And I actually respect their decision." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Tien-tsin Huang from J.P. Morgan. Your line is open." ] }, { "name": "Tien-tsin Huang", "speech": [ "Hey, thanks. Good morning. Can you hear me?" ] }, { "name": "Ajay Banga", "speech": [ "Good morning, Tien (ph)." ] }, { "name": "Tien-tsin Huang", "speech": [ "Hi. Good morning. Just want to make sure you can hear me. Just maybe a couple of quick ones. Just on the modernizing payment systems in the Philippines, in Peru, and et cetera. Just curious, once you're beyond the build period, what's the run opportunities for Mastercard? Do you become an intermediary? Are you in advantage position to power these intermediaries? Just trying to understand what happens beyond the build phase? And then maybe for Sachin, just the incentives line with so some of the fintech deals like Apple coming in and then TSB as Sanjay asked, any considerations throughout the next two, three quarters?" ] }, { "name": "Ajay Banga", "speech": [ "So Sachin will answer that incentive and then I'll give you the answer later on the Philippines. Go ahead." ] }, { "name": "Sachin Mehra", "speech": [ "Okay. Hey, Tien-tsin. So on your question as it relates to incentives. Our incentives continue to be very much in line with our expectations. We expect for deal activity to pick up in Q2, but other than that, not much in the nature of changes as it relates to our expectations on incentives." ] }, { "name": "Ajay Banga", "speech": [ "Hi, Tien-tsin. On the ACH platforms. So what we are trying to do, it depends on what kind of RSP and what kind of deal is constructed. In the Philippines and Peru, the deal is a bit more complete in the form of having infrastructure operation, also included in it. In others, it could be only the software as it is in Saudi, or in the clearing house in the United States or in Singapore's case.", "If it's only software, then it becomes a different ability to intervene in the payment flow. So if it's only software, what we're trying to do is to build app which work off that software. But also to build a value added data analytics tools like the anti-money laundering tools and so on, which we have built in other markets and so we can bring them to these countries that has software. Also to provides scheme related thinking around chargebacks, disputes, fraud management, that kind of thing. So that's the software idea, whereas infrastructure, it's little different. It will be a little bit more like the UK in some ways, where we actually run the basic infrastructure and then we can build products and scheme rules on top of that as well.", "So I give you the two slightly divergent paths, and it depends on what each country wants for their local instant or fast ACH payment system, as these RFPs sort of open up over the next few years. What I was trying to say today was that, if this has been some time coming, because these RFP processes are slower than the usual. But they get done, and we just -- this quarter there were two, there's others as well. And there is more RFPs in the process that we are deeply in negotiation on." ] }, { "name": "Tien-tsin Huang", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of David Togut from Evercore ISI. Your line is open." ] }, { "name": "David Togut", "speech": [ "Thank you. What impact do you see from the two big mergers just recently announced, Fiserv, First Data and then FIS, Worldpay on Mastercard's growth opportunities. And then, as a related question, both companies or both -- in both merger situations they called out growth opportunities in B2B. I'm curious, how you can work with them in addressing B2B?" ] }, { "name": "Ajay Banga", "speech": [ "Sure, Dave. Look we work very closely with issuer processors in many markets. And especially in the United States, which has the more fragmented payments ecosystem than a number of other markets. And I fully expect to continue to partner with these folks, we've talked to all of them. As you can imagine including me personally. The M&A doesn't change that, we got teams working with them to determine how best to collaborate to make them win, while also getting our work done. Remember, they play a really important part in the ecosystem for banks and credit unions of all sizes. And mostly they have to distribute our products and services.", "And so, I kind of feel like there's lots of opportunity ahead, both in the consumer payments side, but also in the B2B side. But it's just too early to demand any of them down. They're both very busy with their own transactions, as you can imagine. And they need to get that done well, because that's their first commitment. And then we can really get deeply involved in what else we can do together with the merged entity.", "Meanwhile, individual (ph) partnerships with the separate entities continue, OK. Just to be clear. The merged entities will have a whole new game, so the merger got to finish before you can do that." ] }, { "name": "David Togut", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Bob Napoli from William Blair. Your line is open." ] }, { "name": "Robert Napoli", "speech": [ "Thank you, and good morning. I mean, Mastercard has been very active on the M&A front. And I was just hoping, Ajay, to get a little more clarity on additional potential areas that you're looking to build up through the M&A. And is there still a very healthy pipeline? Maybe an update on the strategy, the M&A strategy and pipeline?" ] }, { "name": "Ajay Banga", "speech": [ "Yeah. I mean, I mean I think Sachin's sort of baptism by fire on this is the fact that in his first quarter we delivered a couple of extra everyday deals to him, just to keep him happy and make him realize that he needs to do a little bit of work. It won't be an easy thing to follow with Martina's somewhat large shoes. So I hope she is not listening for God sake. But the -- your questions is a much deeper one. Here is the deal, we have not changed our M&A strategy over the years and I've been talking about this. We are trying to use both organic and inorganic ways to grow in the spaces that we think give us possible growth areas for the next decade or two. Hence, safety and security, hence, data analytics and information systems, hence, digital identity systems, hence B2B and cross-border payments. All of these AI, all of these are intertwined in the idea of building out new capabilities and new services. More or less pretty neatly placed in the third block of our strategy, which is in the grow, diversify, build, most of these are in the build space.", "And that's how we've built these services organically and inorganically to now 26%, 27% of our revenue. That's the objective. At the same time, I'm also trying to build the capability to be available and present across all rails of payment. Not just card, but also non-card rails, and hence the Vocalink acquisition and the acquisitions that are going on in B2B spaces to deliver sort of usage results again those. So that's what's going on, nothing is changed in that, you will find us active participants in these spaces, in loyalty and rewards, and those kinds of spaces over the next few periods as well. We have a relatively active pipeline. I mean, Sachin could tell you that his team has -- I don't know, Sachin, during the year '20 to '30 such deals?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, that will be correct. 20 to 30 such deals, which would be actively due diligence." ] }, { "name": "Robert Napoli", "speech": [ "Okay." ] }, { "name": "Sachin Mehra", "speech": [ "The list of deals we would actually scope out will be much broader than that. And just to reiterate what Ajay said, it all kind of starts with the strategy and then we kind of figure out from there on, what's the best way to achieve the strategy between build, buy and partner. And so the M&A component is one big piece of that, but not the only one." ] }, { "name": "Ajay Banga", "speech": [ "Some of these deals, actually, a number of them emanate from us partnering with these people on a commercial deal first, Transfast is an example of that recently. But this has been the case in the past as well, with a number of the transactions we have done, we end up like Brighterion, we ended up being a constructive partner there, having a commercial relationship and then it changes over time into the possibility of an acquisition. So we are trying to use the mix of these, I would say, the acquisition as well as minority stakes, as well as in the case of Fintech's and start-ups a series of early investments as a way of making the company has a layer of its business exposed to all that's new and exciting, which we don't believe we have a full always 100% right to be the only one thinking of new ideas. And so this is a good way to get external thinking, external quality of people, get external -- maybe some product quality or some distribution strength that we may not have. So Ethoca, for example, has both product and software, but also distribution to 4,000, 5,000 merchants, and 4,000 issuers whom they are tied up with. Transfast has compliance capabilities, FX capabilities, but also distribution in a number of countries and licenses to operate in a number of those countries.", "So different things come together in how we make the transaction, but the pipeline is robust. And if we can do one or two transactions a year out of the 20 or 30 we look at, that will be a good year. It just happened that in this quarter a couple of extra ones came through." ] }, { "name": "Robert Napoli", "speech": [ "Great, thank you. I appreciate the answer." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Tom McCrohan from Mizuho. Your line is open." ] }, { "name": "Tom McCrohan", "speech": [ "Hi guys. Can you remind us how much of your cross-border volume occurs in the first quarter. I think there is some seasonality. Just wanted to confirm that? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Tom, I just want to make sure I heard the question correctly? How much of our cross-border volume? What was your question?" ] }, { "name": "Tom McCrohan", "speech": [ "Yeah. Occurs in the first quarter. I think you has -- I think there is one of the weaker quarters? Just want to confirm the seasonality." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. From a seasonality standpoint, what I tell you is, Q3 typically sees a little bit more in the nature of volume on cross-border, but for the most part in the remaining quarters it's pretty stable." ] }, { "name": "Tom McCrohan", "speech": [ "Great. Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Ramsey El-Assal from Barclays. Your line is open." ] }, { "name": "Ramsey El-Assal", "speech": [ "I had a two-part question on some regulatory items. First is on the secure customer authentication rules coming out later in Europe this year. Whether you think that will be any type of -- constitute any type of pressure on European volumes later on in the year? And then second is a more broader question about data localization requirements and having to build out redundant processing capabilities in different national jurisdictions. Over time whether that also constitutes anything like a headwind to operating leverage or any type of incremental pressure? If you can comment on those two things. I appreciate it." ] }, { "name": "Ajay Banga", "speech": [ "Sure. So, the secure authentication rules, as you can imagine, we've been kind of looking at the entire PSD2 implications for both us, merchants and banks in the system, as well as the new entrants PISPs and AISPs who are entering into the European payment system. I actually think that secure customer authentication is an opportunity for a company like ours that has the capability, skills and tools set to provide this for all the players there. Merchants will need it, banks will need it, these new PISPs and AISPs will need to connect properly into the system to ensure that the entire payments ecosystem is kept safe and secure.", "So for us, I see this actually as an opportunity to deliver new value-added services. And in past meetings we've talked about how that's one of the planks of what we are building out as part of our PSD2 strategy. I'm sure other networks are too, this is not a -- this is not about trying to be competitively advantaged. This is about trying to do the right thing for the payments ecosystem.", "The second part, the part about data localization, that's an interesting question. It came up a couple of earnings calls ago as well. It's mostly right time to do with India in that case. And I'd say around the world, in some cases data localization like in India has got real policy ratifications. I others, countries that they engage with us realize that data localization may not be to their benefit. And let me explain that for a second first. The challenge for data localization is actually not the expense, which is what your question comes from. Because that's just a question of putting up some more servers and storing the data on, so on. And to be honest with you, in an expense base of our type, putting a few more servers on soil in a country even as larger as India with the volumes of in India is interesting, but not really the big deal.", "The bigger deal is the fact that by doing so you end up with data that loses its predictive power compared to the wealth of data that generates much higher predictive power when it's combined across many more countries, many more types of transactions, many more types of consumers, many more types of customers. If you talk to anybody in the space of AI or machine learning or good old-fashioned data analytics, you will find that they will tell you that the more the data, the more varieties of data, the more widespread and ubiquitous data you get the better the predictive power. The moment countries balkanize that data they may say they're doing it for security reasons, it is not completely clear to me that in actual fact it give them better security on predicting for fraud and anti-money laundering and capabilities on that front than data which is more widely shared.", "Now we will comply and they have complied in India and we will comply elsewhere, but whatever rules a country finally chooses, because we operate there, because that's what the rules are. But it's our job to try and educate them to what we think and it's their job to decide what's right for them and then we do what we got to do after that. So that's what we got in India, we comply. In other countries we've managed to turn back that thinking based on this logic that I gave you." ] }, { "name": "Ramsey El-Assal", "speech": [ "Thanks so much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Bryan Keane from Deutsche Bank. Your line is open." ] }, { "name": "Bryan Keane", "speech": [ "Hi, guys. Just wanted to ask about the higher expenses expected in Q2. It sounds like most of that is going to be marketing spend, maybe some of that is from acquisitions. Just trying to understand, maybe where the higher expenses are going, especially on the marketing side, anything in particular? And then secondly, just on the strong data so far through April 21. Is there a way to think about how much of that is from Easter versus easier comps versus better economy, share gains, et cetera? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Yeah. Bryan, let me make sure I'm clarifying the Q2 comment over here, which is, we are expecting double the growth rate relative to our full year thoughts on OpEx in Q2. And that growth rate differential is being driven, as I mentioned in my prepared remarks by the fact that, last year in our operating expenses we had the benefit of a fairly sizable FX hedging gain. So I think you need to take that into consideration as you think about the marketing expenses for -- or rather the operating expenses for Q2. In addition to that, we also expect for increased marketing spend in Q2. As I mentioned in Q1, our marketing expenses came in lower than expected. This is just part of what goes on as we run our business. We kind of make evaluations as it relates to when is the optimal time for us to put marketing out in relation to various sponsorship assets and other initiatives, which we've got going on. And this is just par for the course as part of that process. So nothing unusual that I would flag.", "On your second question on April 21 data. I will tell you, look, I mean April 21 data is impacted by the timing of Easter and I think you need to take that into consideration. Just especially given the fact that this 21 days worth of data which we're presenting to you and -- three weeks is not going to make the quarter. So, I would tell you that, by and large the growth trends look solid as we've mentioned for Q1 and we continue to see that going forward as well, but timing of Easter plays a big part in terms of what we're seeing in our April 21 metrics." ] }, { "name": "Bryan Keane", "speech": [ "Okay, great. Thank you, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Craig Maurer from Autonomous Research. Your line is open." ] }, { "name": "Craig Maurer", "speech": [ "Yeah. Hi, thanks. Two questions. One, have you seen any uptick in local network competition anywhere around the world? And secondly, the settlement with the European Commission that you seemingly announced yesterday on inter-regional cross-border. Obviously, that will have an effect on the fee income of banks issuing cards that are being used in Europe. So thinking Citi for you guys. Do you -- can you foresee an impact on the rewards that those banks are offering on those cards for cross-border business, if you're going to see a significant reduction in that fee income? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Sure. So, Craig. First, the second one. That settlement with the European Commision as you know, we kind of discussed it in the fourth quarter earnings call. I've Tim Murphy, my GC sitting here. He is dying to answer that question, but maybe you could -- was it in Q2, Tim?" ] }, { "name": "Tim Murphy", "speech": [ "Yes, Ajay. So we briefed investors in December of last year and there is really no change following what we shared in December, it's just a process update. So that's what you've seen since December, nothing new." ] }, { "name": "Ajay Banga", "speech": [ "Big part of our (inaudible) impact, the rewards that different banks offer, not just Citi, but this is for all banks that would have people traveling into European union territory. It impacts anybody, Australians and Chinese and Americans and everybody else (inaudible). So the fact that it's a relatively small proportion of the total interchange revenue that most of these banks generate. It's also a relatively small proportion of the total revenue, which comes out of not just interchange, but revolving and other fees and therefore, it is not my assessment that there will be that big an impact on the P&L, no. Remember that the reduced rates of 20 and 30 apply to physical card present, whereas for card-not-present e-commerce transactions the rate for debit are 115 basis points and the rate for credit is 150 basis points. And so that's factored into the commentary I'm giving you about the impact for banking institutions. It's not that it's not relevant, it's relevant. It just that it's not enough to, I think, their marketing practices directly in this form.", "Your question about local networks. I haven't seen an uptick or downtick in any relevant strong way over the last six months to a year. Local networks have been strong across the world in different forms over the years. I mean, the EU -- every country in the EU has had a local networks since well before, I mean, since 20, 25 years ago. Mexico has had them, Canada has had them, Brazil and Colombia and Argentina used to have them. China has had it since a long time, Korea has had them. It's not one kind of example here, in fact, if you look at the number of our transactions, if you actually passed through our own rails of the total, today at 56% of our transactions. 10 years back when I joined, it was 40 something percent. So even 10 years ago the majority of our transactions were being taken by local networks in some form for the actual processing of that transaction. We in other ways to raise revenue from the activity around that transaction, but the processing was going through local rails very often. Now actually that number has reduced over the years as they've made inroads in a number of market places." ] }, { "name": "Craig Maurer", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Lisa Ellis from MoffettNathanson. Your line is open." ] }, { "name": "Lisa Ellis", "speech": [ "Hi. Good morning, guys. And welcome Sachin to the call. Couple from me. First, Ajay, can you comment on China and specifically the news reports about potential joint venture announcement with Nets Union there? And then second one is related to the Vyze acquisition and around doing enabling extension of credit trends actually at the point of sale. Just from a vision perspective, can you comment as you look out about building this out, this capability out with Mastercard over the next few years? What that's going to look like, or how should we be thinking about it? Is it almost like another rail and what's Mastercard's role in differentiation exactly there? Thank you." ] }, { "name": "Ajay Banga", "speech": [ "Okay. So, China, I'm not going to comment on a newspaper article. I mean, I wish I was asked for comments in the newspaper articles that give me blood pressure, but nobody does. This one doesn't really give blood pressure, it just what somebody wrote based on what they picked up locally. We are -- this much I will tell you, I'm very committed to finding an appropriate and sensible way to enter the domestic Chinese market and I'm making every effort possible across the company to get to the right place and getting the requisite licenses to be able to do that. And I think as soon as we've got something substantial or real to tell you, we will, trust me. We just don't have anything real or substantial today, because this movie hasn't played out yet.", "So it's going to take some time to play out. And even after it plays out in terms of, let's say, we do get some form of an approval even after that, there's a year long process of national security clearance before you can actually start operating domestically on the ground in China. So this is like a couple of years away at least before we can give you something that's more interesting than just desires. Right. That's the first.", "On Vyze, Vyze to me is interesting. I don't yet know how well to answer that question for you, because I don't yet know how big this could be. Installment lending to me is a really interesting aspect, installment lending at the point of sale. Installment lending through a bank has been going on for a long time, but the idea of allowing a consumer at the point to sale to opt into an installment loan in some ways it's been going on for a long time in sales finance businesses in places like Brazil where ever since by years -- years back at Citibank, we used to see this happening where the transaction at the point of sale had a automatic installment plan built into what was the card payment that is being used by a consumer. That's kind of -- it didn't spread everywhere, it's spread in different ways into the US in the consumer finance business mostly, it didn't really spread to the middle class or the upper class there. But it's spreading around the world in some ways. In Australia there were a couple of players who have launched installment lending. In the US those players have -- one or two of them are coming here, others locally are doing this. It's bank's, it's Fintech's, it's merchants, everyone seems to be interested in this space, but I don't know yet how to tell you how big it could be or where it could go, because I don't really know yet how well it will catch on with the consumer.", "We are certainly putting our foot in the water with this acquisition. Remember, it's not us extending the credit, we are just creating the platform between the merchant and the institution -- the bank or the Fintech which may in turn pass the loan on to a bank, that's what we are really doing. I think I can add a lot of differentiated value in the form of AI, in the form of better tools to identify consumers and help to -- help people underwrite. There is a lot of things we could do with our data analytics and our information services business. Remember that we could also do a lot of things with loyalty and rewards, which could be connected over time into the instalment loan system. So I don't yet know where this will go. It's interesting. I've got my foot on the water and we'll see, it's not different from the way we entered other services four, five years ago, put our foot in the water before we took the full-fledged." ] }, { "name": "Lisa Ellis", "speech": [ "Perfect. Thank you. Well, you know, it's a good quarter when Ajay has to answer all the questions. Thanks, guys." ] }, { "name": "Ajay Banga", "speech": [ "Although, I'm trying to give -- I gave (inaudible)" ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Eric Wasserstrom from UBS. Your line is open." ] }, { "name": "Eric Wasserstrom", "speech": [ "Thanks. If -- I was wondering maybe, Sachin, could you help remind us about sort of all of the components that attribute to your strength in cross-border. I think you have some portfolio wins that should be helping year-over-year, some Maestro conversions. Can you just remind us of all the factors that support that figure?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure. Look, I mean, as a company we remain incredibly focused on cross-border drivers. And as we've said in previous earnings calls, Mastercard had set up the center of excellence within Mastercard, where basically there is a tremendous focus on how we can do good knowledge sharing across the company on what can drive cross-border volumes for this company. Really it all kind of starts with making sure that we have actually truly identified what are the right portfolio to go after from a cross-border standpoint. As we sit back and think about it, we leverage our services business with the data analytics capabilities to identify what are the right portfolio to go after. And those are the ones where there's a larger propensity of cross-border. Thereafter, we go after trying to optimize those portfolios in the best way possible. So to the extent we identify portfolios of our customers, which might be underperforming, we work with them through our consulting practice and our managed services practice in our advisors business to try and actually drive for better and more optimized cross-border focus there. But even beyond that, it's about focusing on the right vertical. So for example, in the wholesale travel space, this is an area where Mastercard has been historically very much focused and has been actually a leader and that contributes to cross-border.", "And then finally I would say on a similar basis, if you think about digital banks and things of that sort, these would be areas where we would focus. Again, going back to the theme of what are the right portfolio to go after and how do you optimize those. That's really what we're doing and it sounds like basic blocking and tackling, but sometimes you actually really have to go down that path to actually make it come through and that's what we're doing." ] }, { "name": "Ajay Banga", "speech": [ "And, Eric, as I said last time, there's -- I'm sure that other networks (inaudible) this is not rocket science, it's just -- it's in the execution and it's in getting it done. And, yes, Maestro to Mastercard conversions do give us some tailwind, because clearly Maestro utilization in e-commerce is challenging. Mastercard debit allows the better utilization and that will continue for a while, because we haven't completed those migrations in every location that we'd like to." ] }, { "name": "Eric Wasserstrom", "speech": [ "Great. And if I can just follow-up. Ajay, any update on the B2B hub. I know that you launched it in Australia, I think a quarter ago. And any update on its international or domestic advancement?" ] }, { "name": "Ajay Banga", "speech": [ "No, not really that -- in fact we discussed it in the last quarter call. Yes, you're right, it's physical launch is actually happening as we speak. And it's very early days, but that's one we are focused on. The whole B2B space has opportunity. The hubs, one way of getting into it, as you know the directory and track in enabling that directory to be fully built out the right way across the world as another one. Payments optimization engines are getting built into it, we are just doing a series of things and hopefully Transfast will enable and help us even more. Meanwhile, Send continues to chug along. that's why I talk more Bank of Montreal, and what it's trying to do with Send. It's doing it for its commercial and business banking clients as well. So there is a series of tools that are being played in the B2B space." ] }, { "name": "Eric Wasserstrom", "speech": [ "Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Don Fandetti from Wells Fargo. Your line is open." ] }, { "name": "Donald Fandetti", "speech": [ "Yes. Ajay, two-part question. I guess in the US Marstercard's had a pretty good track record on these program wins, but it's been a while since we've seen any kind of major sort of bank portfolio flip. Do you expect to see any market share change over the next year or two there? And then separately, any update on the Commonpay button from e-commerce that the industry had some time to digest it. How are you guys feeling about the penetration opportunity?" ] }, { "name": "Ajay Banga", "speech": [ "So on the first one, big bank portfolios. There have been some over the last year or two that we've talked about and we have won on from pass with Capital One to pass with Bank of America and the like. And those are still helping us grow share. In fact, if you look at the way our credit numbers are growing in the US, part of that is co-brands, that's Cabela's and Kroger and the like, but part of it is also these banks portfolios that have been switching over to us. I don't see any huge swings in bank books moving around right now. But they are actively in every transition and every transaction that happens. But I don't see huge runs moving around as we speak, as of now.", "On the SRC progress, we are looking, as I said, the industry to launch this in the second half of 2019. It's probably going to end up first in the US, and then get to additional markets over the next six to 18 months. I think, you'll find the feedback we're getting from issuers and merchants is very constructive to EMVCo. We are trying to adapt to that feedback and get it rolled out all the technology build and branding work is happening as we speak. And I still remain pretty optimistic about what SRC could do for the industry and for the consumer and for merchant and the issuers simpler connect to one connection for all brands, easier to manage for the consumer, kind of trying to replicate the physical experience of one terminal to convert that to a physical -- to a digital experience of one button kind of idea, that's what we're trying to get." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Darrin Peller from Wolfe Research. Your line is open." ] }, { "name": "Darrin Peller", "speech": [ "Hey. Thanks, guys. You know, look, you had a -- I think you had a 200 basis points tough compare in the quarter, and then with FX it looks like you clearly outperformed this quarter growing around 13% constant currency. So first, just what drove the surprise to the upside versus what it -- I think you initially thought, when you talked about your guidance from last quarter for the first quarter trends. And then do you think that the soft spot we saw in cross-border, whether it's fourth quarter or perhaps early first quarter was more of an anomaly at this point. Do you feel better about the trends you're seeing? Thanks, guys." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. So, Darren, I'll take that question. So as it relates to the first quarter, like I mentioned in my prepared remarks, we've slightly exceeded what our expectations were as it relates to our performance from a revenue standpoint, driven by the strength in our services business. So we also saw on an FX standpoint, slightly lower impact on FX in the first quarter relative to what we originally thought. So those were a couple of factors which you might want to kind of take into consideration as you're thinking about it. On your other question for cross-border. You've got to remember that cross-border last year in Q1, we had a 20% growth rate in cross-border. And those tough comps are a large part of what we're seeing in terms of the results in Q1 of this year.", "You'll remember, when we talked about cross-border performance last year, we actually were fairly explicit about saying that, we don't expect our normal run rates to be like what we saw in the first half of last year. So as you think about our business, we continue to believe that our cross-border is trending and performing as we would normally see it, actually performing. So I wouldn't make too much of swings between quarters, because we are always doing comparisons between year-over-year tough comps.", "Our business continues to grow well. We like what we see in terms of our portfolio. Just a little bit more color, if it's helpful from a cross-border standpoint. The US outbound volumes continue to hold up pretty nicely and our China business from a cross-border standpoint continues to grow also in the high single digits, much like we've seen historically. So all-in-all business carries on as we expected to be." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Ajay do you have any final comments?" ] }, { "name": "Ajay Banga", "speech": [ "Thank you all for your questions. And I'm going to wrap up with a few closing thoughts. First, we had a solid start to the year, reflecting the strong operational focus, execution focus, and continued growth across each of our regions. And we are executing against a strategy with a couple of particularly (ph) noteworthy milestone this quarter. The first one being the progress in extending our real-time payments capabilities in Asia and Latin America and in the Middle East. And secondly, we announced these strategic acquisitions and partnerships that we think will complement our existing products and services and position the company well for the next decade or two of growth as well.", "So with that, I'd like to thank you for your continued support for the company and for joining us today." ] }, { "name": "Operator", "speech": [ "This concludes today's conference. You may now disconnect." ] } ]
MA	2022-07-28	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "AllianceBernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Rayna Kumar", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "MoffetNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Robert W. Baird and Company -- Analyst", "name": "Dave Koning", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "William Blair and Company -- Analyst", "name": "Bob Napoli", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, and welcome to the Mastercard Inc. Q2 2022 earnings conference call. [Operator instructions] Thank you. Warren Kneeshaw, you may begin your conference." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Julie. Good morning, everyone, and thank you for joining us for our second quarter 2022 earnings call. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. [Operator instructions] You can access our earnings release, supplemental performance data, and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com.", "Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted. Both the release and the slide deck include reconciliations of non-GAAP measures to their GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance.", "Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days. With that, I will now turn the call over to our chief executive officer, Michael Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren. Good morning, everyone. Starting with the key highlights for the quarter. We delivered strong revenue and earnings growth with further improvement in our underlying operating metrics, notably in cross-border travel.", "Quarter 2 adjusted net revenues were up 27% and adjusted operating income up 40% versus a year ago on a non-GAAP currency-neutral basis, excluding special items. On the macroeconomic front, we continue to monitor a number of factors that have both positive and negative influences on economic growth. Inflationary pressures have remained persistent, and we are now seeing central banks taking even more aggressive steps to reduce inflation as we have seen with the Fed yesterday. The situation has been compounded by geopolitical tensions and supply chain constraints, which have eased from pandemic peaks but remain in many industries.", "Despite this, unemployment rates remain low, wages are rising and consumer savings levels remain high. With this backdrop, consumer spending and particularly travel-related spending remains strong. Looking at this from a geographic standpoint. U.S.", "retail spending remains healthy as consumers navigate a high inflation environment. Spending has been aided by strong job creation and the buildup of excess savings during the pandemic. According to our Mastercard SpendingPulse, which is based on all payment types, including cash and check, U.S. retail sales ex auto ex gas were up 6% in the second quarter versus a year ago.", "In Europe, spending trends are positive, although the risks related to both the supply of natural gas and higher interest rates remain headwinds. Growth in Latin America continues to moderate following a strong rebound in 2021. Asia has generally lagged the recovery of other regions. While COVID-related requirements have been relaxed in several countries, strong restrictions remain in others.", "Asia continues to have significant upside potential. Looking more specifically at our switched volume trends. Domestic volumes continued to show strong growth with notable strength in airline, lodging and restaurant spend. We've seen some shift in spend toward gas and groceries from discretionary categories like home furnishings in the U.S.", "Cross-border continues its strong recovery as border restrictions continue to be relaxed. Cross-border travel in Quarter 2 has now reached 118% of 2019 levels. Cross-border card-not-present ex travel continued to hold up well. Notwithstanding the strength in consumer spending, we will continue to watch the environment closely, including fiscal and monetary policy responses to high inflation and their potential impact on spending.", "Within this environment, we will continue to be nimble in managing our expenses. We have the flexibility to respond quickly across a number of levers as we showed in 2020. Having said this, we will continue to invest in the business to drive top and bottom line growth over the longer term. We have well diversified business model, and we are executing against our three key strategic priorities: expanding in payments, extending our services, and embracing new networks.", "And here's an update on how we're progressing against each one of those. First, we're expanding in payments by continuing to grow card volume, driving acceptance growth and leaning into innovation to capture other prioritized payment flows. We're driving growth in card volume with new consumer, small business, co-brand, and travel wins globally. In Canada, we're excited to announce that we secured a new partnership with CIBC that creates an opportunity for material share shift for Mastercard with the bank.", "We also renewed our relationship with the Royal Bank of Canada, including a range of services that will enable us to grow our proprietary and co-brand volumes with them. In the U.S., we established a new partnership agreement with the U.S. Bank, which extends our current debit, credit, co-brand, and small business credit programs. It includes several new products, including the first large-scale launch of a consumer credit product, a small business credit offering and the development of Buy Now Pay Later installment solutions.", "We're excited to announce that we have completed the conversion of Gap Inc.'s existing 10 million card members to Mastercard across the Old Navy, Gap, Banana Republic, and Athleta brands. We renewed and expanded our co-brand with Brooks Brothers issued by Citi, and we have renewed and expanded our co-brand with Barnes & Noble in partnership with Barclays. Outside of North America, we have secured several new wins and renewals, including a number of deals that position us well in Asia Pacific as the region rebounds from the pandemic. In Australia, we've extended our partnership with Bendigo and Adelaide Bank Limited, enabling us to maintain exclusivity with Bendigo and convert several of their regional debit portfolios.", "We're pleased to announce that National Australia Bank and Mastercard has signed an agreement to retain and grow the Mastercard components of Citigroup Australia's consumer business that was acquired by NAB. This marks the first significant issuing relationship between the two companies in years, and we look forward to partnering to grow these portfolios. In Hong Kong, we partner with Citibank and HKT's loyalty program and digital ventures arm, the club, to launch the Citi The Club Credit Card. In India, we're happy to report that the embargo on new issuance has been lifted.", "Issuers have restarted card issuance and they are eager to expand business with us. An example is Yes Bank, where we signed a consumer credit agreement that will enable us to maintain a majority share and includes a commitment to scale our World Elite portfolio. We've worked on to expand our travel-oriented portfolios, which positions us well to capitalize on the strong recovery of travel. For example, in Asia Pacific, we entered into a 10-year commercial card issuance deal with Trip.com, one of the world's largest online travel agencies.", "In the UAE, we renewed our co-brand portfolio with Marriott. In the U.S., we have renewed our long-standing co-brand relationship with Amtrak, and we've extended our co-brand partnership with Virgin Atlantic in the U.K., a partnership that will leverage our Test & Learn, innovation labs, and SessionM loyalty assets. We're also driving growth in payments by continuing to expand acceptance. Mastercard is now accepted in 90 million merchants' locations worldwide, and we have more than doubled the number of acceptance locations over the last five years.", "Mastercard has been driving Tap on Phone innovation, enabling billions of active smartphones to become potential acceptance devices with over 130 deployments across 55 markets. This includes working with Apple to enable acceptance of Mastercard contactless cards and digital payments through the Tap to Pay on iPhone capability. This allows businesses to accept payments directly on their iPhones. Mastercard is further empowering the ecosystem through our cloud commerce capabilities, which enables our channel partners to quickly deliver cost-effective acceptance.", "It also provides easy access to a range of payment solutions and services, including Tap on Phone, QR, Installments, Loyalty, data insights, and more via the Mastercard cloud. In addition, we continue to drive adoption of our Click to Pay online guest checkout capability. Click to Pay is now enabled in over 20 markets across all regions, and transactions have been growing over quarter. We're expanding in payments through innovations like Mastercard Installments.", "Our open loop buy now, pay later program has been very well received. Mastercard's Installment is now soon to be live, with Saudi National Bank and several new partners adding their support to the program. Examples include Cross River Bank, Evolve Bank & Trust, Jifiti, Live Oak, MOCA Financial, and WebBank in the U.S. as well as HSBC, NatWest, and JPMorgan's payments division in the U.K.", "In addition, Apple recently announced Apple Pay Later, which uses the Mastercard Installments program. Finally, we're driving growth in payments by leaning into innovation to capture a prioritized set of new payment flows, including disbursements and remittances, commercial point of sale, B2B accounts payable and consumer bill pay. This is at the heart of the investments we've been making to develop a range of capabilities that span cards, account-to-account payments, push payments, and blockchain. We're at various stages of scaling our capabilities across these different flows, and we're making steady progress.", "For example, we are expanding network reach through new cross-border services relationships with partners like Doha Bank and Vodafone in Qatar, and UPT, a leading money transfer operator in Turkey. We are targeting specific use cases and scaling distribution through B2B partnerships with Mastercard Send. A few examples, Caesars Sportsbook will leverage Send for instant payment of online winnings, and Paysafe will integrate Mastercard Send into their payments platform to enhance the payout capabilities offered to their merchant customers in the U.K. and the EU.", "Now turning to services. Our service capabilities have proven to be a tremendous growth driver and differentiator for our business, build on a foundation of investments and experiences built over the years. Looking forward, we continue to see a significant opportunity for services in three primary areas. First, services will continue to enhance the value of payments.", "Services make payments intelligence safe and secure. For example, our Identity Check payment authentication service is driving double-digit improvements in approval rates. We are working with Postepay in Italy to support the deployment of their issuing portfolio, assist in growing their acquiring business and enhance the customer engagement approach. Now our consulting team in Europe is engaging with ING to help them create a seamless payment experience for their clients.", "Second, we see the needs of our customers expanding beyond payments. We can leverage our full suite of differentiated services to address these needs. A recent example is Travelodge with utilizing our Test & Learn capabilities to support optimization of new investments in their business. And third, our services can be deployed to support new networks, making our open banking and digital identity propositions even stronger.", "With these adjacent networks, it's our services that will enable us to establish a differentiated position to scale and win. For example, we recently launched a new Biometric Checkout Program. The program outlined a set of standards from banks, merchants and tech providers, helping to ensure the security and privacy of personal data when people pay with a smile or with a wave. Now beyond expanding in payments and expanding in services, our third key strategic priority area is embracing new networks.", "As a reminder, our current focus is on two areas: open banking and digitalized entity. We're leveraging our Finicity and Aiia acquisitions to expand our open banking footprint, grow our customer base and deliver new solutions. This quarter, we expanded our Engage partner network to include our open banking services with new fintech partnerships, including Dwolla, Synctera, i2c and others. They can now use our open banking capabilities to easily build and implement solutions for their end customers across a range of use cases from lending to payments to financial management.", "In addition, we recently launched a global Start Path Open Banking program. This program enables us to co-innovate with start-up fintechs like Dapi, Finantier, mmob, Mono and Paywallet as we support their path to scale. We've expanded our open banking product offering as well. We announced Pay by link in Europe, which allows businesses to send payment requests through invoice, email, SMS or social media chat.", "This can expedite the payment of invoices in a cost-efficient way, enabling both parties to better manage cash flows. Online accounting provider, Visma Dinero is using Pay by link to simplify invoice payments for over 75,000 small- and medium-sized businesses. And in the digital identity space, Ekata continues its strong performance, signing over 200 new deals in expansion since we acquired the company just over one year ago. This includes many of the leading buy now, pay later, and crypto companies.", "It also includes real-time payment software providers like ACI Worldwide, who's leveraging Ekata's capabilities to help their global merchant network more accurately identify fraudulent transactions. Open banking and digital identity are attractive and growing opportunities, and Mastercard is uniquely positioned to be successful in both. So in summary, our business fundamentals remain strong. We delivered robust revenue and earnings growth again.", "We're executing against our strategic priorities in payments, services, and new networks. We have fortified our strong position with travel-oriented portfolios to capitalize on the continued recovery in travel. On the macroeconomic front, we continue to monitor a number of factors influencing economic and spending growth. And with all of that, we will continue to manage our expenses carefully.", "That said, we will also continue to invest in the business to drive top and bottom line growth over the longer term. Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. Now turning to Page 3, which shows our financial performance for the quarter on currency-neutral basis excluding special items and the impact of gains and losses on our equity investments. Net revenue was up 27%, reflecting the continued execution of our strategy and the ongoing recovery in spending. Acquisitions contributed one ppt to this growth.", "Operating expenses increased 12%, including a five ppt increase from acquisitions. Operating income was up 40%, which includes a one ppt decrease related to acquisitions. EPS was up 40% year over year to $2.56, which includes a $0.05 contribution from share repurchases. During the quarter, we repurchased $2.4 billion worth of stock and an additional $448 million through July 25, 2022.", "So now let's turn to Page 4, where you can see the operational metrics for the second quarter. Worldwide gross dollar volume or GDV increased by 14% year over year on a local currency basis. On the same basis, if you exclude Russia from the prior period, GDV increased by 19%. In the U.S., GDV increased by 10% with credit growth of 25%, reflecting the recovery of spending on travel.", "Debit declined by 2%. Excluding the impact of a roll-off of a customer agreement, debit increased by 1%. Outside of the U.S., volume increased 16% with credit growth of 19% and debit growth of 13%. Cross-border volume was up 58% globally for the quarter, reflecting continued improvements in travel-related cross-border.", "Turning to Page 5. Switched transactions grew 12% year over year in Q2. Excluding Russia from the prior year, switched transactions grew 22% year over year in Q2. Card-present and card-not-present growth rates remain strong.", "Card-present growth was aided in part by increases in contactless penetration in all regions when excluding Russia. In addition, card growth was 5% or 9%, if we exclude cards issued by Russian banks from the prior year card comp. Globally, there are 3 billion Mastercard and Maestro-branded cards issued. Now let's turn to Page 6 for the highlights on the revenue line items, again described on a currency-neutral basis, excluding special items, unless otherwise noted.", "The increase in net revenue of 27% was primarily driven by domestic and cross-border transaction and volume growth as well as growth in services partially offset by growth in rebates and incentives. Acquisitions contributed approximately one ppt to this growth. Looking quickly at the individual revenue line items, domestic assessments were up 13%, while worldwide GDV grew 14%. Cross-border volume fees increased 61%, while cross-border volumes increased 58%.", "The three ppt difference is primarily due to [Inaudible] geographic mix. Transaction processing fees were up 22%, while switched transactions grew 12%. The 10 ppt difference is primarily due to favorable mix, FX-related revenues, and pricing. Other revenues were up 23%, including a three ppt contribution from acquisitions.", "The remaining growth was driven by our Cyber & Intelligence and Data & Services solutions. Finally, rebates and incentives were up 23%, reflecting the strong growth in volumes and transactions and new and renewed deal activity. Note, rebates and incentives as a percentage of gross revenue is higher relative to Q1 2022, primarily due to volumes and related revenues generated from a sizable customer in Russia in Q1, with no related incentive agreement on such volumes. Moving now to Page 7.", "You can see that on a currency-neutral basis, total operating expenses increased 12%, including a five ppt impact from acquisitions. Excluding acquisitions, the remaining increase was primarily due to increased spending on personnel to support the continued execution of our strategic initiatives as well as unfavorable foreign exchange-related expenses due to the remeasurement of monetary assets and liabilities. Turning to Page 8. Let's discuss the operating metrics for the first three weeks of July.", "For your reference, to help you understand the trends in the business ex Russia, we have included an appendix later in this deck to show all the data points from the schedule if you excluded activity from Russian-issued cards from prior periods. As a general comment, our metrics are holding up well in July. Going forward, however, the year-over-year growth metrics will face tougher comps as we begin lapping periods when COVID-related restrictions eased and spending levels started to rebound. Going through the metrics in turn, starting with switched volumes.", "For the first three weeks of July, we grew switched volumes 18% year over year, down three ppt versus Q2. Switched transactions grew 10% year over year through the first three weeks of July, down two ppt from Q2. Overall, cross-border volumes through the first three weeks of July grew 54% year over year, down four ppt versus Q2. Cross-border travel had another quarter of strong growth as border restrictions continue to be lifted.", "In the first three weeks of July, cross-border travel was up 89% year over year, down 55 ppt versus Q2 due to more difficult year-ago comps, as I just noted. Cross-border travel is now at 126% of 2019 levels, up eight points versus Q2. Cross-border card-not-present, excluding travel, was up 16% year over year in July. The increase of nine ppt compared to Q2 reflects a reduced headwind from crypto purchases and the timing of significant e-com promotional activity between the periods.", "This metric continues to hold up well in relation to 2019 levels. Turning to Page 9. I wanted to share our thoughts on the remainder of 2022. Let me start by saying that we have strong momentum with our customers.", "We continue to enhance our product and service offerings and that our business fundamentals remain very strong. Consumer spending remains robust and cross-border travel has improved more quickly than expected as border restrictions ease and consumers increase their spending toward travel. And there is more room to grow as some borders remain either restricted or have yet to recover to historical levels of growth. For instance, based on our switched volumes, Asia, which represented approximately 14% of cross-border inbound travel in 2019 is only at approximately 60% of 2019 levels in Q2.", "Similarly, the U.S., U.K., and Canada, which represented approximately 20% of cross-border inbound travel in 2019 is at about 110% of 2019 levels, still well below the historical trajectory. Specifically, if inbound travel to these three countries had continued to grow at the historical three-year CAGR through [Inaudible], we would have expected to be at approximately 135% of 2019 levels rather than approximately 110%. We are well-positioned to capitalize on this growth with our travel-oriented portfolios. As Michael mentioned, there are a number of macroeconomic factors that could influence future economic growth: employment and wage levels, consumer savings levels, persistent and elevated inflation and rising interest rates, and geopolitical tensions in particular.", "We are monitoring each of these, but on balance, expect a modest improvement in cross-border travel versus 2019 levels and a generally resilient consumer spending through the remainder of 2022. Taking this all into account, including our well-diversified business model, we are increasing our expectations for net revenue growth for the full year 2022 to a low 20s rate on a currency-neutral basis, excluding acquisitions and special items. Acquisitions are forecasted to add about one ppt to this growth, while foreign exchange is expected to be a headwind of five to six ppt for the year primarily due to the strengthening of the U.S. dollar versus the euro.", "It is worth highlighting that this performance is despite the cessation of our Russian operations in Q1. For the year, we expect operating expenses to grow at the low end of a low double-digit rate on a currency-neutral basis, excluding acquisitions and special items. This reflects continued investment in our people and strategic priorities as well as impacts from FX-related expenses primarily due to remeasurement of monetary assets and liabilities. Acquisitions are forecasted to add about four ppt to this growth, while foreign exchange is expected to be a tailwind of approximately three to four ppt for the year.", "We are prepared to quickly adjust our operating expense base as we did in 2020 should circumstances dictate. With respect to the third quarter of 2022, year-over-year net revenue is expected to grow at the high end of a high-teens rate, again, on a currency-neutral basis, excluding acquisitions and special items. Sequentially, this reflects continued strong consumer spending, including a modest improvement in cross-border travel spending trends relative to 2019, reduced FX-related revenues as a result of lower anticipated FX volatility, and finally, the lapping of a stronger year-ago quarter as the recovery took hold last year. Acquisitions are forecasted to add about one ppt to this growth, while foreign exchange is expected to be a headwind of approximately seven to eight ppt for the quarter.", "From an operating expense standpoint, we expect Q3 operating expenses to grow at the high end of a low double-digit rate versus a year ago on a currency-neutral basis, excluding acquisitions and special items. Acquisitions are forecast to add about five ppt to this growth. Foreign exchange is expected to be a tailwind of approximately five ppt for the quarter. Other items to keep in mind.", "On the other income and expense line, we are at an expense run rate of approximately $115 million per quarter given the prevailing interest rates. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics. And finally, we expect a tax rate of between 19% and 21% in Q3, which includes a discrete tax item related to an unfavorable court judgment, the details of which we are still assessing. We expect a tax rate of approximately 19% in Q4.", "And with that, I will turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Sachin. Julie, we're now ready for the question-and-answer session." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] And your first question comes from Harshita Rawat from Bernstein. Please go ahead." ] }, { "name": "Harshita Rawat", "speech": [ "Hi. Good morning. So Michael, Sachin, can you comment on the media reports yesterday about a potential bill for introducing routing choice for credit cards? I know the Durbin Amendment for debit has market share. How could a credit routing choice -- how could be implemented given many alternative networks don't have those capabilities? And finally, just taking a step back, can you talk about routing decisions for merchants, and why they choose Mastercard or might choose Mastercard where they have a choice of alternative? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Harshita, let me start off with that. This is -- so we read the same article. Clearly, it's early stages because we haven't seen the bill yet. So we're all speculating here, I think, what might happen.", "So we'll engage. We'll try to find out more over the weeks and months to come. But if you just assume for a moment that the article would be complete and this would actually happen, a few things come to mind that are straightforward, from our perspective. First of all, we believe in competition.", "We believe in a level competitive landscape and playing field and even vested massive amounts in safety and security, and we focus on providing consumer choice, different ways of paying, credit, debit, whatever it is. So that's been our strategy. So we're going to look at this proposal -- proposed bill through that lens. So that's one -- that's a starting point for us.", "Some of the questions that you touched on, some points here. What are practicalities? What are the technical aspects of this? How many providers are ready that have made the same kind of investments to really ensure that the consumer can rely on safety and protection and so forth? Those are open questions. We'll have to see what the regulation actually foresees. Overall, the concept of interchange is a balancing factor.", "And the ecosystem is one that has served the ecosystem, including the consumers, well in terms of rich propositions and all of that. We'll have to see what becomes out of that. Those are a whole range of questions that we've talked about over years that need to be considered by all stakeholders. And we will spend the time and the effort to ensure that everybody is well informed about the puts and takes around this proposed bill." ] }, { "name": "Harshita Rawat", "speech": [ "Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from Sanjay Sakhrani from KBW. Please go ahead." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. Sachin, you talked about what's being baked into your forward view on cross-border being a modest improvement in cross-border, but you talked also about the long runway you still believe you have in terms of cross border. Could you just help us think about what's factored in versus what practically can happen as we look forward? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Sanjay. So what I shared was that we are thinking ahead in terms of cross-border travel seeing a modest improvement relative to 2019. And as you can see in our metrics, cross-border travel in Q2 was at 118%, and the first three weeks of July is at 126%. Without getting too specific as to what exactly we're building in there, the point we've got is the following: we expect a modest improvement in travel when indexed back to 2019, and it's predicated on certain data points.", "And the data points are: if you think about what's going on in Asia Pacific, we've talked about how Asia Pacific from a cross-border travel standpoint has been lagging and has historically not come back over the last few years since COVID hit in the same way, say, as intra-Europe has come back. In fact, I shared with you the metrics as to where we stand from an inbound cross-border travel standpoint in Asia Pacific. So there's a lot of room to grow there. We think that opportunity exists.", "Markets in Asia Pacific, such as Australia, New Zealand, Singapore, even Japan, they've started to open up and actually have opened up fairly well. The one thing which we have always taken comfort in is that the fundamentals of cross-border travel and on cross-border in total remain very sound. When people have the ability to travel, they have demonstrated their intent to travel. And I think we've got enough data points now over the last 18 months to suggest that when barriers toward travel are lifted, people get on the road again.", "And so if you think about that and you think about the context of what's going on in Asia and the potential there, we've got opportunity there. But even beyond Asia, there are several other corridors such as the U.S., U.K., and Canada, which still have not reached the historical growth levels. They're higher than their 2019 index levels from an inbound standpoint, but there's still more room to grow. So we've kind of built all of that in, in our thoughts for the rest of the year." ] }, { "name": "Michael Miebach", "speech": [ "I'd like to just add to that. I find travel is such a fascinating topic and certainly very central to our business. There's been a discussion around of pent-up demand, like this is going to be a bubble and then it's all going to go back to where it was during the last two years. Why would anybody that has now has the chance to see their family and their friends again stop doing that in a year from now? So I think that actually doesn't make any sense.", "So we believe exactly the point that Sachin just made. If there is a possibility, people will continue to travel the way they have been before COVID. One other thing to add is -- one thing is the underlying trend that we have built in and our outlook on the data points that Sachin just talked about, but it's also to strengthen our position vis-a-vis that travel trend. All the portfolios, we talked to you about American Airlines, about JetBlue, about Cathay Pacific.", "Everything that we have won in the last two years is going to really come to bear to really make the most of this." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from Rayna Kumar from UBS. Please go ahead." ] }, { "name": "Rayna Kumar", "speech": [ "Good morning. Thanks for taking my question. During the '08, '09 recession, Mastercard generated solid revenue and earnings growth. And I'm curious to know what you think has changed the most about Mastercard since then that could help you generate positive results through another potential economic downturn, even if you're not seeing it right now.", "Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Right, Rayna. I think the last word, as you said, is instructive as we are not seeing it right now, generally resilient consumer spending for the time being. And we talked about the modest improvement in cross-border and thus, same set of spending behaviors until the end of last year. Now you're taking us really a long time back in 2008 and 2009.", "I think the first thing I would say is it's a very different scenario. The story that we're looking at externally, I come to the company in a moment, externally is we are not having a crisis around unemployment. We're having high consumer spending levels. So we don't have an asset bubble that looks anything similar than what we've seen at that time.", "So a different starting point. I would say it's a somewhat more benign starting point than we had at that time. Now the company also looks entirely different than it looked in 2008 and '09. It's a much more diversified business.", "It's a highly diversified business. I think we were largely consumer credit debit oriented at the time. We have a whole range of card-based spendings from push payments into general payments for goods and services opening up new verticals and so forth. And then there is our progress into new flows, so that gives us resilience on underlying payments.", "It also -- our reach of our business model and how many payment transactions we touch that allow us to build a set of service on it looks entirely different. Our switching ratios at that time were much, much lower than they are today, which has led to a very successful services business, which we have seen in the last two years is actually quite resilient when you go into -- through up and down cycles. And as we continue to build into the future to see whenever we might phase the down cycle, are we more resilient with other activities around digital identity and open banking and so forth that go into a world of open banking and move even further before or after the payment transaction to give us more resilience. So better earnings quality, higher diversification, and we've been tested.", "We've been tested over the last two years. I mean there was a down cycle, and we needed to demonstrate that agility and the speed in managing our expenses, make the right investment decisions. So we feel we're well-positioned to navigate what's going to -- whatever is going to come. Hopefully, it's positive." ] }, { "name": "Operator", "speech": [ "Your next question comes from Darrin Peller from Wolfe Research. Please go ahead." ] }, { "name": "Darrin Peller", "speech": [ "Thanks, guys. It looks value-added service fees [Inaudible] can pay off. And I think to your point, it underscores that your customer base is still [Inaudible] to really spend on some of those areas. Can you just talk about what you're seeing in terms of the strength there and what kind of resilience you'd expect those to have in different economic scenarios? And then Sachin, just one quick one on processing yields.", "It came in a lot better than our -- relative to transaction growth. Processing revenue line up. You mentioned pricing, other variables. Can you just talk about if that's sustainable spread? Thanks, guys." ] }, { "name": "Sachin Mehra", "speech": [ "Yes. Darrin, happy to take the second question first. I must say you were breaking up on the first part of your question, so we might ask you to just kind of state that again. But on your second part of the question, what you're seeing in transaction processing growth rates relative to the growth in switched transactions is exactly like I said, the three things kind of going on there, right? The favorable mix piece, which I talked about; the higher FX-related revenues; and then there's some elements of pricing.", "Look, I mean, the reality is we're operating in an environment in which you've seen a few things happen. One is the mix has shifted toward more cross-border. And we make cross-border fees both in the cross-border volume fees line as well as in switched transactions. So sometimes that's kind of an overlooked element, but that's an important piece to keep in mind, that we do make cross-border fees on the transaction processing line.", "And as the shift has gone toward more cross-border, that's helped us. Number two is there's high levels of volatility in the foreign exchange markets. We delivered some very important services when we do switching of transactions and when we do the settlement of those transactions. In a highly volatile FX environment, it's actually work in our favor.", "And on pricing, the baseline is the following, which is at the end of the day, we continue to deliver value to the ecosystem. And as we put value out into the ecosystem, we price for that value. And what you're seeing there is exactly that come through, which is we are reflecting that in the nature of pricing. You'll see puts and takes in different quarters in terms of what we may or may not do in terms of pricing, depending on what we believe is the value we're delivering as well as what the market's appetite to accept that is, and that's what you're seeing through there." ] }, { "name": "Darrin Peller", "speech": [ "OK. That's helpful." ] }, { "name": "Michael Miebach", "speech": [ "Could you repeat the first question?" ] }, { "name": "Sachin Mehra", "speech": [ "Yes. That's much better." ] }, { "name": "Darrin Peller", "speech": [ "I was just trying to figure out the value-added services, the new flows, all the areas that are driving other revenues, obviously, are continuing to trend very well. And I mean if you could just revisit what do you think are the top two or three drivers there? And what kind of sustainability in different macro scenarios you'd expect for that? Just -- it looks like the investments you made there are clearly paying off. Think we're just wondering on the cyclicality of this. Thanks again, guys." ] }, { "name": "Michael Miebach", "speech": [ "All right. Good. So what we're seeing here is, first of all, on the backdrop, let's just pick up on the structural changes, again, that we have seen over the last two years, clearly driven by social distancing measures are a significant push into more digital engagement by consumers, they were sitting at home, so all that. It's a more digital world.", "So here, services that help make a more digital world safer and more easily understood. That's really the general thrust of what's driving the growth and the interest from our customers across established customer sets as well as new ones. Earlier, I talked about travel watches. People come to us and say, \"Hey, I want to use all of that data to get a better understanding of my business.", "So taking it one by one, safety, security, anything in the fraud space and in the authentication space has been a joy for us. You go further into cyber risk assessments. Our small business is safe, those many small businesses that have opened up in a more digital fashion now over the last two years. And you go all the way into digital identity because in a more digital world, people find they have more passwords and nobody really wants that.", "So digital identity is now a solution that's really taking hold. So that's that whole space. And you saw us -- actually, it doesn't stop at current types of payments. So the last thing I should add is our acquisition of CipherTrace and how we're going into the crypto space, making that safer as that is certainly something that captures consumers' interests.", "One space. The second piece is what do you do with all of that data, retail and commerce, travel lodging? I give you one example. Many other customers are trying to understand how to make -- run their business better using the payments data that is thrown off and we helped them with that. Our Dynamic Yield acquisition is one of them, where we help customers, retail and commerce customers, engage their end customers in a more targeted fashion.", "I imagine the landing page has now has personalized offers, in our case, always with strong consent from consumers and a focus on data privacy. So those are the two headlines. We do various other things and services from consulting into processing-related activities and so forth, but that's center [Inaudible]." ] }, { "name": "Sachin Mehra", "speech": [ "And Darrin, I'll just add as it relates to how we see the other revenue line item and services, in particular to what Michael was talking about. Look, we see really good demand from the customers, and we see good growth potential there. The reality is we are doing deeper penetration of those services with our existing customer base. We're expanding the set of services we've got across our customer base.", "And the third element, we're actually taking those same services and moving across to the new network side of things as well. And Michael alluded to one part of that when he was talking about what we do in the CipherTrace, but more broadly, even in open banking, for example. So the potential is there, and we do expect that given the suite of services we've got, there's good growth potential going forward." ] }, { "name": "Operator", "speech": [ "Your next question comes from Lisa Ellis from MoffettNathanson. Please go ahead." ] }, { "name": "Lisa Ellis", "speech": [ "All right. Good morning. Thanks, guys. Good stuff here.", "I wanted to ask a question about some of the news related recently to the CFPB, the Consumer Financial Protection Bureau, looking into stand-alone service providers, both in the P2P space, so meaning the fraud issues we've seen in Zelle and other private P2P services. And then also on the BNPL side, looking at the stand-alone providers there with the marketing and kind of risk management that they're doing. Can you just comment on how Mastercard is kind of positioned relative to the areas they're looking into? Is this an opportunity for Mastercard to perhaps play a larger role with Mastercard Send in P2P and with MasterCard Installments in BNPL? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Lisa. So let me start off on that. Where the consumer protection agency here in the U.S. and some other markets are going is really to ensure that there is the right kind of protections for consumers that goes all the way from responsible lending to safety, security and so forth.", "The -- we follow that. But if I look just in-house and see what we're doing, if I look at our data principles, what we have done around the Mastercard Installments program to ensure that the participating lenders go through a vetting process and follow responsible lending rules that we have set as part of our franchise, we feel well-positioned. I feel we are a good industry custodian to ensure that these responsible practices are being held around. Now is that also an opportunity for us in all of this? Absolutely.", "We have learned to partner with P2P systems in many countries around the world with safety and security solutions, the services I actually just talked about when we say, \"Hey, you have a fraud issue, we get it. Here's a set of answers that we have for you to partner.\" And in other markets, we compete head-on because we simply believe we have the better solution and players not necessarily always want to partner with us. So it's a bit of a mix, give and take, but it's an interesting and dynamic field that we are very focused on." ] }, { "name": "Operator", "speech": [ "Your next question comes from Tien-Tsin Huang from J.P. Morgan. Please go ahead." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey. Thank you so much. Thanks for going through all of this. I heard the CIBC when -- I'm just curious how deal activity is going.", "Are the known conversions that you have proceeding in a timely way? I don't know if there's been any change given some of the macro uncertainty there. And then also, Sachin, would you mind just rehashing the FX-neutral opex numbers again? Are you changing your underlying investment strategy or inflation assumptions given what we've learned around the macro? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Tien-Tsin, let me start off with the deal activity. The momentum that we have seen over the last two years throughout the pandemic, where we lean with our customers and say, \"Hey, what do you need?\" And these are tough times. I think we set ourselves up as a trusted partner and help to shape that deal pipeline that we currently see, which is very strong. Deal pipeline is strong across all regions.", "And we gave you a few examples today from -- we haven't talked much about Canada lately. So this is -- these are strong wins. This is excellent. Some of the very significant wins, we talked about over a year ago in Europe.", "When you think about NatWest, Deutsche Bank, the multi-regional deal that we have with Santander, they are progressing according to plan. The conversions are going on. I mentioned very specifically back to United States. The GAAP conversion is actually done on those 10 million cards.", "So overall, we talked to you at the Investor Day in November last year that we see share growth across all of our card products, and we continue to feel very good about that. So momentum, it's competitive out there, of course. But I think the mix of what we have in various payment solutions as well as services set us apart. We've also relooked at how we deploy our sales resources across the company with all the acquisitions that we have so that we can do the best possible work for our customers.", "So overall, strong momentum that I think will continue." ] }, { "name": "Sachin Mehra", "speech": [ "Yes. Tien-Tsin, on your question as it relates to the outlook for the full year 2022 on opex. So on a currency-neutral basis, excluding acquisitions, we are guiding along the following lines, which is on opex that we expect to come in on a full year basis at the low end of the low double digits range. And just to remind you on what we're talking about opex.", "On the revenue side, also, we have changed our full year guide and our revenue, again. On a non-GAAP growth basis, currency neutral, excluding acquisitions, is now at the low 20s rate, which is higher than what we had shared with you previously." ] }, { "name": "Operator", "speech": [ "Your next question comes from David Togut from Evercore. Please go ahead." ] }, { "name": "David Togut", "speech": [ "Thank you. Good morning. Among your largest geographic regions, Europe continues to generate the greatest payment volume outperformance versus our model. You underscored a number of geopolitical and economic risks for Europe.", "Going forward, especially as we head into the winter, can you talk through Mastercard's growth algorithm, what that might look like in a significant economic slowdown in Europe. Historically, you've been a big share gainer there, particularly against the national payment networks. You've got the secular shift working in your favor, but if you could just kind of talk through your thought process, that would be much appreciated." ] }, { "name": "Michael Miebach", "speech": [ "All right. Let me start, and then Sachin can chime in. So David, the matter of fact is Europe is not homogenous. That's the first thing I would say.", "When you look at where we are on the arc of the secular shift, it's very different. So there's lots of opportunity across the board from further digitization. The opportunity to go beyond P2M and sets of flows is wide open in Europe. The push of the European authorities to digitize beyond just in-store payments and online payments is significantly there.", "We're well-positioned with our tools in Europe, which is pushing on open banking, which is then pushing on open -- on account-to-account, which is pushing bill pay solutions. So we have all of that in the hop. So we feel that there is significant opportunity. And as I said before, there is uncertainty on the European macroeconomic front, but on the other hand, macroeconomic GDP, overall economy, in our baskets are two different things, and we'll have to kind of see how that will play out.", "I can't really predict that. I'm from there, so I have a sense, but I'm not in the business of predictions." ] }, { "name": "Operator", "speech": [ "Your next question comes from Ramsey El-Assal from Barclays. Please go ahead." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi. Thanks so much for taking my question. I had wanted to ask about some of the longer-term drivers of rebates and incentives. It seems like today -- or not seems like today, rebates and incentives as a percentage of gross revenues are several hundred basis points higher than they were in 2019.", "I guess the question is, is the mix and the mix-related drivers of that increase are very clear. But as we move forward over the next couple of years, and your mix normalizes, should we see downward pressure on rebates and incentives as a percentage of gross revenues? Or is this something where this new baseline is sort of here to stay? And if that's the case, maybe give us some reasons why." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So Ramsey, I'll take that one. So look, I mean, I think you're well aware about the fact that rebates and incentives are influenced by a number of factors, right, some of which you alluded to, which is what's going on from a volume growth rate, what's going on from a mix standpoint, how the pipeline of new deals are looking. You take all of that into consideration.", "But the reality is, if you just think about where we are from a mix standpoint, particularly on cross-border between where we were pre pandemic and where we are today, we've still not gone back to the historical mix levels from a cross-border to domestic volume standpoint. So as that reverts back to the mean, and when I say the mean, means closer to what the pre-pandemic levels were, you would expect to see some benefit of that come through in rebates and incentives versus as a percentage of growth. You would see that come through. But the reality is there are other countervailing factors which are also taking place, right, which is a function of what the pipeline of deals looks like, what the timing around that is.", "But the basic premise is correct, which is as more cross-border happens, you're going to see a benefit come through in rebates and incentives as a percentage of growth." ] }, { "name": "Ramsey El-Assal", "speech": [ "Got it. Thank you so much. Appreciate it." ] }, { "name": "Operator", "speech": [ "Your next question comes from Bryan Keane from Deutsche Bank. Please go ahead." ] }, { "name": "Bryan Keane", "speech": [ "Hi, guys. Good morning. I just wanted to ask a clarification, Sachin, on the opex. The non-GAAP growth, currency-neutral ex acquisitions, that went up from high single digits originally.", "I think it was last quarter that you guided to that for the year to low end of low double digits. So I guess, why the increase in opex? And is it just taking the opportunity to invest more due to the strength of the top line? But any color may be on where some of those investments might be going with the additional expense." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Bryan. So a couple of things which are -- you're right. We had previously guided to high single digits and now are guiding to low end of low double digits on this non-GAAP metric on opex. A couple of things going on.", "One is we have taken foreign exchange-related losses on the remeasurement of our assets and liabilities during the first two quarters, order of magnitude about $70 million. And you'll see all of this in our reports, which we've kind of publicly put out there. So that's certainly impacting it. And then a couple of other things which, to me, are more critical, which is we continue to invest in the long-term growth of our business, that which includes investing in our people.", "In a hot talent market, we want to make sure we've got the best people. We want to be there. In terms of having those best people help us execute on what we've laid out as our strategic priorities, which is what we're doing right here. We've always kind of followed the philosophy of let's keep an eye on the top line and then kind of also as to what we want to do from an expense and investment standpoint, and that's the philosophy we're following.", "We'll continue to follow that philosophy going forward, Bryan." ] }, { "name": "Bryan Keane", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Dave Koning from Baird. Please go ahead." ] }, { "name": "Dave Koning", "speech": [ "Yeah. Hey, guys. Thanks so much. And I guess my question is on cross-border yields.", "One thing that was interesting this quarter, intra-Europe cross-border grew faster than non-intra-Europe for the first time in a long time. And yield was up regardless. So it seems like the last few quarters, mix helped a lot, but now there seems like another driver on top. I guess is -- is that right? Maybe what's that other driver? And should we get faster growth in non-intra-Europe kind of in coming quarters?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure, David. So you're right in terms of what the mix shift between inter and intra was this quarter versus last quarter. I think there are a few things to keep in mind. That's the mix shift between inter and intra, but there's also within the world of inter, what are the corridors which are coming back versus the corridors which have not come back, right? And as you started to see more of the higher-yielding corridors come back, that's actually helping us in providing us the tailwind we're talking about right here.", "For example, you've got markets -- like inbound into the U.S., as that starts to come back, you start to see the benefit of that come through. Markets like Asia, inbound into Asia, you'll start to see the benefit of that come through." ] }, { "name": "Dave Koning", "speech": [ "Yep. Great. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Jason Kupferberg from Bank of America. Please go ahead." ] }, { "name": "Jason Kupferberg", "speech": [ "Good morning, guys. Wanted to get your perspective on just the relative health of the lower-income consumer versus higher income. And then if you can just make some remarks about how we should think about rebates and incentives for Q3 and Q4. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Jason. So on your first question, here's what we're seeing, actually. Overall, the consumer and consumer spending patterns are very healthy. And again, you've got to parse this data out between what we see in the U.S.", "versus what we see in the rest of the world, right? And different people have different definitions on what is lower income versus what is the affluent, but let's just start kind of with that as the frame. In the U.S., what you are seeing is good strength across both, but a declining trend in terms of the growth rates on the lower income side of things. Affluent spend continues to be very healthy and carries on in a very nice way. Outside of the U.S., we're not seeing much in the nature of a shift between how the affluent category is spending versus what the lower income category is spending.", "So the benefits of what we've got in Mastercard by being a diversified business and being diversified from a geographical standpoint is actually helping us very nicely. Because independent of what happens in one market versus the other, the value of what we got across the globe comes through in terms of spend levels here. And then your second question was around rebates and incentives. Look, I just talked about things which influence rebates and incentives, so I won't kind of belabor that point.", "What I'll share with you is the following: that we expect that incentives as a percentage of growth will be roughly similar in Q3 to what we saw in Q2." ] }, { "name": "Jason Kupferberg", "speech": [ "Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "Your next question comes from Bob Napoli from William Blair. Please go ahead." ] }, { "name": "Bob Napoli", "speech": [ "Thank you and good morning. I just want to follow up on a lot of your comments on the open banking digital ID and your investments there. Can you maybe give some color on what you feel like the revenue TAM is for those businesses? And -- and what type of -- where you see the most opportunity, what the kind of the growth trajectory is of those businesses?" ] }, { "name": "Michael Miebach", "speech": [ "Right. So open banking, let me start off, more generally speaking. So clearly, a global trend, one that's to stay. It's happening in Brazil.", "It's happening in Australia. Certainly was there in the United States and Europe. The way we approach it is, first of all, have a relevant position in connectivity and then building out a bunch of use cases. And the use cases, that would get really to the heart of your question, where you see very different type kind of revenue models, value exchange models.", "First of all, on connectivity itself, you have per API call kind of a logic. If you go into financial management solutions, it depends on who's our customer here. Let's say it's a fintech. That could again be by API, but you could start to see, as we go into lending, mortgage verification, asset verification, kind of use cases.", "Those are kind of -- that's the broad range of currently what we're seeing. No established model at this point in time. I mean, we're investing heavily in Asia, Finicity because we feel there is a tremendous opportunity. This is -- it's going to help to pull so many new customers into -- consumers into the ecosystem, on the financial inclusion side, on the SME side and so forth.", "So hard to answer very specifically right now where we are, but those are those kind of different kind of models, and it's going to be multi-geography and it's going to be around to stay." ] }, { "name": "Sachin Mehra", "speech": [ "And I'll just add to that. A couple of thoughts. One, I think defining any sort of TAM in open banking at this point in time will just be an incorrect -- we'll be looking for precision where it doesn't exist because use cases are still to develop. So I think what we see is tremendous potential with what open banking does by providing us access to an alternative network.", "It's a data network, which comes with its own sets of use cases. The second point I'll bring out is regardless of whether it's open banking or digital ID or all of our services, we think about that in the context of the revenues they generate for Mastercard, the company, but it's really important to remember that the -- all of this is one big circular wheel. Our open banking assets power our payments, our services power our payments. So there is the collateral advantage, which comes through by virtue in being in all of these spaces, which trickles down to all parts of our business." ] }, { "name": "Bob Napoli", "speech": [ "Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Thank you so much for that last question. Exciting space. We're going to close the call now. We're at the top of the hour.", "I appreciate your time this morning. Do want to thank our 24,000 colleagues around the world, and I want to thank all of you who have joined us today for your continued support for Mastercard. Talk to you in the quarter. Thank you so much." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2019-10-29	[ { "description": "Executive Vice President of Investor Relations", "name": "Warren Kneeshaw", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Bernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Assal -- Bank of America Merrill Lynch -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "Stephens Inc. -- Analyst", "name": "Brett Huff", "position": "Analyst" }, { "description": "Sandler O'Neill & Partners -- Analyst", "name": "Christopher Donat", "position": "Analyst" }, { "description": "Citigroup -- Analyst", "name": "Ashwin Shirvaikar", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Donald Fandetti", "position": "Analyst" }, { "description": "William Blair -- Analyst", "name": "Robert Napoli", "position": "Analyst" }, { "description": "Susquehanna Financial Group -- Analyst", "name": "James Friedman", "position": "Analyst" }, { "description": "Robert W. Baird -- Analyst", "name": "David Koning", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by and welcome to Mastercard Incorporated's Third Quarter 2019 Earnings Conference Call. [Operator Instructions] After the speakers presentation, there will be a question-and-answer session. [Operator Instructions]", "I will now like to hand the conference over to your speaker today Warren Kneeshaw, Head of Investor Relations. Please go ahead." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Mellisa, and good morning everyone. Thank you for joining us for our third quarter 2019 earnings call. With me today are Ajay Banga, our President and Chief Executive Officer; and Sachin Mehra, our Chief Financial Officer. Following comments from Ajay and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session. It is only the end of the queue will open for questions.", "You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the Investor Relations section of our website mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted.", "As a reminder, in Q2 we updated our non-GAAP methodology that exclude the impact of gains or losses on our equity investments. We are excluding these items as we believe this will facilitate a better understanding of our operating performance and provide a meaningful comparison of our results between periods. Our non-GAAP measures also exclude the impact of special items, which represent litigation judgments and settlements and certain one-time items.", "In addition, we present growth rates adjusted for the impact of foreign currency with the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I'd like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance.", "Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of the earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days.", "With that I will now turn the call over to Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thanks, Warren, and good morning everybody. So we drove strong results this quarter, revenue up 16%, EPS up 23% versus a year ago. On a non-GAAP currency-neutral basis, growth was broad-based and reflects our focus on execution, robust business drivers across the board and ongoing investment in our business for the long term.", "On the macroeconomic environment, our view is kind of unchanged. That is that consumer spending remains relatively strong with some moderation versus 2018. We obviously, like everyone else, is monitoring ongoing trade negotiations and other economic and geopolitical factors which are showing signs of weighing on business sentiment in particular. And the U.S. economic growth remains stable with low unemployment and solid consumer confidence. Retail sales were pretty consistent with the prior quarter, growing at 3.8% versus a year ago ex auto, ex gas, according to our SpendingPulse estimates.", "In Europe, we see modest growth overall. Third quarter total retail spending in the UK were solid according to our SpendingPulse estimates while uncertainty around the potential impact of Brexit obviously remains. It's a daily drama being played out on television. In Asia Pacific, we are monitoring the impact of the U.S.-China trade negotiations, which are negatively affecting business sentiment in the region. We are however seeing accommodative monetary policies in several markets there to support growth.", "And in Latin America, the outlook is mixed with countries like Brazil and Colombia showing some positive signs from weakness in Argentina and Mexico. That's the backdrop, and against that, we are driving healthy double-digit volume and transaction growth for Mastercard across most of our markets with momentum in our core product areas in services and in new payment flows.", "So let's dive into some recent business highlights. First, core products, we are driving growth in our core products with new and renewed customer relationships across credit, debit, prepaid and commercial. I'm pleased to announce that we have extended our global agreement with Citi for an additional five years through 2029. With this we will remain Citi's exclusive global partner in Citi branded consumer credit, debit, and small business. We're also continuing to build upon our strong partnership with Citi's Treasury and trade solutions group where we are working together to expand the breadth of services provided with Citi's corporate clients, including through the use of Mastercard's payments gateway. And together, I think these position us to partner even more closely over the next decade on digital initiatives, on driving consumer credit and debit growth on B2B and the development of new payment solutions and joint marketing efforts to continue growing our businesses together.", "We've also extended our global deal with HSBC for its premier credit portfolio focused on the high-net-worth segment and that builds on our existing partnership which includes products like the HSBC Rewards card that we launched in the UK and the multi-currency debit card launched in Hong Kong last month. HSBC is another great example of a customer that leverages several Mastercard services like Advisors, MasterCard Lab and Loyalty to bring value to its customers and drive growth across its account base.", "With Bank of America, we have renewed and expanded many of our business lines across consumer and small business credit and debit in the United States, including brand exclusivity on the forward issuance of small business credit and the small business travel card. We will work together toward continued growth in our debit and commercial business, in particular with Mastercard as the primary network on new commercial business outside of the United States. Additionally, Bank of America has committed to being our next Mastercard Track B2B Hub customers bringing enhanced account payable capabilities to its clients in the United States.", "H&R Block has renewed its agreement to offer Mastercard prepaid cards and additionally, we'll be piloting our APT Test & Learn capabilities and new data fraud tools.", "On the U.S. co-brand front this quarter, we won a flip [Phonetic] of the BMW consumer credit co-brand portfolio and they're making further progress in Europe, extending our debit agreement with Intesa Sanpaol in Italy which is committed to converting more than 6 million Maestro cards to Mastercard debit. We've also expanded our relationship with UniCredit to become its preferred Pan-European partner.", "In other markets, we are building on our momentum of issuers, merchants and diverse partners like telcos. You can see that in Latin America where we've executed a regional deal with Scotiabank and we'll be converting debit cards in several Caribbean markets to Mastercard. In India, where we won an exclusive consumer credit co-brand with IndiGo Airlines, the country's largest airline; and in Africa where Airtel will exclusively use Mastercard's network for it's prepaid virtual cards and QR capabilities from mobile wallets across 11 markets there.", "Now specifically related to our core commercial business, we've expanded our relationship with Brex. You know them as an innovator in the corporate space, and now we will be their preferred network in the U.S. We've also inked a 10-year deal with Emirates Islamic Bank to be its exclusive commercial credit network across the UAE.", "And to our efforts to partner with local switches to increase the transaction that we switch, we are the first Internet national network to receive central bank approval and have begun domestic switching our Mastercard branded debit cards in Indonesia through an agreement with the largest domestic switch Artajasa.", "Our current digital initiatives click-to-pay, which is the name for the EMV secure remote commerce standard is now live in the U.S. aiming at enabling a faster, most secure checkout experience across the web and mobile sites, mobile apps and connected devices. Rocket Time, Movember, Cinemark are the first merchants to the launch together with distribution partners such as IDM, FIS global payments, and Stripe. We are planning for a broader market launch in the first half of 2020 with click-to-pay, Mastercard's merchant partners would benefit from automatic access to NuDetect, a Mastercard artificial intelligence and merchant machine learning solution that provides an added layer of security when a consumer has to check out using Mastercard on click-to-pay.", "On the fintech front, we've strengthened existing partnerships and winning new deals around the globe by leveraging our technology and relationships in new ways to support these customers who have very specific needs. And a couple of examples include an expanded global partnership and Revolut which has been a Mastercard issuer for several years in Europe and will first launch its cards in the U.S. with Mastercard by the end of the year, followed by other markets across Asia-Pacific and Latin America.", "Monzo has selected Mastercard to be its exclusive debit partner for its U.S. launch. And SoFi has also chosen Mastercard for its credit and debit programs. Now, additionally, we expanded our Accelerate program to the U.S., providing local fintechs with support through all stages of growth with easy access to a range of programs including our digital fund solutions, our API and development programs and our start-up engagement platform Start Path.", "In our new payment flows and as you know we've developed and acquired a broad set of capabilities, which together with our card rails allow us to differentiate our offerings and address new payment flows and operate as a one-stop shop for our customers providing choice across multiple rails. In this quarter, we announced our intent to acquire the clearing and instant payment services and e-billing solution of the Nets' Corporate services businesses in the Nordics as we capitalize on the large global real-time payments opportunity.", "Real-time payments provide a smarter and faster alternative to traditional ACH cash and checks to bring efficiency, much richer data, and a much better user experience. We believe Nets will complement and strengthen our existing capabilities across all three layers of our strategy, which as you recall from Investor Day would offer infrastructure applications for end-users and value-added services for account payment trails. Now this builds upon prior real-time payment wins, including in the Philippines, Peru, Saudi Arabia and our partnership to P27 to deliver real-time and batch payments in the Nordics. We've talked about these in prior earnings calls and on Investor Day.", "In the meantime, we are progressing our B2B initiatives. I already mentioned Bank of America signing up for the B2B Hub in the U.S. First Hawaiian Bank has also agreed to be their customer. And as we discussed at our Investor Day, we are addressing business payments more comprehensively, both accounts payable and accounts receivables, with Mastercard Track Business Payment Service. To solve for the complexities involved with B2B payments, this service will help companies find businesses that they need to pay, operate within a known set of standards and rules, provide full and rich remittance data, and offer a single connection with access to multiple payment types and rails.", "We showed you one of the use cases that runs on real-time payment rails, payments on delivery, and this is the one where drivers who are delivering goods through a physical store can be paid electronically real-time by buyers who can manage all of their invoices and payments more efficiently. I'm pleased to announce that BNC is the first bank to pilot this capability with its customers in the U.S.", "As a multi-rail network, we're also able to offer services to our customers based on account-to-account flows. So for example, we already have customers in the U.K. benefiting from data insights, we are able to provide with our broad view through VocaLink. This helps them with anti-money laundering compliance and identification and prevention of other financial crimes. Continuing with the idea of expanding these services outside of the U.K., the clearing house has just announced that it will launch our Phase [Phonetic] financial crime solution for AML compliance in the U.S.", "And as previously announced, we will be launching these services in the Philippines as well as part of our real-time payment infrastructure there. Before I close, I wanted to mention the announcement we made about acquiring SessionM, a U.S.-based technology company that provides end-to-end loyalty solutions for merchants. We expect this acquisition to strengthen our ability to provide a complete platform-based loyalty solution, starting from data management to campaign execution and program measurement to our merchant customers, doing all of this while delivering a seamless digital experience for the consumers of those merchant customers. SessionM has a growing base of leading customers that includes McDonald's, PepsiCo and Lowe's among others. We expect to close this acquisition this year.", "With that let me turn the call over to Sachin for an update on our financial results and operational metrics. Sachin?" ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Ajay. Turning to Page 3, you will see we delivered strong performance this quarter. Here are a few highlights on a currency-neutral basis and excluding both special items related to certain legal and tax matters in 2018, as well as the impact of gains and losses on the company's equity investments.", "Net revenue grew 16% driven by solid momentum in our core and was slightly ahead of our expectations due to stronger-than-expected services growth. Acquisitions contributed approximately 1 ppt to net revenue growth in the quarter. Total operating expenses increased 16%, which includes in 3 ppt increase related to acquisitions. The remaining 13% was related to our ongoing investment in strategic initiatives and was slightly lower than expected.", "Operating income grew by 17% and net income was up 20%, reflecting our strong operating performance. Each includes a 1 ppt reduction due to acquisitions. Net income growth was also positively impacted by approximately 2 ppt due to a one-time tax benefit and approximately 1 ppt due to certain non-recurring gains, within other income and expenses.", "EPS grew 23% year-over-year to $2.15, which includes $0.04 related to the one-time tax benefit, and $0.01 due to the non-recurring items and OIE that I just mentioned. The remaining $2.10 includes a $0.05 contribution from share repurchases and $0.02 of dilution related to our recent acquisitions.", "During the quarter, we repurchased about $1.8 billion worth of stock, and an additional $449 million through October 24, 2019.", "So now let's turn to Page 4 where you can see the operational metrics for the second quarter. Worldwide gross dollar volume or GDV growth was 14% on a local currency basis, up 1 ppt from last quarter, primarily due to the impact of the differing number of processing days between periods.", "U.S. GDV grew 12%, up approximately 2 ppt from last quarter with credit and debit growth of 15% and 9% respectively. Outside of the U.S., volume growth was 16%, up 1 ppt from last quarter. Cross border volume grew at 17% on a local currency basis in line with expectations and driven by double-digit growth across most regions.", "Turning to Page 5, switched transactions showed strong growth at 20% globally, reflecting in part the ongoing adoption of contactless payments. We saw a healthy double-digit growth in switched transactions across all regions. In addition, card growth was 6%. Globally, there are 2.6 billion Mastercard and Maestro branded cards issued.", "So now let's turn to page for highlights on a few of the revenue line items, again, described on a currency-neutral basis unless otherwise noted. The 16% net revenue increase was primarily driven by strong transaction and volume growth, as well as particularly strong growth in our services offerings, partially offset by rebates and incentives. As previously mentioned, acquisitions contributed approximately 1 ppt due to this growth.", "Looking quickly at the individual revenue line items. Domestic assessments grew 12% while worldwide GDV grew 14%. The 2 ppt difference is driven by mix and the impact of an additional processing day on GDV growth in Q3.", "Cross border volume fees grew 16% while cross border volumes grew 17%. The 1 ppt difference is mainly driven by mix, partially offset by pricing. Transaction processing fees grew 18% while the switched transactions grew 20%. The difference is primarily due to mix. And finally, other revenues were up 34%, including a 4 ppt contribution from acquisitions. The remaining growth was higher than expected and was primarily driven by growth in our data and services and cyber and intelligence solutions.", "Moving on to Page 7, you can see that on a currency-neutral non-GAAP basis, total operating expenses increased 16%, this includes 3 ppt related to acquisitions. The remaining 13% of growth related to our continued investment in strategic initiatives such as digital enablement, safety and security, geographic expansion, and new payment flows. This was lower than expected due to the timing of certain investment initiatives, which we now expect to occur in the fourth quarter.", "Turning to Slide 8, let's discuss what we've seen through the first three weeks of October where each of our drivers are broadly consistent with what we saw in Q3. The numbers through October 21 are as follows. Starting with switched volume we saw global growth of 15%, down 1 ppt from Q3. In the U.S., our switched volume grew 11% down 1 ppt sequentially in part due to lower PIN debit growth. Switched volume outside the U.S. grew 19% similar to the third quarter.", "Globally, switched transaction growth was 20% similar to the third quarter. With respect to cross border, our volumes grew 16% globally, down 1 ppt.", "So as we close out 2019, our business continues to perform well as we have had another solid quarter featuring several new and renewed deals, as Ajay just mentioned, as well as strong services revenue. Consumer spending remains healthy with some moderation versus year ago as expected.", "In terms of net revenues, on a currency-neutral basis, excluding acquisitions, we now expect to grow at the high end of the low-teens rate for the year, up slightly from prior expectations. Acquisitions will add about a half a ppt to this revenue growth for the year. In addition, due to the stronger U.S. dollar, we now expect FX to be a 3 ppt headwind to revenue for the year. For our operating expenses on a currency-neutral basis, excluding acquisitions and special items, we continue to expect growth at the high end of high-single digits for the year.", "On the same basis for the fourth quarter, we expect growth in the high single-digits range versus a year ago. Acquisitions will add about 3 ppt to opex growth for the year and 6 ppt to the fourth quarter, primarily related to purchase accounting and integration-related costs. In addition, we expect FX will be a tailwind to opex of about 2 ppt for the year and 1 ppt for Q4.", "And now just a quick comment on acquisitions. Overall, our acquisitions are progressing well and our approach toward managing them has not changed. We expect them to breakeven within 24 months of close, after which the acquisition is included in the base and the respective manager responsible for delivering on the revenue and earnings growth targets within that context.", "As a reminder, Q3 other income and expense included some one-time benefits that are not expected to recur in Q4 and investment income has been trending down due to lower interest rates. In terms of the non-GAAP tax rate for the year, we now expect it to be approximately 18% due to the discrete tax benefits taken year-to-date.", "With that, let me turn the call back to Warren to begin the Q&A session." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Melissa, we're now ready to take questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator Instructions] Your first question comes from the line of Ramsey El-Assal from Barclays. Your line is open." ] }, { "name": "Warren Kneeshaw", "speech": [ "Let's go to the next one." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Darrin Peller from Wolfe Research. Your line is open." ] }, { "name": "Darrin Peller", "speech": [ "Hey, thanks guys, nice trends again. Can you just first start off talking a bit more about the cross-border trends continue to hold up well? We're hearing a lot of questions macro-wise, but it seems like it's not really affecting you. So first, maybe a little more granularity of what you're actually seeing there. And then quickly on the expense side, again, it beat us, and I know you mentioned some one-time items, Sachin, just what are your thoughts on the growth profile? Is it consistently like modeling wise high single-digit the right way to think about it?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Darrin. And let me take that. I'll take the cross-border question first. So, what we're seeing from a cross-border standpoint is very much in line with our expectations. We continue to see double-digit growth across most of our regions, and we continue to actually expect mid-teens growth for the full year 2019. They drill down a little bit more into it, what we're seeing is that U.S. inbound and outbound cross border volumes are very much in line sequentially, China cross border growth continues to be also stable in that low double-digits range. Europe continues its strong trends there The fintech leadership position that we've got in Europe and in particularly in the U.K. as well as our commercial travel programs are too particularly strong contributors that we're seeing here. So all in all, actually, what I tell you from a cross-border fence standpoint, in line with our expectations, we continue to believe that we'll deliver mid-teens growth for the full year of 2019 and really things look pretty good.", "On your question as it relates to expenses, you're right, in Q3, the expenses did come in lower than our expectations. We now expect that those expenses will be incurred in Q4 as per what I just shared with you. Holistically, what I would tell you is that for operating expenses, on a full year basis, we continue to believe that we'll be at the high end of high single digits very much in line with what we've shared with you previously as well." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question please." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Tien-Tsin Huang from JPMorgan. Your line is open." ] }, { "name": "Tien-tsin Huang", "speech": [ "Hi, good morning, good results. The services line, you mentioned Sachin was better than expected, so what can you give us a little bit more on what surprise to the upside and maybe some guidance on the growth from here in the short and mid-term. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. Tien-tsin. So, yeah, you're right. Services came in stronger than expected. We had, you know, good performance across both our cyber and intelligence solutions as well as our data and services solutions. The one thing I'll remind you about services is they tend to be lumpy. Quarter to quarter depending on the customer deals which we've signed and those which we've executed on, the number is kind of -- move around based on how the execution plans are going on in that.", "All in all, the performance in services continues to be strong. We've had a couple of, what I would say, stronger than expected quarters between Q2 and Q3 but nothing other than that that I would report as being unusual. There is very good receptivity for the capabilities that we're putting out into the market. As you heard Ajay talk in the script, he mentioned about how some of the wins we've had recently have been enabled by what we deliver from a services capability standpoint and you're seeing all of that manifest itself in the numbers coming through right now." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question please." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Lisa Ellis from MoffettNathanson. Your line is open." ] }, { "name": "Lisa Ellis", "speech": [ "Hi, good morning, Ajay and Sachin. I had a question about the investments in more sort of strategic or the holistic question around fast ACH. One topic that doesn't get a lot of attention when it comes to fast ACH or push payments more broadly, it is around fraud, which I imagine is quite different from the nature of fraud on the poor payment side like what we're accustomed to with card payments. Can you just talk about as you're building out VocaLink and now niche, what's the nature of fraud exactly when it comes to fast ACH and how do you make that or how do you differentiate versus other providers? Thank you." ] }, { "name": "Ajay Banga", "speech": [ "Hi, Lisa. Your voice came and went a little bit in between but I got the idea that you are checking on fraud to do with fast ACH as compared to cards is very different. So my -- the first thing is if you get invoice fraud, that kind of happens as part of the game. You get not just the payment fraud, you invoicing fraud as well. So it's kind of got two sides to the story in commercial payments and one of the things that we can do using AI and machine learning is we can help with both aspects of that transaction, the presenter [Phonetic] of that invoice to be accurate, being able to search through the invoices they are getting, to be able to find and track invoices that don't fit the pattern or don't fit the trend you should be getting and as well as on the payment side. And then, of course, you get the opportunity for managing authorization levels and approval authorities and the like inside a corporation as well with the tools we can build.", "And then there's the bigger picture, which is the one we talked about, which is around anti-money laundering at a level in a market as a whole in VocaLink's case in the U.K., because we see so many of the transactions, principally all of the transactions in the U.K. I think once we get P27 and Nets done in the Nordics, that will be the same case there as well as in the Philippines and others. We can actually apply these AI tools to find pockets of money mules and nodes of money movement that you cannot easily find otherwise. Of course, the Holy Grail here would be to be able to connect us across markets, so we can find anti-money laundering trends that also are happening cross border and cross markets. Those are harder because as you know ACH has tended to be whether batch or real-time has tended to be country by country. And so, it's a little more difficult to, to get the cross-border trends as of now." ] }, { "name": "Lisa Ellis", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Harshita Rawat from Bernstein. Your line is open." ] }, { "name": "Harshita Rawat", "speech": [ "Hi, good morning. Sachin, a question on switched transactions [Technical Issues] nicely from last quarter and it's probably the strongest we have seen in many quarters. So can you talk about the drivers there in terms of increasing contactless penetration as you noted, but also [Technical Issues] penetration and change in transaction side [Technical Issues]? And also, how does the contactless rollout in the U.S. impact this in 2020 and beyond?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, thanks, Harshita. You're right. Switched transaction growth continues to be moving along at a healthy pace and there are a few factors which are kind of impacting that. There's certainly the adoption of contactless payments globally. We are seeing good strength in markets in Europe. We're seeing good strength in Canada and in market strength in Australia, but also in the U.S., right.", "So with the recent launch of contactless payments in the transit systems particularly in the New York area, you were starting to see good adoption come through both from a acceptance standpoint, but also from a card issuance standpoint. So that's kind of one facet which is contributing to switched transaction growth, but I would remind everyone here that besides contactless payments, the fact that we have market share gains and those market share gains are occurring in markets where we have more switching taking place, it is also a contributing factor to our switched transaction growth.", "And then the final piece, which I'll mention is, as we are working actively to win more switching from what was previously being done on domestic switches, case in point as what Ajay mentioned as it relates to the work bidding in Indonesia, those are all contributing factors which are helping with this trajectory from a switched transaction growth standpoint." ] }, { "name": "Ajay Banga", "speech": [ "We are now seeing about 56-odd percent of our transactions and that's up from 40-something percent 5 to 10 years ago. And that's a very conscious effort to see more transactions so we can do more with them in the form of our services business as well, as well as increase our relevance domestically in each country. Once you start seeing more transactions, you're playing a better role in the transaction flow of that marketplace." ] }, { "name": "Harshita Rawat", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Ramsey El-Assal from Barclays. Your line is open." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi guys, thanks for taking my question. I wanted to ask about B2B payments. And the addressable market there has been large for so long and it feels like the ecosystem is gaining momentum and you guys have launched track. What has constrained B2B broadly speaking before and what is changing now? What factors are changing now that are allowing you guys to go after it more aggressively?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, Ramsey, it's Sachin. I'll take that one. So he're what I'd tell you. I'd say, you've got to think about B2B payments in the context of things which we, as a network, have been doing for some time now, which is addressing them at the point of sale because there are business to business payments which take just to the point of sale, which is our traditional commercial business which has been growing at a healthy clip and has been any decent revenue contributor over many years. This is our typical T&E products, our small business propositions, our [Indecipherable] products. And then there is in the accounts payable space, which is the opportunity which has and historically been penetrated in a meaningful manner. But over the last four or five years, starting with our merchant card capabilities, we've been making good advances out there.", "All of that still happens to be on card rails related to payments. The problem statement in B2B actually extends beyond just moving money from point A to point B. It's also about delivering data effectively between the buyer and the seller of goods and services. And as we go down the path of our Mastercard Track capabilities, you will see that a lot of what we are doing in addition to delivering payments is enabling more seamless transmission of data to allow for better reconciliation of those payments.", "So it's about creating the right ecosystem to be able to capture the data, transmit the data, and deliver it in a manner where the use or the receiver money can apply that data in a useful manner. So that's what things like Track do. So that's kind of one piece you should think about.", "The other piece comes around the importance of safety and security in B2B payments. And as we've been building new services capabilities in the safety and security space, it will be -- what will help us, also expand the B2B universe.", "The bottom line is the following. This will take some time. There is an ecosystem which has got to be built out. There is capabilities which we have invested in and continue to invest in, we will be able to to rollout. Like, the point really is, it's not just about the payment. It's much more than the payment when you think about B2B payments.", "And then there's real-time payments, which comes into play. Everything I've spoken about right now relates to cards and data. But as we go into the real-time payment universe you will see things like payment and delivery. It's a B2B solution. We just announced that we are piloting that with PNC. That is about leveraging our multi-real strategy to participate in those accounts payable also well beyond cards." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question." ] }, { "name": "Ramsey El-Assal", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Brett Huff from Stephens. Your line is open." ] }, { "name": "Brett Huff", "speech": [ "Good morning and congrats on the nice results. Can you guys embellish a little bit on the Mastercard Track? It's sort of interesting you said that there is an ecosystem that needed to be built out, I think you were referring specifically to that. This is a product that we've been particularly focused on. Can you tell us kind of where we are there in terms of signing people up and when we kind of reached the tipping point for when that growth -- we can see that growth really start to take off?" ] }, { "name": "Ajay Banga", "speech": [ "Brett, it's Ajay. I think this is not an easy answer that will be done in your x month or y year. This is a build, I think of in the consumer payments space where are all the network plays is to create that ecosystem. Start with a directory. Basically, merchants and consumers are two sides of a directory. We need such a directory in B2B payments connecting millions of buyers with millions of sellers. Mastercard Track has got a directory of 200-plus million businesses on it. There is still more to be added. It's been a fragmented system across many countries with many different players. Bringing it together and making it less fragmented is a job that will take years before it actually gets to fruition in its full form.", "But then you can start building with what you've got. And inside that, we are building with it a set of payments optimization engine on multi-rails. So the buyer and the seller can decide whether they want credit or they want to pay in advance and/or a frac of the bill or they want pay later. All that comes out of that optimization engine. And for buyers and sellers to understand that and to begin to incorporate that, remember, we are not talking big companies here. Those guys are very sophisticated in what they do. Just the big mass of middle market and small businesses that actually need help on this front.", "And then there's the whole issue of what Sachin talked about, the information and the richness of the data that enables reconciliation of payments to be much more seamless. That's a fairly large tasks and they aren't as easy as connecting points and switching people on. You've got to find your way through all these aspects. So we are working our way through it.", "So when you see us launching a B2B Hub in the U.S., and I think more banks and other companies into it, those are buyers' agents and sellers' agents, you can see us getting scale by adding more people there. Similarly, in Australia, we launched the B2B Hub with what was MYOB and there's more coming into that that's all part of getting scale.", "So, as I said often, we are doing a lot of things in this space. You should think of this as a two-, three-, four-year effort to get to scale and size. And that's what we are investing in it." ] }, { "name": "Brett Huff", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Chris Donat from Sandler O'Neill. Your line is open." ] }, { "name": "Christopher Donat", "speech": [ "Hi, good morning. I had a question about click-to-pay or secure remote commerce. I'm just wondering as you move from the soft launch that's going on now to the more serious launch in 1Q 2020, can we expect a big uplift in marketing spend or will this be sort of within the context of your typical marketing efforts?" ] }, { "name": "Ajay Banga", "speech": [ "Yeah, I mean, we'll play that a little bit by ear as we normally do with an event like this. I think you'll see us do some spending on marketing because, we are keen to get this established, but we're going to start the marketing in a bigger way when there is enough distribution off the button and enough merchants, so that the marketing dollar we'll spend is spent well amortized over many merchants. So I don't know that will be a 1Q event. You might see it later in the year. It just depends on the pace of installation of this button through our distribution partners. You heard me talk about FIS an RDN and global payments and Stripe and others like that, and of course, through all the efforts, we as an industry make directly as well." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question please." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Ashwin Shirvaikar from Citi. Your line is open." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Hi, Ajay. Hi, Sachin. So the question is could you shed more color on the healthcare unit announcement from yesterday that primarily a formalization of your capabilities you already had because I thought you're already doing some of the analytics and billing work there. And more broadly, clearly, healthcare is an important vertical, but should we expect more of a verticalized push, I noticed here in Vegas, you guys have a major presence not only at Money 2020, but also at the digital health event." ] }, { "name": "Ajay Banga", "speech": [ "Hey, what happens in Vegas should stay in Vegas, so you ought to remember that. You're making it on a public call for God's sake, I don't know. Okay. I'm just kidding. So yes, healthcare, so yes, we participate in healthcare through Flexible Spending Account and healthcare saving account, and Health Reimbursement arrangement and all those three-letter acronyms that we've got in the U.S. around healthcare payments for consumers to the cards, we do those.", "And you will see us continuing our effort to gain share in that space because that's kind of a lower hanging fruit in the healthcare space to take away one of the pain points in the healthcare payment and reimbursement system. But it's only one. There are plenty more. And the real issue we're trying to do with this announcement is to show you that we are beginning work on those other pain points. We've got a few clients already who have worked with us over the last six months to one year on some of these topics. They include providers like hospital systems. They include payers like individual sort of the insurance companies. And what we are trying to do is to systematize that and make that a business opportunity for our company and take our analytics as well as our payment capability and apply it across this very obvious paint point industry in the United States. For the time being, it's U.S.-centric.", "So to give you examples, we are talking about getting into what we call a patient payment assurance, which is really predictive analytics to enable the hospital, the provider, the doctor in it to get more effective billing strategies that are tailored to the kind of patient they're getting. So if you look at segment patients basing on payment burden, on individual payment behaviors, and you would develop new billing strategies customized to that patient's unique profile.", "The second one is to use AI and machine learning to detect suspicious claims and if you go to the insurance companies, they will tell you that fighting suspicious claims is one of the most important things, that's why you as a consumer very often get these detailed inquiries from your insurer, which gets you to be unhappy. All they are trying to do is to fight the issue of suspicious claims. And again, we can help new providers reduce on-boarding risk. We can monitor provide behavior and risk levels. We can manage daily transaction fraud risk in real-time. That's kind of what we do in the payments business. That's why our cyber and intelligence business are growing well. I think we can apply the same knowledge and capability to this marketplace.", "And then thirdly, we are focusing on data security. And there, the idea is, to use bio-metrics which will allow patients to be identified better and of course behavioral analytics to protect health information. So it's through mobile access being authenticated better to access the accounts and call centers and patient portals auto-detect cyber threats in real time, so we can lower operational investigative costs, those are examples.", "So think of us as taking our current capability in payments and data, adapting into the need of a specific sort of vertical called healthcare, both for payers and for providers, and then finding a way to get that into distribution. That's the real task. We will get it out there with enough providers and with enough payers. That's the work we are undertaking now and probably what you heard in Vegas." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Ajay. Next question please." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Don Fandetti from Wells Fargo. Your line is open." ] }, { "name": "Donald Fandetti", "speech": [ "So, Ajay, interesting comments on the Citi renewal around Treasury and trade solutions. Just wanted to get your sense on how B2B is really impacting negotiations with issuers on renewals, and then kind of makes me think out loud that, if you look at digital and B2B, the integration is becoming deeper and things like switches are much more unlikely going forward. And then will we see any type of impact to the economics, whether it's rebates, etc., or will it not really be visible to us what's going on behind the scenes on B2B?" ] }, { "name": "Ajay Banga", "speech": [ "Yeah, so, I mean, I wouldn't conclude that the Citi deal renewing the consumer aspect of 2029 including small business, I wouldn't conclude that that deal had economics from the B2B aspect of our relationship built into it. That's not what I said. What I said was we renewed the Citi consumer deal for 2029 exclusive for Citi branded cards both consumer debit and small business. We are continuing our partnership with the trade services business on things like the Mastercard payments gateway. And frankly, a bunch of other things that I haven't even talked about and as part of our B2B payments, including what we are going to do with real-time payments and cross-border possibilities with the company.", "Your question is deeper. Your question is that, does this help us go to institutions with a more holistic discussion? I think Don, as you recall from your days even in other institutions, it depends a little bit how well-stitched together their org structure is. In a number of the larger banks around the world, the institutional client group, the corporate banking business tends to be isolated from the consumer group. In others, they don't. And so, in some institutions, they started coming together in portions of it like in acquiring or in a payment gateway, in others they're quite distinct. Commercial cards tend to be in one space. Corporate T&E cards [Technical Issues] while consumer tends to be in the other. That is kind of how these institutions are run.", "And so, there is a opportunity over time for us to stitch together our improving B2B capabilities with our consumer capabilities. Certainly, the institutions look at it holistically, but over time, even as others as they come together. And clearly, at the right level of management, we do that all the time. So if you talk to the CEO or the CFO of somebody up at that level -- Mike Corbat was at our office the other day, obviously, we're discussing all aspects of Citi because he cares deeply about the whole of Citi's P&L and that's how it should be.", "So I wouldn't conclude right now that this has made so much progress that you will be able to get insights that are different in them. It's kind of like two efforts going alone in the company." ] }, { "name": "Donald Fandetti", "speech": [ "Thank you." ] }, { "name": "Ajay Banga", "speech": [ "But your point about will it make switching harder, I don't know. We'll see. By gentle belief is that the more you do with an institution, the more your value is visible to that institution. And that's kind of how we've approached it. And if you have value that you bring, whether it's a merchant or a bank or a telco or a government, they will tend to be more thoughtful on their transactions with you." ] }, { "name": "Donald Fandetti", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Bob Napoli from William Blair. Your line is open." ] }, { "name": "Robert Napoli", "speech": [ "Thank you and good morning. The -- just want to dig a little deeper into the services business and the organic growth of that business and then what -- and I know you mentioned, Ajay, that data and cyber in particular were strong this quarter and then what you're looking to add to that additionally through the M&A side?" ] }, { "name": "Ajay Banga", "speech": [ "Bob, the organic growth is great. I mean, I'll give you an anecdotal example but Applied Predictive Technologies, APT is the company that helped us understand what it can do on Test and Learn through their patented processes, which we've now put into almost all our data and services business. We actually did revenue bookings in them in one month, a few months ago which is equal to what we did in the year we bought them. That gives you a sense of the multiplier factor that a good business with outstanding people can get through the distribution that we can give them and the link to our client base that they we can provide. That's the -- we bought them and then we've grown them organic. So there's that going on.", "The same is true of new data and what we now call NuDetect. So they get bought as inorganic. Then they get merged into us and then it becomes part of our organic base two years later then it's basically being put through our distribution system to get access to much larger scale. And then we keep adding capabilities into that business through our own team of AI and machine learning and data scientist people who can help us build out the repertoire that that company is willing and capable of offering.", "Where do you see us doing more of this? Well, as I've said, sometimes we are very keen to continue to expand in everything we do with cyber security and predictive modeling of that space. I continue to believe that digital identity, cyber security, identifying fraudulent transactions, the capacity to identify people correctly companies correctly you you heard me say that on the B2B payment answer a little while ago, that's going to be very important.", "Similarly, loyalty and rewards, and we've added scale to that and we continue to build that out as part of our managed services business. I continue to believe that to be an area where you will see us focusing. You will see us focusing on anything that can help us with AI and data analytics as we go back. These are to me all important spaces in services as distinct from what we might want to do in real-time payments and B2B. I think that's the kind of space you'll see us focusing on." ] }, { "name": "Robert Napoli", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of James Friedman from Susquehanna. Your line is open." ] }, { "name": "James Friedman", "speech": [ "Hi, thank you for taking my question. Sachin, in your prior answer, I thought that the inference was that there are some services pull through from B2B. I want to make sure that that was right. You mentioned safety and security and you mentioned Mastercard Track. Is that true that that's a place that where we would see B2B being populated? And I just -- I'm going to try it. So you reported 34% FX-neutral in other revenue. Is that a good proxy for services or is that too simple? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. So I'll take the second part of your question first. And I think I need a clarification on your first question. But on the second part, other revenues does comprise services-related revenues. But services revenues also show up in our transaction processing fees. So I think, you've just got to be careful about assuming that there is a one-to-one correlation between other revenues, and our services revenue. Other revenues has other stuff going on in there as well. So that's kind of point one.", "On the 30% growth rate. About 4 points of that, like I said, came from acquisitions, and then the remaining 30% came from a whole bunch of activity, primarily driven by the strong growth we've seen in our services capabilities both on deal and services as well as on our cyber and intelligence solutions.", "And Jimmy, I want to make sure I got the first question right. What exactly were you asking? I wasn't sure I quite understood that." ] }, { "name": "James Friedman", "speech": [ "Yeah, I was trying to figure out is just simply put is services showing up in the B2B ecosystem because it -- maybe I was exaggerating but it seemed like in the answer to one of your prior questions you had suggested there might be some pull through there." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, well, I mean it's like AML and the money laundering product. If that will stop as a B2B solution and that's a service in terms of data analytics, right Ajay?" ] }, { "name": "Ajay Banga", "speech": [ "Yeah. And again, if you go back to what we've articulated previously as part of our strategy, which is we will participate at the infrastructure level, at the application level, and the services level. So if you think about services, that is something we will apply not only to card rails, we will also apply it to our non-card rails. The question really is where we started, which is mostly our services capabilities have been focused on servicing our customers on the card side. As we keep building out our B2B capabilities on the non-card side, that is very much going to be a focus area where we go from a services capability standpoint." ] }, { "name": "James Friedman", "speech": [ "Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Dave Koning from Baird. Your line is open." ] }, { "name": "David Koning", "speech": [ "Yeah, hey guys, this is just kind of a high-level simplistic question, but last year, revenue growth kind of organic constant currency revenue growth was actually the weakest in Q4, so you have quite an easy comp in Q4 this year. Are there any call outs to think of last year that might or might not make this Q4 '19 actually be the fastest growth given the easy comp on last year?" ] }, { "name": "Ajay Banga", "speech": [ "So, Dave, as I said in my opening remarks, no more real color I'm going to give you as it relates to specifics on revenue growth for Q4. We did mention that we believe our net revenue growth for the full year will now come in at the high end of the low-teens rate, which is up slightly to what we had previously shared. And look, it's business as usual, right. There's lots of puts and takes, which take place as it relates to how our revenues are growing. I think the bottom line, which I would leave you with is the following. The driver growth continues to remain strong and that's across the board, it's true for GDV, it's true for our cross-border. It's true for switched transactions. It's true for our other revenue line item. That's point number one.", "Point number two is, we did talk to you a couple of weeks ago or about a month ago at our Investor Community Day and, well, I'm not updating our three-year outlook at this point in time. We did mention to you at that point in time that we still expect our three-year outlook to be as what we mentioned at our Investor Day. So look, I mean, the bottom line I would tell you is the following, we are running the business to make sure we're driving valuables in the short, medium and long-term and that's what we'll continue to do on a going forward basis." ] }, { "name": "David Koning", "speech": [ "Great. Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Time for one final question." ] }, { "name": "Operator", "speech": [ "Your next question is from the line of Craig Maurer from Autonomous. Your line is open." ] }, { "name": "Craig Maurer", "speech": [ "Yeah, good morning. Thanks. Two quick questions. First on rebates and incentives, is there anything we should be thinking about either related to the Citi renewal or the cadence of renewals next year that will influence the percentage of gross one way or another? And secondly, with regards to the acquisition of Nets, can you talk about how the Omni Billing technology will accelerate what you're already doing with transactors [Phonetic] and Bill Pay Exchange. Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Sure, Craig. So I'll take, I'll take the question you've got as it relates to deal renewals and stuff like that. Look, I mean, I think you've got to keep in mind that the renewals which you hear about every quarter are not happening primarily within the quarter. In other words, they might close in a particular quarter but they're typically in the works for a while. So when we share with you our outlook, which is what we've shared with you both on this call for 2019, as well as the Investor Day for our three-year objectives they contemplate this level of renewal to take place. So I wouldn't call anything special out as it relates to unusual activity from our previous and incentive standpoint, all contemplated in what we shared with you in these various two forums.", "On your other question, as it relates to the Omni Billing solution for Net, it's a very solid capability, it is one where we see is the potential for tremendous amounts of synergies, both in terms of how we expand that capability globally as well as how we bring some of the capabilities that we will acquire at the time we close the transaction due to our Bill Pay Exchange, which we've announced in the U.S.", "So again, I take you back to the use case and the application layer associated with real-time payments in this instance being bill payments, sizable opportunity in a global basis. We believe we're well positioned both with our Bill Pay Exchange capability as well as with the closing of the Nets transaction with what they bring from anomaly standpoint to be able to take that and take that end mass across the globe." ] }, { "name": "Craig Maurer", "speech": [ "Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Ajay, any final comments?" ] }, { "name": "Ajay Banga", "speech": [ "Yeah, I was thinking of giving them a 10 because he was dying for a question that I will do it. So that is for all your questions, I'd like to wrap up with a few closing thoughts. We had another solid quarter, driven by robust business drivers and broad-based growth. We have extended significant relationship with critical partners such as Citi, Bank of America and HSBC. We are doing this while continuing to invest in our business for the long term, including our multi-rail strategy and our wide range of services.", "With that, thank you for your continued support of the company. And thank you for joining us today." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
MA	2023-04-27	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Tsin Huang -- JPMorgan Chase and Company -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Rayna Kumar", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "AllianceBernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Andrew Jeffrey", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mastercard Inc. Q1 2023 earnings conference call.", "All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator instructions] Mr. Warren Kneeshaw, head of investor relations, you may begin your conference." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Audra. Good morning, everyone, and thank you for joining us for our first-quarter 2023 earnings call. With me today are Michael Miebach, our chief executive officer; Sachin Mehra, our chief financial officer; and Devin Core, our incoming head of investor relations and my successor. Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data, and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website for 30 days. With that, I'll now turn the call over to Michael." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren. Good morning, everybody. Another quarter, let's jump right in. The headline is that in Quarter 1, consumer spending has remained remarkably resilient, in that, despite continued economic uncertainty.", "We kicked off the year with strong revenue and earnings growth. Quarter 1 adjusted net revenues were up 15%, and adjusted operating income was up 17%, both versus a year ago, as always, on a non-GAAP currency-neutral basis, excluding special items. Focusing on the macro for a moment. Let's take stock, both the positive and negative factors we have been monitoring.", "First, the labor market in aggregate remained strong, while savings remain above historical levels and consumers continue to access credit, which all are key drivers of consumer spending. Second, Central Banks continue to combat elevated inflation levels with higher interest rates. Although we are seeing signs of inflation cooling, additional stresses on the banking sector have emerged. We will continue to monitor how banks respond to these evolving conditions.", "And finally, economic growth around the globe continues to vary by country and sector. The reopening of China is a positive catalyst. However, the impact of monetary and fiscal tightening in many countries will likely be with us for some time. So, overall, many moving pieces, but even so, consumer spending levels have remained resilient, while the mix of spending has continued to rebalance toward experiences.", "Looking at our switch volume trends. Domestic volume growth has remained relatively stable with some recent moderation in the U.S., in part due to lower tax refunds. Cross-border travel in Quarter 1 reached 148% of 2019 levels with all regions above 2019 levels. This includes notable improvement in Asia.", "Cross-border travel, not present ex travel, continues to hold up well. We will continue to watch the environment closely. And as we have demonstrated in the past, we are prepared to adjust investment levels appropriately while maintaining focus on our key strategic priorities. And as a reminder, these three priorities are expanding in payments, extending our services, and embracing new networks.", "Now, I've been on the road for much of the quarter, meeting with customers, partners, government leaders, and, of course, our teams. These conversations reinforce the energy we have for our collaborative approach and show the importance that many place on digital payments in driving much of today's economic activity. And it's with that in mind that I'll share some examples of how we are progressing against our three strategic priorities. First, we're expanding in payments by winning deals across a diverse set of customers, innovating in and growing acceptance, and expanding solutions to address new payment flows.", "We see our partnership deepening with a diverse set of co-brand partners, financial institutions, and fast-growing fintechs around the world. This quarter, we had a significant win with Costco Wholesale in Taiwan, the largest co-brand portfolio in the market. The deal is a competitive flip that ensures exclusive co-brand issuance and exclusive acceptance of Mastercard co-brand cards in stores, effective in August this year. We also announced our exclusive partnership with Wells Fargo and Choice Hotels to launch their new credit card program in the United States.", "In the Middle East, we inked the renewal with National Bank of Egypt, the largest issuer in the country. And on the fintech front, we renewed our deal with N26, one of the largest neo banks in Europe, for Mastercard to be the exclusive provider for issuing and processing services. And in Latin America, we expanded our relationship with Uala, one of the fastest-growing fintechs in the region to be the exclusive network on prepaid, debit, and credit. So, we are continuing on our trajectory, delivering another solid quarter of new and renewed wins, an important element of our growth algorithm.", "Beyond new wins, we are driving growth in payments through the development of innovative solutions like our installment offerings. In Australia, we're scaling our solutions with some of the largest banks in the market, including Commonwealth Bank of Australia, National Australia Bank, and Westpac. Providing the way to pay is central to what we do. So too is making sure people and businesses can use those payment tools when and where they want.", "Along those lines, we are continuing to drive growth in acceptance, expanding connectivity and trust across all forms of card payments. Our acceptance footprint has now surpassed 100 million locations, effectively doubling over the past five years. And that's just the start. Our innovative contactless, cloud commerce, and Click to Pay solutions give more merchants the ability to accept electronic payments with simple technology connectivity.", "To us, that's an opportunity to bring more physical and digital transactions onto a common network. Over 100 markets have now reached at least 50% contactless penetration, double the number three years ago. Contactless drives higher consumer engagement and helps accelerate the secular shift to digital payments by accessing lower ticket size purchases that have historically been cash-based. In Quarter 1, our tokenization capability was selected as part of a mobile payments launch in South Korea, enabling a significant number of private label cards for contactless and thereby giving us the opportunity to deliver services on those transactions.", "We continue to see momentum in Tap on Phone with programs across more than 70 markets globally. We continue to scale, including the Stripe we announced in Quarter 1 that they have enabled Tap to Pay on Android in multiple markets. In addition to helping our partners bring Tap on Phone to market, our cloud commerce acceptance technology, is now live in Europe. Our cloud commerce capabilities make it easier and quicker for businesses of all sizes to accept payments on virtually any device.", "And Click to Pay is now live in nearly 30 markets globally, including key markets such as Australia, Brazil, U.K., and U.S. We are partnering with payment service providers like Nexi in Italy to further expand our presence. This is all complemented by our work with partners to grow acceptance by integrating the payment experience where their customers are. You see that in the social commerce space with WhatsApp in Brazil, enabling consumers to make purchases directly from small businesses right within a chat.", "Further, we remain focused on expanding our set of new payment capabilities to capture a prioritized set of new payment flows. I'll highlight a couple of areas we are targeting. Starting with commercial. We had a strong growth in the space with volumes across our commercial credit and debit products in Quarter 1, up 21% versus the prior year, on a local currency basis.", "We see substantial opportunity to grow in commercial, particularly with our virtual card and small business solutions. With virtual cards, where we are the market leader, one of our initiatives is to integrate our solutions with leading B2B technology platforms. This quarter, we signed a partnership agreement with Coupa to enhance their Coupa Pay solution, which embeds virtual cards to address accounts payable flows. On the small business front, today, only a small fraction of payments are captured on card.", "We are enhancing the value propositions from programs like Easy Savings, which offers automatic merchant-funded rebates to nearly 40 million enrolled cardholders in over 80 countries. And we are growing by establishing new issuance deals through partners like Galileo in the United States, where Mastercard will be the preferred brand for small business and commercial programs. Now, beyond commercial, disbursement and remittances flows represent a significant opportunity for growth through geographic expansion, new distribution partners, and an expanding set of use cases. In terms of new markets, our gaming use case is now live in Canada and Peru, and we have added cross-border origination to the UAE and Uzbekistan.", "By connecting with MFS Africa, a leading digital payment company, we have enabled mobile payouts across 10 markets in Africa. We are working with distribution partners like Checkout.com to increase reach to even more customers in Asia and the United States. And we're enabling our cross-border services solutions to small and midsized banks through cross-border services express with this simple-to-use digital-first solution, participating financial institutions can offer their customers the ability to send money or pay vendors across the globe quickly and securely. In terms of expanding use cases, we have enabled cash in at U.S., in Europe, and the U.K., facilitating underbanked customers to safely load cash into their accounts from a nonbank location, which can also help drive follow-on card spend.", "So, as you can see, we continue to make broad-based progress in addressing our prioritized set of new payment flows. Turning now to services. We love services, where we are focused on growth and resiliency through scaling our existing solutions and adding new capabilities. As merchants and consumers shift to digital, our comprehensive set of cybersecurity solutions becomes even more critical.", "For instance, risk recon helps an enterprise identify their own cybersecurity vulnerabilities, as well as for their ecosystem partners. With our acquisition of Baffin Bay Networks this quarter, we now have a solution to help these customers act on this information. Specifically, Baffin Bay's AI-enabled cloud-based threat protection helps to stop cyberattacks related to malware, ransomware, and DDoS attacks. The acquisition also complements our other cyber offerings, including our simulation and assessment tools, as well as our cybersecurity consulting practice.", "You all are familiar with our comprehensive set of data analytics, marketing, and loyalty assets. These are about helping our partners make smarter decisions to drive better outcomes. For example, Agoda, one of the world's fastest-growing online travel platforms in Asia, is leveraging our economic insights to inform their strategic planning. In MediaMarktSaturn, the largest electronics retailer in Europe, is utilizing our test and learn capabilities to support the assessment and optimization of new business initiatives.", "We also continue to make progress signing deals with retail and commerce partners like Hyundai Motors, Europe and Puma to utilize our recently acquired personalization platform Dynamic Yield. We continue to look for ways to combine all these assets to deliver valuable end-to-end solutions. We just announced Element, a suite of applications, which brings insights from Mastercard's data analytics to enrich Dynamic Yield's personalization experience. Our third key priority area is embracing new networks where we are making progress in the areas of open banking and digital identity.", "In open banking, we continue to work with a broad set of banks and fintechs who are interested in its potential across a wide range of use cases. In addition to the Pay-by-Bank solution with JPMorgan that we announced last quarter, we are working with payment risk and identification company, GIAC, a member of the London Exchange Group, to embed a secure account verification solution. Also, Saxo Bank will use our open banking technology for account opening and top-ups in Europe. Further, we are developing capabilities on top of our open banking platform.", "We have advanced analytics partner with fintech innovators like upSWOT, Nav, Enigma, and GenEQTYGen to expand excess to capital with better data for making lending decisions. This is another great example of how our technology supports small business. Moving next to digital identity. We continue to see strong adoption of our intelligent identity solutions powered by machine learning.", "This quarter, we secured a key partnership with Southwest to embed our intelligent identity solutions from Ekata to reduce and friction in digital interactions. Still early stages with open banking and digital identity that we are making progress scaling our technology to new markets and use cases with notable partners. So, with that, I will wrap it up. And in summary, we delivered another strong quarter of revenue and earnings growth, reflecting a resilient consumer and a continued recovery of cross-border travel.", "We will continue to watch the environment closely and are prepared to act as circumstances dictate. We see significant opportunity ahead, having now surpassed 100 million acceptance locations worldwide. And our focused strategy, diversified and resilient business model, and strong relationships around the globe position us well through economic cycles. Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. Turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis, excluding special items, and the impact of gains and losses on our equity investments. Net revenue was up 15%, reflecting resilient consumer spending and the continued recovery of cross-border travel. Operating expenses increased 12%, including a 2-ppt increase from acquisitions.", "Operating income was up 17%, which includes a 1-ppt decrease related to acquisitions. Net income was up 2%, which includes a 1-ppt decrease related to acquisitions. EPS Was up 4% year over year to $2.80, which includes a $0.07 contribution from share repurchases. Of note, the respective growth rates of net income and EPS were negatively impacted by a low tax rate in 2022 as a result of sizable discrete tax benefits last year.", "During the quarter, we repurchased 2.9 billion worth of stock and an additional 602 million through April 24th, 2023. So, now let's turn to Page 4, where you can see the operational metrics for the first quarter. Worldwide gross dollar volume, or GDV, increased by 15% year over year on a local-currency basis. On the same basis, if you exclude Russia from the prior period, GDV increased by 16%.", "In the U.S., GDV increased by 9% with credit growth of 15%, reflecting in part the recovery of spending on travel. Debit increased 3%. Excluding the impact of the roll-off of a previously discussed customer agreement, debit increased approximately 6%. Outside of the U.S., volume increased 18% with credit growth of 17% and debit growth of 19%.", "Cross-border volume was up 35% globally for the quarter on a local-currency basis, reflecting continued improvement in travel-related cross-border spending. Turning to Page 5. Switched transactions grew 12% year over year in Q1. Excluding Russia from the prior year, switched transactions grew 20% year over year in Q1.", "Both card-present and card-not-present growth rates remain strong. Card-present growth was aided in part by increases in contactless penetration as contactless now represents over 58% of all in-person switched purchase transactions. In addition, card growth was 9%. Globally, there are 3.2 billion Mastercard and Maestro-branded cards issued.", "Turning to Slide 6 for a look into our net revenues for the first quarter which were above our expectations. As a reminder, we recently revised our disaggregated revenue disclosure. Net revenues are now broken down into two new categories, payment network and value-added services and solutions. Now, getting into the numbers described on a currency-neutral basis.", "Payment network net revenue increased 10%, which would have been 1 ppt higher if we excluded the Russia-related special item, which benefited Q1 2022. The growth in payment network was primarily driven by domestic and cross-border transaction and volume growth and also includes growth in rebates and incentives. Value-added services and solutions net revenue increased 21%, including a 1-ppt benefit from acquisitions. The growth was primarily driven by the continued strong growth of our cyber and intelligence solutions, driven by underlying driver growth, higher demand for our fraud solutions, as well as the scaling of our identity and authentication solutions.", "And we saw a healthy demand for our data analytics, consulting and marketing services, as well as our loyalty solutions. Now, let's turn to Page 7, starting with key metrics related to payment network, again, described on a currency-neutral basis unless otherwise noted. Looking quickly at each key metric. Domestic assessments were up 9%, while worldwide GDV grew 15%.", "The difference is primarily driven by mix and the underreporting of volumes from sanctioned customers in Russia last year, which accounted for approximately 2 ppt of the variance. Cross-border assessments increased 39%, while cross-border volumes increased 35%. The [Inaudible] ppt difference is primarily due to favorable mix as higher-yielding ex intra-Europe cross-border volumes grew faster than intra-Europe cross-border volumes this quarter. Transaction processing assessments were up 14%, while switched transactions grew 12%.", "The 2-ppt difference is primarily due to FX-related revenues. Other network assessments related to licensing, implementation, and other franchise fees were $212 million this quarter. It's important to note that these other network assessments may fluctuate from period to period. Moving now to Page 8.", "You can see that on a non-GAAP currency-neutral basis, excluding special items, total adjusted operating expenses increased 12%, including a 2-ppt impact from acquisitions. Excluding acquisitions, the remaining increase was primarily due to increased spending on personnel to support the continued execution of our strategic initiatives. Operating expenses were higher than expected in part due to personnel costs to support higher-than-expected revenue, as well as unfavorable foreign exchange related expenses due to the remeasurement of monetary assets and liabilities. Turning to Page 9.", "Let's discuss the operating metrics for the first three weeks of April. As a general comment, our metrics are holding up well in April. As expected, the year-over-year growth rates are being impacted by two opposing factors: one, more difficult comps as we began lapping the effects of omicron; and two, the lapping of the drag created by the suspension of our operations in Russia in March of last year. To aid in your understanding of the underlying spending trends and eliminate some of the noise induced by the lapping effects, we have also included the metrics index 2019 levels on the slide.", "Let's discuss each of the metrics in turn. Starting with switched volumes. Through the first three weeks ago, we grew 17% year over year, down 1 ppt versus Q1. This reflects more difficult comps and some modest slowing in the U.S.", "due to lower tax refunds. This started in March and continued into April. This is partially offset by a 3-ppt benefit from the lapping of Russia. Switched transactions grew 18% year over year through the first three weeks of April, up 6 ppt versus Q1.", "This includes an 8-ppt benefit from the lapping of the suspension of operations in Russia. As a reminder, Russia had a relatively low average ticket size, which results in a larger relative impact to this metric. In terms of cross-border, volumes grew 29% on a year-over-year basis, down 6 ppt from Q1. This reflects the continued recovery in cross-broder travel, as well as the positive impact of lapping the suspension of our Russian operations, but is more than offset by a tougher year-ago comp as travel surged after the passage of omicron last year.", "Cross-border volume is indexing at 171% of 2019 levels in April, up from 168% in Q1. To further assist your understanding of the trends in the business ex Russia, where we suspended operations in March 2022, we have included an appendix to show all data points from the schedule if you exclude activity from Russian-issued cards from current and prior periods. Turning to Page 10. I wanted to share our thoughts on the remainder of the year.", "Let me start by saying that our business fundamentals remain strong, and our diversified business model and our momentum with our customers position us well for the opportunities ahead. Consumer spending overall remains healthy, albeit with some recent moderation in domestic spending in the U.S., in part due to lower tax refunds this year. At the same time, as Michael noted, the recovery in cross-border travel continues with inbound travel to all regions now well above 2019 levels. Within Asia, in Q1, China outbound cross-border travel increased to approximately 65% of Q1 2019 levels, while inbound reached 45% on the same basis.", "As a reminder, China made up 2% of outbound and 1% of inbound cross-border travel in 2019. We remain well positioned to capitalize on this growth with our travel-oriented portfolios and related service offerings. While we are monitoring a number of macro and geopolitical factors, our base case scenario assumes consumer spending remains resilient and cross-border travel continues to recover. For the year, our outlook has improved modestly, reflecting our stronger-than-expected performance in Q1.", "We expect net revenue growth for the full-year 2023 to be at a low teens rate on a currency-neutral basis, excluding acquisitions and special items. This growth rate would be higher by approximately 1.5 ppt if you exclude Russia-related revenues from 2022. Foreign exchange is expected to be a tailwind of 1 ppt for the year, and we expect minimal impact from acquisitions. Our expectations for operating expense for the year are unchanged with growth expected to be at the high end of a high single-digit rate on a currency-neutral basis, excluding acquisitions and special items.", "Acquisitions are forecasted to add about 1 ppt to this growth, while foreign exchange is expected to have a minimal impact for the year. Again, we are prepared to proactively adjust our operating expenses if we see meaningful changes to top-line growth. With respect to the second quarter, year-over-year net revenue is expected to grow at the high end of a low double-digit rate, again, on a currency-neutral basis, excluding acquisitions and special items. Coming off of a strong Q1, this sequentially reflects a tougher year ago comp, lower anticipated FX volatility, partially offset by lapping the suspension of operations in Russia.", "Foreign exchange and acquisitions are not expected to have much of an impact for the quarter. From an operating expense standpoint, we expect Q2 growth to be at the high end of a low double-digit rate versus a year ago on a currency-neutral basis, excluding acquisitions and special items. This includes cost of approximately 2 ppt associated with the wind down of our efforts related to the P27 project, given their decision to withdraw their license application in the Nordics. Acquisitions are forecast to add approximately 0 to 1 ppt to this growth, while foreign exchange is expected to be a tailwind of approximately 0 to 1 ppt.", "Other items to keep in mind. First, on the other income and expense line, we forecast an expense of approximately $100 million for Q2 given the prevailing interest rates and debt levels, which includes a sequential increase due to our recent debt issuance. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics. Second, we expect a non-GAAP tax rate of between 18.5% and 19% for both Q2 and the full year based on the current geographic mix of our business.", "Before I turn the call back over to Warren to begin the Q&A session, I wanted to express my deep gratitude to Warren for the thought leadership, dedication, and friendship he has demonstrated over his last six-plus years at Mastercard. As previously announced, Warren will be handing over the head of IR role to Devin Core, effective May 1, and will be with us through year-end in an advisory capacity. Thank you, Warren, and over to you for the Q&A session." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Sachin. I have to say it's been a distinct pleasure. With that, let's turn it over to questions. Audra, we're ready to go." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] We will take our first question from Lisa Ellis at MoffettNathanson." ] }, { "name": "Lisa Ellis", "speech": [ "Hey. Good morning. Thanks for taking my question. And, Warren, you will be missed, of course.", "I just had a question about FedNow coming in July. Of course, VocaLink has been involved in the clearinghouses RTP network. Can you just kind of give your perspective on how you expect the rollout of FedNow to affect Mastercard's business in the U.S. positively or potential pressures?" ] }, { "name": "Michael Miebach", "speech": [ "Good morning, Lisa. Thanks for your question. And thank you for missing Warren. So, on FedNow, important development, of course, we've been watching closely.", "As you know, for years, we've been involved in real-time payments. So, it's been our learning over the years that it's really critical that there is a proposition for merchants, there's a position for consumers for really for these systems to grow. On the merchant side, criticality is reach. And for the consumers, it's got to be a proposition that's an easy experience and it's got consumer protection in it.", "So, those are all aspects that the card systems have demonstrated over years, and we'll have to see where these P2P systems go with that. Fundamentally, we appreciate competition. It makes us a better company as we try to make our proposition even better. Now, on FedNow very specifically here, a technical go-live is different from being available for consumers and merchants, as I've just discussed, and we have to see where that goes and what the features will be, what is the user experience, what are any kind of protections that would be in there for consumers and so forth.", "We will continue to seek ways to partner with B2B systems, and the same applies here in the United States. For the flows that this might target, which are currently flows on account-to-account, you will recall the announcement that we've made in the last quarter with Chase on Pay by Account. So, those are alternative solutions that would be in the market to capture some of these new flows. So, opportunity threats, we'll have to see how it plays out.", "I think we're well positioned." ] }, { "name": "Lisa Ellis", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll go next to Tien-Tsin Huang at JPMorgan." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey, thanks. And my thanks to Warren as well. I forgot that May 1st crept up on us. I won't to ask a macro question because, Michael, I think you asked for more questions last quarter.", "So, I'll ask you one on generative AI, if that's all right. And given that you guys have --" ] }, { "name": "Michael Miebach", "speech": [ "Right." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Yes. So, I know you have a data analytics and consulting business within your PAS. And so just curious, how are you thinking about generative AI and ChatGPT gets a lot of attention. So, your thoughts on impact on PAS maybe on the broader business as well." ] }, { "name": "Michael Miebach", "speech": [ "Correct. Thank you, Tien-Tsin. This is certainly a topic that got a lot of attention, particularly since the latest model of ChatGPT was out there. [Inaudible] gets attention every day, there's a whole set of headlines.", "You know, for us, we've been using AI for the better part of the last decade, so it's embedded in a whole range of our products. Just now, I talked in my prepared remarks about Baffin Bay Networks, which you will all be surprised is actually not in Canada but in Sweden, the company. They're using AI-enabled threat protection solutions. So, you'll find it embedded in a range of our products, including generative AI.", "So, we have used generative AI technology, particularly in creating data sets that allow us to compare and find threats in the cybersecurity space. You will find AI in our personalization products. So, there's a whole range of things that we set us apart. We use this as foundational technology.", "And internally, you can see increasingly so, that generative AI might be a good solution for us when it comes to customer service propositions and so forth. So, we're actively engaged on that. Fundamentally, though, I think we all have to be aware that the application of AI needs to be done in a principled way. We approach data privacy in a principal way.", "We approach crypto space in a principled way, and the same thing applies here. So, trustworthy the AI is clearly the focus. We've encouraged our employees to experiment with the technology, but we set very clear guardrails. Don't do it in production.", "But it's something that we cannot afford to ignore. We will not. We will lean in, but make sure that we are a trusted party when it comes to scaling it up." ] }, { "name": "Operator", "speech": [ "We'll go next to Darrin Peller at Wolfe Research." ] }, { "name": "Darrin Peller", "speech": [ "Hey. Thanks, guys. Maybe you could just give a quick update on business activity. Obviously, incentives and rebates, it's not reported the same way, but I know we have a pickup in the year.", "And so, going back '15 and '16 -- 2015 and '16 when you had big incentive rebates here, it tended to be followed by an acceleration in volume and revenue growth in the years after. So, maybe just give us a sense of what's driving the increase this year? What's -- what kind of activity levels you're seeing now? And if we can expect a similar follow-through of the years to come?" ] }, { "name": "Michael Miebach", "speech": [ "Right. Darrin, let me start on that. We see a very encouraging activity. In fact, we -- it was tough to make choices here, what not to tell you in the 15-minute overview that I gave you.", "So, solid activity in deal wins. And you recall some of the bigger deals that we have announced in 2021 and 2022, which are behind some of the share gains that we're seeing, particularly if you look at the Europe numbers. So, that is having some impact on how the R&I plays out. But I'll defer to Sachin to say a little bit more.", "But overall, the activity is very healthy." ] }, { "name": "Sachin Mehra", "speech": [ "Hey, Darrin. Good morning. Look, it's like Michael said, right? I mean, we compete every day in the market. We are being successful in what we're doing in terms of winning new business and retaining existing business.", "That's very much the mantra on the table we've adopted as a company. That's a very important part of the growth algorithm, which we have laid out for ourselves to drive growth for us. Because at the end of the day, we believe very firmly that being in the flow is important because you get the benefit of PC, you get the benefit of secular shift, but you also get to deliver additional services by being in the flow. And so, really, what we are trying to do is we're trying to win profitable market share and, at the same time, drive an accretion in our overall net revenue yield, which is really about taking it together in the composite because payments and services and our new networks are very tightly integrated together.", "They -- one relies on the other, and we have to look at this from an overall net revenue yield base. So, that's really what's going on. To your specific question about rebates and incentives, look, I mean, we've always kind of shared with you rebates and incentives and be sharing with you what the rebates and incentives on our payment network are even now. The reality is, as and when deals come up, we will compete for them.", "We will do that in a smart manner. For Q2, I can tell you that rebates and incentives as a percentage of total payment network assessments, it would be roughly similar to what we had in Q1. So, based on everything we can see from a line-of-sight standpoint in terms of deals and activity and so on and so forth, that's what I can share with you at this point in time." ] }, { "name": "Operator", "speech": [ "We'll go next to Rayna Kumar at UBS." ] }, { "name": "Rayna Kumar", "speech": [ "Good morning. Congratulations, Warren and Devin. I want ask about Europe. You saw a 31% volume gain in the quarter.", "That's outstanding. Can you talk a little bit about some of the market dynamics you're seeing in that region and whether your growth is more reflective of market share gains or just strength in the overall shift to electronic payments?" ] }, { "name": "Michael Miebach", "speech": [ "Rayna, I think almost partially answered your question just now. So, deal activity is strong. But here -- to the second half of your question there, through the last three years, you saw some European markets, some large European markets that have been historically less digitized and more cash focused to really catch up. The stats I gave earlier on contactless penetration, that includes a good number of European markets jumping ahead in the ranking.", "So, strong secular shift. That's an opportunity. You start to see some of the payment service providers driving more acceptance into more parts of the economy. And that's also reflected in some of the acceptance growth that we talked about 100 million.", "A good chunk of that is coming from Europe. So, it's a mix of the share wins that we have seen very specifically in the U.K. and the secular shift. So, we feel very well positioned in Europe." ] }, { "name": "Operator", "speech": [ "And we'll move next to Bryan Keane at Deutsche Bank." ] }, { "name": "Bryan Keane", "speech": [ "Hi, good morning. Just want to ask about cross-border volume. I know it was up at 29% for the month of April -- or through April 21st. Just thinking about how that might grow throughout the year.", "Is that the right number to think about for our models? And just thinking about the Asia recovery what's left there. Obviously, we talked about China and just thinking about that business as we progress through the year." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Bryan. Look, just what I would tell you, I'd say the things to keep in mind when you're putting your model together, and this will be no surprise to you, is we did see an opening up of economies last year coming out of COVID. And as we mentioned, in Q1, we were in the base of omicron. You're starting to see that recovery kind of take place as omicron passed.", "And so, what you should expect is there are going to be lapping-related issues, which will be a headwind to year-over-year growth rate on all metrics and [Inaudible] and cross-border as well. Now, offsetting that, to some extent, would be the recovery from Asia Pacific, which is something we saw happen toward the tail end of last year coming into this year. So, there are puts and takes. I'm not going to give you a specific forecast as to what that growth rate should look like from our model assumption standpoint.", "But I think there are these important puts and takes which you've got to kind of keep into consideration as you think about cross-border. The most important thing, I think, is that the value prop we deliver through our cross-border proposition is still fundamentally very sound. This is really important. As you remember, over the last two or three years, it was being questioned as to whether cross-border was something which was going to remain challenged over the long term.", "The reality is it has come back. It has come back strong. We have positioned ourselves really well through the pandemic period, to be winning good portfolios, to be able to ride the way back up. And you're seeing the results of that come through with some really strong cross-border performance in Q1 with 35% year-over-year growth.", "And so, the reality is that cross-border proposition remains good. Just as a matter of reference, if you look at our cross-border volumes for Q1 at 168% of 2019, and you can do this math as well. The reality is that reflects approximately a 14% compound annual growth rate over the window from prior to the pandemic to where we are in Q1. And so, you've pretty much caught up the last time as part of that process, if you go back to what historical rates in cross-border work.", "So, I kind of wanted to share that with you in terms of how we see cross-border going forward." ] }, { "name": "Operator", "speech": [ "We'll move next to Sanjay Sakhrani at KBW." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks, good morning. I guess, I know you're not changing your views on the macro for the rest of the year, but you're monitoring the situation. Maybe you could just give us a little bit more color if we parse underneath the covers. Just what gives you the confidence things are stable despite the slowing in April -- March and April and then, sort of the forward look on the spending trends in cross-border? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. Hey, Sanjay. Look, I mean, at the end of the day, what we see is what you see from a consumer spend standpoint. And we have our best estimates as to what we kind of think that looks like on a go-forward basis.", "Like Michael said, there are positive and negative factors. The health of the consumer remains strong, backed by record-low unemployment rates, and that gives us a level of confidence. On the flip side, you've got the headwinds which come along with higher interest rates, more recently the banking crisis, which we're all going through. And we have no idea as to what the implications of the banking crisis are going to look like on a go-forward basis.", "So, our views in terms of the strength of the consumer remains pretty much unchanged. There are puts and takes by region. And based on the fact that, at this point in time, there's no real evidence to see that the consumer is not showing good strength from a spend standpoint. They're in good shape.", "The year-over-year growth rates, like I mentioned earlier, are going to change. You're going to see the lapping effect of that come through because of the recovery last year. That's got less to do with what spend levels this year are as compared to anything else. And it's on the base of that that we have modestly increased our full-year guide on a currency-neutral basis, excluding acquisitions, to reflect the fact that we had a stronger Q1.", "And we feel like, overall, from a consumer health standpoint, our assumptions are relatively unchanged between what it was one quarter ago toward where we are right now." ] }, { "name": "Michael Miebach", "speech": [ "One thing to add here, I'm just looking at my phone here, can you imagine in the conference call, but it was the reporting of the Quarter 1 GDV numbers. And if you look into that, there is -- the consumer does stand out positively. So, the resilience even in that number is reflected. I think -- the point on that I mentioned earlier on the impact of stresses on the banking sector, that's another one that we did talk about.", "And here, if you think about what does this mean in terms of potentially additional regulation, what it means in terms of credit appetite for banks and self-host, those are all not near-term effects that we're -- we can judge at this point in time. So, some of the outlook that we are taking here is a near-term outlook for the year, and we'll have to see how things develop over time. Again, flexibility and agility is critical. And so, we feel ready for all of that." ] }, { "name": "Operator", "speech": [ "We'll move next to Harshita Rawat at Bernstein." ] }, { "name": "Harshita Rawat", "speech": [ "Hi, good morning. I have a question on value-added services. Can you unpack the competitor set for these different services, cyber intelligence, data services, other and kind of highlight Mastercard's opportunity to increase penetration of these services within existing client base and also continue to get new clients? And just as a follow-up. Sachin, if you can also remind us of the profitability of value-added services versus your business and network business, that would be great.", "Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Harshita, let me start on this. So, first on the competitive landscape. As Sachin was saying earlier, our services strategy is closely tied in with our payment strategy. So, we're not your average service competitor as in a cybersecurity company that competes with a bunch of other cybersecurity companies.", "We are somewhere in the middle between bolts and being in the flow gives us additional data points that makes us a fairly unique competitive landscape for us, which is why we like the combination of both. But it's very specifically on cybersecurity. You have a whole set of specialty players Baffin Bay was a specialty player, and yet, we're dealing in threat protection. As we were ourselves with RiskRecon before, it's just a slightly different angle of that.", "So, we are very aware of the wide competitive landscape here, but our position, I think, sets us apart. Now, there's other potential comes closer to the payment space. So, looking at services as well. So, we're trying to keep our services set differentiated and ahead of the curve.", "It's the same thing for data and services. Yet again, a lot of data and SaaS companies that are building their businesses. But on the other hand, we have a captive set of customers today, and we have a captive set of transactions of these customers that these companies want to understand and whether they come to an integrated provider that helps them with both. So, that's, again, a unique position for us to look at.", "I think dynamic yield and how we're combining that with our data set, as I referred to my earlier remarks, I think it's an excellent example of that. So, that's the competitive landscape that we're looking at. It's a fast-moving one, so we have -- we will continue to have that in focus." ] }, { "name": "Sachin Mehra", "speech": [ "Hey, Harshita. I'll just add a couple of thoughts to what Michael said. I'll get to your question around how the financials play out for -- what we on the services side. So, a couple of things.", "One, just even adding to what Michael said, structurally, if you think about how the world is going more digital and as the world goes more digital, there is going to be likely increasing fraud-related issues which come on increasingly digital world. There are structural tailwinds which we feel good about. And so long as we can continue to grow our portfolio to ride those structural tailwinds is another piece which helps us think that there is good runway on services. The second piece, which Michael said, which was around data and the power of data is one of the ingredients which makes us successful across both C&I and D&S.", "But then there are others, which is do you have the technology? Do you have the AI capabilities? And can you seamlessly deliver this to your customers so that there isn't big implementation challenges? All of which when you think about our network play allow us to do that in a very efficient manner, which is what's been helping us drive the kind of growth we've seen. On your question on the financials, I will tell you that, I mean, there's a range of what I would call incremental costs, which come depending on the nature of the service we deliver. So, things which are more, I would say, attached to the payment network, such as some of our cyber and intelligence solutions, some of our data solutions, they tend to come with lower incremental cost. There are others such as our consulting capabilities, such as our marketing service capabilities, they come with a little bit higher in the nature of incremental cost.", "And so, the overall mix is really important because they all kind of hang together. It's important for us to provide those consulting services and marketing services in order to be able to be a full service provider to our customers. And that's only speaking about services. Now, when you take that and you kind of tie that back to how it helps us win market share and payments, that's the other piece which is super important as part of this because the economics need to be thought about in the composite as opposed to each one of these services individually." ] }, { "name": "Operator", "speech": [ "We'll go next to David Togut at Evercore ISI." ] }, { "name": "David Togut", "speech": [ "Thank you. Good morning. Last summer, London Heathrow Airport put some severe capacity limits on airlines. Those limits came off a while back, but I'm curious whether you're getting any indication on advanced cross-border summer travel as things opened up a bit more at Heathrow.", "And how can we think about the impact on cross-border revenue for the rest of this year?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure, David. What I'd say, I'd say you hear what we hear as it relates to what the airlines plans are from a capacity release standpoint. And the reality is, I think everybody is trying to kind of find that right balance between bringing on more capacity and what the implications for the price proceed is as part of that process. And so, we feel generally good about the prospects of travel.", "I mean the reality is there's a trend from the consumer toward more spending on experiences. Experience tends to be travel and entertainment-related stuff. And so, generally speaking, that trend is going in the right direction. As more capacity comes on, which we expect will happen, right, you will tend to see the benefit of that come through in our cross-border travel metrics.", "Again, I would remind you, strong value prop, year-over-year lapping issues, which are there from a year-over rate as a standpoint. And then the third piece is we have the potential for recovery in Asia Pacific. And I wanted to kind of bring that whole thing into the picture beyond the capacity question you asked." ] }, { "name": "Michael Miebach", "speech": [ "So, hard to predict -- hard to predict, but the fact is, capacity isn't fully back. So, that's one important aspect when we gave you the outlook later on." ] }, { "name": "David Togut", "speech": [ "Understood. And just as a quick follow-up on Europe. Just your updated thoughts on the rollout of ACH payments in Europe under open banking would be appreciated." ] }, { "name": "Michael Miebach", "speech": [ "Right, David. So, let me take a look at that. Conversations in Europe have been going on for years on ACH systems. As you know, when the U.K.", "was part of the EU -- I don't even know if it's Europe right now or not, but we invested in Vocalink. So, we have a counter account systems in Europe for a long time. We're having some stakes in other P2P systems on the continent and so forth. The most late -- the most recent development here is the announcement around the European payment initiative, which is yet another effort in account-to-account.", "Europe is the land of domestic systems and domestic payment solutions. It's a very versatile competitive landscape, and there is more coming. We have found ways to partner. We have found ways to compete.", "And in the case of EPI, we are partnering with the owner banks to push our solutions. At the same time, we'll have to see where EPI goes, and then we stand ready to engage one way or another depending on their willingness. As you can see, Europe has been a source of share growth for us and revenue growth, so we know how to play this environment." ] }, { "name": "David Togut", "speech": [ "Understood. Thank you." ] }, { "name": "Operator", "speech": [ "We'll go next to Ramsey El-Assal at Barclays." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi, thanks for taking my questions. And best of luck to Warren in his future endeavors. My question is for Sachin. I wanted to ask -- you called out tax refunds a couple of times just weighing on U.S.", "volumes sort of more recently. Should we think about that as normalizing into Q2? Does it flip to more of a tailwind? And then, I guess, secondarily, how do you see the spread, which is pretty wide between U.S. and worldwide metrics trending this year, ex Russia? Will it stay pretty wide? Will it tighten as maybe tax refunds normalize? How are you looking at it?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. Look, I mean, the data we look at for what we're seeing from a tax refund standpoint is what we see on the IRS website, right? And so, you can take that for what it's worth because that's the insight we've kind of garnered. And what we've seen is that the tax refunds tend to happen mostly in this window around, call it, March and going into April. So, we view this impact of the lower tax refund to be relatively transitory.", "And I say that only because as the year progresses, if there were lower tax refunds, the implications of that would be minimal just because the vast majority of the refunds happen around the period we're talking about right now. So, that's why we use them as being transitory. The other thing to keep in mind is on account of some of the natural which have taken place, there are some states in the U.S., which have -- where from a federal tax standpoint, they've been given more latitude in terms of what the tax filing date is. And so, that's the other thing to keep in mind in terms of what the potential might be for a catch-up on some of these lower tax free funds.", "Again, very hard to predict, but I want to kind of bring those two pieces out there. On your second question on U.S. versus rest-of-world trends, at the highest level, I'd tell you, I feel pretty good about what we are seeing on our overall operating metrics. I mean, these are pretty compelling operating metrics from a growth rate standpoint.", "You've got 15% credit growth taking place in the U.S. It's being driven in a large part by just consumers' desire to get back to experiences. Our portfolios, our co-branded portfolios, our travel portfolio are performing very well. And again, if you kind of were to think about the go forward, the reality comes back to the broader questions we were talking about how do we feel about drivers from a domestic spend standpoint and the cross-border spend standpoint.", "All of that will manifest itself in terms of what U.S. volumes look like going forward. On the rest-of-world side, obviously, we've got some really good metrics there as well, both across debit and credit. And you're seeing the impact of some of our market share wins in those metrics.", "As the year progresses, you're going to start to see the impact of that market share on some of the players start to tail off just because you'll be reaching the lapping stage on that. So, you need to keep that in mind. That should help you kind of model out as to how the gap between the U.S. and the rest of the world plays out as we progress through the year." ] }, { "name": "Ramsey El-Assal", "speech": [ "Super helpful. Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "We'll go next to Andrew Jeffrey at Truist Securities." ] }, { "name": "Andrew Jeffrey", "speech": [ "Hi, good morning. Appreciate you taking the questions. Michael, I'd like to ask you about the India opportunity and specifically the potential inclusion or inclusion of Mastercard credit products and UPI. I just wonder if you could frame that up so much talk about rest-of-world growth in cash-based economies and especially those in which perhaps account-funded wallets have moved to the four.", "Can you just dimensionalize or give us an update on your India positioning?" ] }, { "name": "Michael Miebach", "speech": [ "Right. So, India is a hugely important market for us. We have a large number of our employees based in India, serving the Indian market, as well as other markets in Asia, deep engagements with customers there. It's interesting when you look at the market from where it has gone, under the lead of India's government, they've built a tremendous digital economy.", "So, the India tech stack has really opened up the digital economy at a much, much different scale than before, and we like that. That gives you opportunities for us to engage with our customers, to many more Indian citizens. So, we generally see that opportunity. It's also true, though, that today, everyday solution around debit and credit matter.", "And we have -- now we reached -- we're back to pre-embargo growth on the issuing side with our customers in India. So, that is looking very, very positive. We're back in the market there. So, we're playing both of that.", "It's a market where we'll see more innovation coming from us of the folks that are based there. So, there isn't a financial inclusion opportunity. There's an everyday opportunity in credit and debit, and it's now the most populous country in the world. So, it's going to be the theatre of the future, and we're excited to be involved there.", "Where is all the engagement going with the India tech stack? What does it mean for our cards? And how will cards be linked into UPI and so forth? The details have yet to be seen, but we're active in those conversations. And in the end, when we have an opportunity to partner, then we will try to do that." ] }, { "name": "Andrew Jeffrey", "speech": [ "OK. I look forward to tracking that. Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Audra, we have time for one more call -- question." ] }, { "name": "Operator", "speech": [ "And we'll take that from Jason Kupferberg at Bank of America." ] }, { "name": "Jason Kupferberg", "speech": [ "Hey, thanks, guys. Maybe just building on that last question a little bit. You just talked about India to some extent. But which emerging geographies are you most excited about over, say, the next five years or so just in terms of the general cash-to-card opportunity?" ] }, { "name": "Michael Miebach", "speech": [ "Right, Jason. So, here, the opportunity, I wouldn't really point to a particular geography. I think generally, the set of countries that have a lower digitization rate is a tremendous opportunity for us. We have learned how to drive digitization.", "Just look at Latin America. You take like a country like Mexico, tremendous opportunity in terms of driving digitization up. And part of that we have seen in Brazil. So, you can start to make those comparisons, and you add that up across the wood that is a tremendous opportunity.", "In terms of large-scale country opportunities, we just talked about India and certainly not in the category of emerging markets, but China is a market that we are very engaged on today in the cross-border business. And you do know that we have a license application out there to participate in the domestic market, and we stand ready to invest forward with the Chinese consumers and businesses. So, we'll see where that one goes." ] }, { "name": "Warren Kneeshaw", "speech": [ "Great. Thanks, Michael. Any final comments?" ] }, { "name": "Michael Miebach", "speech": [ "I do have final comments. So, I've made it a habit to thank the 30,000 people at Mastercard for what they did, what they all do. And I shall do that again for this quarter. I thought it was a good quarter, and it is reflective of their work.", "But I do want to thank you as well, Warren. So, it's been fun three years for me and previously with Ajay. So, thank you for everything that you did. I know we all talk about you.", "I do want to talk about Devin as well. So, if you could picture us here in this room, here's Devin, and we're looking forward, Sachin and I, to work with you. And I do want to say, Warren has -- you have built a tremendous set of relationships with the folks on the call. And I look to those folks on the call, first of all, thanking you guys for your support, but also to give Devin the same kind of support that you have in the past.", "With that, thank you very much and speak to you one quarter from now." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2019-07-30	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "President and Chief Executive Officer", "name": "Ajay Banga", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "General Counsel", "name": "Timothy Murphy", "position": "Other" }, { "description": "Cowen & Company -- Analyst", "name": "Georgios Mihalos", "position": "Analyst" }, { "description": "Tsin Huang -- JP Morgan Chase & Co, Research Division -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Keefe Bruyette & Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "James Schneider", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Moshe Orenbuch", "position": "Analyst" }, { "description": "William Blair -- Analyst", "name": "Robert Napoli", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Donald Fandetti", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mastercard Second Quarter 2019 Earnings Conference Call. [Operator Instructions]", "I would now like to turn the call over to Warren Kneeshaw, Head of Investor Relations. Mr. Kneeshaw, you may begin." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Brandy. Good morning, everyone and thank you for joining us for our second quarter 2019 earnings call. With me today are Ajay Banga, our President and Chief Executive Officer; and Sachin Mehra, our Chief Financial Officer. Following comments from Ajay and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session. It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning.", "Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted. As a reminder, starting this quarter, we have updated our non-GAAP methodology to exclude the impact of gains or losses on our equity investments. We are excluding these items as we believe this will facilitate a better understanding of our operating performance and provide a meaningful comparison of our results between periods. For the three and six months just ended, net gains of $143 million and $148 million have been excluded. Prior year periods were not restated, as the impact of the change was de minimis. The non-GAAP measures also exclude the impact of special items, which represent litigation judgments and settlements and certain one-time items. In addition, we present growth rates adjusted for the impact of foreign currency. Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts.", "Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days.", "With that, I'll now turn the call over to our President and Chief Executive Officer, Ajay Banga." ] }, { "name": "Ajay Banga", "speech": [ "Thanks, Warren, and good morning, everybody. So our strong performance continued this quarter, revenue was up 15%, EPS was up 17% versus the year-ago on a non-GAAP currency-neutral basis as Warren just said. These results reflect the continued execution of our strategy as we invest for long-term growth.", "On the macroeconomic environment, consumer sentiment and spending remains relatively strong with some moderation versus 2018 as expected. We are continuing to monitor ongoing trade negotiations and other economic and geopolitical factors, which are showing signs of weighing on business sentiment in particular. In the US, we are seeing continued growth; low unemployment, healthy consumer confidence. Retail sales grew 3.2% versus a year ago ex auto, ex gas, according to our SpendingPulse estimates, and that reflects some moderation from Q1 and from last year. In Europe, the outlook is mostly unchanged as we continue to see modest growth. UK retail spending remains healthy, although it has slowed somewhat from Q1 according to our SpendingPulse estimates, and of course the uncertainty around Brexit remains.", "In Asia Pacific, trade tensions continue to weigh on business sentiment, particularly in China. We are however seeing improved consumer confidence and more accommodative monetary policies in several markets there. And the outlook in Latin America continues to be mixed as growth in markets like Brazil, Colombia and Chile are partially offset by weakness in Argentina and Mexico. Meanwhile, we continue to drive healthy double-digit volume in transaction growth for Mastercard across most of our markets by successfully executing against our strategy. I'm going to give you a few examples of how we are growing our core business, diversifying our customer base and building new areas for our business.", "So starting with growing our core. We continue to make good progress driving growth across our credit, debit, prepaid and commercial products, and we are expanding acceptance across both physical and digital channels. We expanded a number of important issuer relationships in the credit space, including National Commercial Bank, the largest bank in Saudi Arabia, where we secured full exclusivity across their credit, debit, prepaid and commercial business, along with flipping their credit portfolio. We also signed a new consumer and small business co-brand partnership in the US with Houzz, a rapidly growing online home remodeling marketplace. And we won a 10-year exclusive co-brand credit deal with Despegar, a leading online travel agency in Latin America in 5 new markets across the region, as with the many of our other co-brands, Despegar will integrate our loyalty program into their offering to deepen their customer engagement. In Germany, we have renewed our credit relationship with DZ Bank, the second largest retail banking group in the country and they represent hundreds of cooperative banks across the country and they will continue to issue Mastercard cards to their customers.", "Turning to debit, we signed an agreement in the UK with nationwide, who selected us as their business debit card provider, due to our experience in the small business pace and our demonstrated expertise of working with FinTechs. So nationwide plans to launch a new business banking proposition to over 5 million small businesses in the UK, early next year. In Colombia, we were in exclusive debit partnership with Scotiabank and secured long-term debit agreements with Bancolombia and Davivienda, the 2 largest debit issuers in the country. And in Germany, we extended our long-standing partnership with the German Savings Bank Group, Sparkassen. Collectively these debit renewals leverage a series of Mastercard services to help drive contactless adoption, advanced digital security and accelerate the migration of Maestro, debit Mastercard.", "In terms of the Secure Remote Commerce initiative, we are making good progress in June, and we go launched the new SRC payment icon and technical specs. We are currently testing SRC end market with issuers and merchants. We are actively working on MasterPass upgrades to SRC with partners like Tickets.com., Expedia Group, Saks 5th Avenue and Norwegian Cruise Line. And we expect to launch in the United States in the next few months. And then we have developed the Mastercard Digital Wellness program, which will provide merchants with access to a host of technologies and resources, including extensive compliant collects to be a check out, but most importantly added security through tokenization and AI technology, along with cyber security resourcing to combat online tax. We are working with payment processors and platforms such as Worldpay, Square, Adyen, Stripe, and of course our own Mastercard Payment Gateway Services to make these unique features through the Mastercard Digital Wellness program available to merchants.", "So let me turn now to the second pillar of our strategy, where we are continuing to diversify our business by expanding across new geographies and customers. An example in India, where as you know, we are building partnerships with local retailers and issuers to help drive growth and further develop the payment ecosystem. We are pleased to launch an exclusive credit co-brand program with Flipkart, the largest online retailer in India. In addition, Paytm Payments Bank has signed a new issuance agreement with Mastercard. We've also established a new acquiring relationship with them to drive open-loop acceptance with them in that market in India. Paytm will also be using our self-capability to enable credit card bill payments.", "By leveraging our assets to design unique solutions for specific verticals, such as the growing gig economy. We were selected as the network for the Lyft Direct Mastercard Debit Card, which provides Lyft drivers with instant access to their earnings. Elaborating with evolved bank and trust and branch, who will issue Mastercard prepaid cards and will utilize Mastercard Send to help their corporate customers provide interest fee pay advances to their already workers. And in Mexico, we've partnered with Uber and BBVA to provide a new Mastercard debit card for Uber drivers.", "Working in the FinTech space, I believe we just continue to lead that they've established a series of successful partnerships with FinTech around the world, who value the services we provide as well as our solution selling approach. This quarter we signed a deal with Railsbank to bring new consumer and commercial Debit Card programs to market in the UK. And in Brazil, we are working with digital bank, BanQi and Via Varejo, to offer a new digital prepaid card targeting there approximately 60 million customers.", "So now onto the third pillar of our strategy focused on building new areas for our business. We have developed and acquired, as you know, a broad set of capabilities, which together with our existing card rails, allow us to differentiated offerings, address new payment flows, and most importantly operators are one-stop shop for our customers. And let me give you a few examples. First, we recently announced a partnership with P27 Nordic Payments Platform owned by six of the largest banks in the Nordics, provide a leading edge real-time and batch multi-currency payment platform across the region. This new platform leverages our Vocalink assets will replace the existing payments infrastructure and provides instant and secure payments across the region. And I believe this partnership represents another milestone in our strategy to offer customer choice in the form of real-time, account to account payments infrastructure, applications and services and build there are series of wins across Latin America, Asia-Pacific and the Middle East that I've highlighted to you over the last few quarters.", "Second, we continue to build additional debt and scale in our cross-border capabilities, which already allow us to dispose payments across bank accounts, mobile wallets and cards, all through a single API. For example, we just completed the acquisition of Transfast, which will not only enable us to service a greater number of markets and end points for our customers, but Transfast by the way allows us to reach over 90% of the world's population, but also provides a suite of leading compliance, FX, messaging and licensing capabilities to address many of the cross-border pain points that exist today.", "We are executing on our cross-border strategy through a new partnership agreement with Interac in Canada, which leverages our Mastercard Send push payment capabilities to allow Canadians to send money internationally across Interac's e-Transfer platform. The National Bank of Canada will be the first issuer to launch this new international remittance solution. We're developing new capabilities to penetrate the bill payment space and completed the acquisition of transactors to accelerate our go-to-market strategy for the Mastercard bill pay exchange. Transactors offer the unique combination of technical assets, distribution partnerships and customer relationships, which when combined with our current Bill Pay Exchange capabilities will allow consumers to view, manage and pay bills across multiple payment methods and channels, whether we are real-time account to account payments or card rails on your mobile banking app or through a business website.", "And finally in B2B, we announced a partnership to integrate our Mastercard tracked with the OpenText supplier portal to help buyers and suppliers in the automotive industry, streamline and digitize financial supply chain processes to increase the speed, compliance and security associated with business information, payments and financing.", "So with that let me turn the call over to Sachin for an update on our financial results and operational metrics. Sachin?" ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Ajay, and good morning, everyone. So turning to Page 3, you will see we continue to perform well. Here are a few highlights, on a currency-neutral basis, and excluding both special items related to certain legal matters, as well as the impact of gains and losses on the company's equity investments. Net Revenue grew 15%, driven by solid momentum in our core, and was slightly ahead of our expectations due to stronger services growth. Acquisitions contributed a minimal amount to net revenue in the quarter. Total operating expenses increased 17%, which includes a 2 ppt increase related to acquisitions and a 5 ppt increase related to the differential in hedging gains and losses versus year ago. The remaining 10% relates to our ongoing investment in strategic initiatives. Operating income and net income each grew by 15%, reflecting our strong operating performance, and", "each includes a 1 ppt reduction due to acquisitions. EPS was $1.89, including a $0.02 drag related to our recent acquisitions. EPS growth was 17% year-over-year, with share repurchases contributing $0.04 per share. During the quarter, we repurchased about $1.9 billion worth of stock and an additional $493 million through July 25th, 2019.", "So let's turn to Page 4, where you can see the operational metrics for the second quarter. Worldwide gross dollar volume or GDV growth was 13% on a local currency basis, up 1 ppt from last quarter, in part due to the ramping of co-brand wins in the US, as well as fewer processing days in Q1. US GDV grew 10%, up approximately 2 ppt from last quarter with credit and debit growth of 12% and 8%, respectively. Outside of the US, volume growth was 14%, up 1 ppt from last quarter. Cross border volume grew at 16% on a local currency basis in line with expectations and driven by double-digit growth in all regions.", "Turning to Page 5, switched transactions continued to show strong growth at 18% globally, reflecting in part the continued adoption of contactless. We saw healthy double-digit growth in switched transactions across all regions. In addition, card growth was 6%. Globally, there are $2.6 billion Mastercard and Maestro-branded cards issued.", "Now let's turn to Page 6 for highlights on a few of the revenue line items, again described on a currency neutral basis unless otherwise noted. The 15% net revenue increase was primarily driven by strong transaction and volume growth, as well as growth in our services offerings, partially offset by rebates and incentives. Looking quickly at the individual revenue line items, you'll see that domestic assessments grew 13%, in line with worldwide GDV growth of 13%. Cross-border volume fees grew 19%, while cross-border volume grew 16%. The 3 ppt difference is mainly driven by pricing, partially offset by mix. Transaction processing fees grew 15%, while switched transactions grew 18%. The difference is", "primarily due to mix. Finally, other revenues were particularly strong this quarter, up 24%, driven by growth in our Cyber and Intelligence and Data and Services solutions. Acquisitions contributed 2 ppt to this growth.", "Moving to Page 7, you can see that on a currency-neutral basis, excluding special items, total operating expenses increased 17%. As I just said, this includes 7 ppt related to acquisitions and the differential in hedging gains and losses versus year ago. The remaining 10 ppt of growth relates to our continued investment in strategic initiatives, such as digital", "enablement, safety and security, and geographic expansion.", "Turning to Slide 8, let's discuss what we've seen through the first three weeks of July, where each of our drivers are at or slightly ahead of what we saw in Q2. The numbers through July 21st are as follows. Starting with switched volume, we saw global growth of 16%. In the US, our switched volume grew 13%, up 1 ppt from the second quarter, due to the timing of certain social security payments this quarter. Switched volume outside the US grew 19%, also up 1 ppt, primarily driven by Europe. Globally switched transaction growth was 19%, a sequential increase of 1 ppt, primarily driven by the US and Europe. With respect to cross-border our volumes grew 16% globally, similar to the second quarter.", "Looking ahead, our expectations for 2019 are consistent with our prior estimates. We had a solid first half and we continue to grow our business both in terms of new and renewal deals, as well as with our service offerings. We continue to see healthy consumer spending with some moderation versus year ago as expected. In terms of net revenue, on a currency-neutral basis and excluding acquisitions, we continue to expect to grow at a low teens rate for the year. On the same basis for the third quarter, we also expect to grow at a low teens rate because of a sequential increase in deal activity as well as some moderation of services growth versus a very strong Q2. We expect FX to be a 2 ppt headwind to revenue for the year and about 1 ppt to 2 ppt headwind for the quarter. In addition, acquisitions will add about 1 ppt to third quarter revenue growth.", "For operating expenses, on a currency-neutral basis, excluding both special items and acquisitions, we continue to expect growth at the high-end of high-single-digits for the year. On the same basis, for the third quarter, we expect growth in the mid-teens versus year ago due to the timing of marketing spend, which is more heavily weighted to Q3 this year, as we promote contactless usage and invest in sponsorships. Year-over-year FX will be a tailwind to opex of about 1 ppt for both the year and Q3. In additions, acquisitions will add about 5 ppt to third quarter opex growth. As a reminder, we issued $2 billion in debt at the end of May, and this will impact our interest expense run rate going forward. In terms of the tax rate, we now expect it to be approximately 19% for the year.", "With that, let me turn the call back to Warren to begin the Q&A session ." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Brandy, we're now ready for the question-and-answer session." ] } ]	[ { "name": "Operator", "speech": [ "[Operator Instructions] Your first question comes from the line of George Mihalos with Cowen." ] }, { "name": "Georgios Mihalos", "speech": [ "Congrats on another strong quarter. Ajay, I wanted to ask a question, you brought up contactless is that, obviously that's been a good driver. How long does it take when you introduce contactless, or how long do you think it will take as you introduce it in sort of a new geography for it to really peak up and meaningfully drive, I guess accelerated growth?" ] }, { "name": "Ajay Banga", "speech": [ "So contact has basically targets low value cash transactions as the first place that it kind of changes the paradigm. And the speed of adoption, although, we've got our 10, 12 markets around the world where contactless has grown very strongly, Australia, Canada, Turkey, Poland, Hungary, and the likes, UK, it depends a great deal on how many cards are in the market that are contactless-enable combined with contactless terminals, combined with the used case for every day payments. So if transport system gets contactless-enabled, it tends to ramp faster. If it doesn't, it tends to ramp slower. So, if we take Australia as an example, where the bank fee acquirers and the merchant community worked really hard together on promoting contactless. It went from non-existent to being like close to 80% of all transactions under AUD100 were contactless in 4 years to 5 years after launch. If it was not that case in other markets, but I'd say 4 years, 5 years to get to a very large percentage of small dollar transactions with all the effort in the market is a pretty good number." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please?" ] }, { "name": "Operator", "speech": [ "Your next question comes from Tien-Tsin Huang with JP Morgan." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hi, thanks. Good, good growth here again. Just, if you don't mind, a couple of quick ones. Just on the stronger services growth, maybe can you be more specific. You mentioned cyber and data. And I'm curious if these are project-related or more recurring type work, it's just little bit more there. And then just on the payback on your M&A, I know you get that third quarter outlook, which is helpful. Is the payback on those types of deals, outside of the traditional retail card space and bill pay and etc., is it different than what we've seen in the past? Thank you." ] }, { "name": "Ajay Banga", "speech": [ "Hi, Tien-Tsin. Let me take the first part and then Sachin being far more comprehensive on numbers and probably correctly, but here we go. The first part is the services revenue, a lot of the cyber revenue has recurring competence built into it, because it involves the selling of AI and other products that are sold into banks and merchants and governments in a way that they tend to have reutilization quarter-after-quarter. What would change is it the volumes going through them change, and our revenue profile from them will obviously change, because it's not dissimilar to our card business and that is a volume goes through our cards, we have more. That's kind of the first part.", "What is improving our capability in cyber and intelligence aside from our own efforts that developing new tools and the acquisitions of Brighterion and new data and the work we're doing well was improving, it is, we now see a much larger percentage of our transactions than we used to 10 years ago. We are now seeing 55%, 56% of our transactions. It is to be 40-something percent, every time you see more transactions, the predictive power of your AI tools improves. So that's kind of the -- the second part by the way impacts some of our data business as well. But on the C&I space, it tends to be more recurring.", "The data and services space, some aspect for them are recruiting, some of them are one-off projects. Sachin referred to the fact that you should expect that the third quarter, it sounds maybe a little slower in growth than the second quarter primarily caused by the fact that the 2Q had enormous growth rates, but part of that is lapping of our comparison to prior year, but part of that is some projects in part of our business, like in D&I. So I'd kind of the -- D&S, sorry, though it could be the acronyms confusing, the data business. And so you've got a mix inside our business, where the cyber business is more recurring, the data businesses are fairly high proportion of recurring, but it doesn't have some project-related work as though." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. And Tien-Tsin, I'll just add to that, so like Ajay said, right, so in the second quarter. First, this number moves around quarter-to-quarter, as you've seen, even last year in the first quarter of last year, we had very strong services growth take place. And that's a little bit of function of what are the projects, which are being delivered in a particular quarter, which cause for things to move between quarter-on-quarter, and that's particularly on the advisors side. So I would tell you in the second quarter, our advisors growth came in slightly stronger, which would be what -- in line with what Ajay said on the consulting side of our business.", "On the second body of question, on M&A, look, I mean, we've shared with you what we think the dilutive impact will be for the acquisitions, which have been completed. The couple of things, which I remind you is the acquisitions are closed during the course of the second quarter. There's one acquisition which is Transfast, which closed early in the third quarter. So all of that has been taken into consideration, as we think about what our outlook for acquisitions is. We continue to expect that our acquisitions will be dilutive between $0.07 and $0.08 in 2019. And as it relates to the revenue profile, these acquisitions are across different lines of what we do. So for example, the acquisition of Ethoca, which is in the safety and security space will follow a little bit more from a revenue model standpoint along the lines of what Ajay just described. Then there are other businesses such as transactors, which is in the bill payment space, where it's a function of what kind of engagement volume we get off, though presentments coming into the business and how we charge on the basis of that. So that will be more in the nature of -- part of bill presented, what kind of transaction fees we charge on those bills." ] }, { "name": "Ajay Banga", "speech": [ "Hi, Tien-Tsin, there's nothing change in our basic M&A philosophy, which is 2 philosophies remain; one being we try and make sure that the dilution stops by year 2, and therefore becomes accretive in the third year. Secondly, remember that by the second year, the business is embedded in the core of whatever business we are running, and therefore we don't do an ex-acquisition after the second deal, which means the discipline on buying something and making it work for you by the end of the second year is now fairly strongly embedded in every business line in the company." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please?" ] }, { "name": "Tien-Tsin Huang", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Sanjay Sakhrani with KBW." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks, good morning. I have a question on Europe. The growth in the region continues to remain robust and has been for some time. Could you talk about how long you expect that to persist, because I know you've had some fintech wins and Maestro conversions that have helped. And then maybe you could also speak to any visible impacts from Brexit? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Sanjay, I have been saying this, since the day I became CEO, that Europe is a growth market for our company. It's now almost 10 years. I see no reason to change that prediction. Europe is a cash dominant market in large parts of the continent, even now. And therefore the opportunity to convert cash in personal payments remains strong and healthy. To give you an example, just in quarter one of 2019, that's the first quarter of this year, we grew merchant acceptance locations in Europe by 10% over the prior-year first quarter. And so this is not a developed payments market in the sense -- having said that, the Nordics are developed, don't get me wrong. I'm talking about most of Continental Europe has got enormous opportunity for growth as we have best market share growth as well, which is share growth, not just against our large global competitors, but also against local, national schemes, all of whom are finding it hard to keep pace with technology, innovation and regulation trends and therefore they tend to come to us for helping the systems and that allows us to get a stronger foothold even in their businesses. And so and this is all have done with commercial and B2B, and there is yet another space in the SME and B2B space in Europe that we are growing. So fintechs yes, of course, regular banks, yes, of course, that's the share growth angle. But just think in terms of cash and acceptance and B2B payments, there's an enormous opportunity even now in Europe, and I remain very bullish on what Europe is capable of doing." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question --" ] }, { "name": "Ajay Banga", "speech": [ "Forgot to answer. I forgot to answer the Brexit impact for Sanjay. And nothing directly yet, I mean, it's interesting the UK still remains a market where people seem to be spending and growth and spending remains healthy. So I can't tell you that I'm seeing direct impact to there, but just what the currency is volatile, obviously you expect that as we get closer to October 31st, if there isn't clarity, you're going to get more volatility in the market. But consumer spending is still healthy, inbound and outbound cross-border flows are pretty interesting yet, still I think in fact, inbound is stronger than outbound, but you know the UK still remains an attractive market." ] }, { "name": "Warren Kneeshaw", "speech": [ "So, next question." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Jim Schneider with Goldman Sachs." ] }, { "name": "James Schneider", "speech": [ "Good morning. Thanks for taking my question. I was wondering, if you could maybe just comment on the -- what you did before relative to transactions process growth. It seems like the big drivers there have been, first of all, the move to contactless, but also the reduction in Maestro Cards. Can you maybe just kind of give us a sense about whether there is any reason to believe that level of growth in the high teens is not sustainable from here. Since it's pretty much at the highest level, it's been and I think the last 5 years or 6 years? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. So Jim, I'll take that one. I think you should think about our switched transaction growth across the vectors, which you just spoke about, which is as we continue to drive contactless adoption that's going to be a helpful fact in terms of driving growth on switched transactions. The other piece is, obviously the migration which we're doing from Maestro to debit Mastercard, which should be helpful, but then these which we should also remain focused on is you will see over the years, the percentage of switched transactions for Mastercard as a company has increased and that continues to remain a focus area for us, which is how do we continue to engage to drive more switching over our network, vis-a-vis that of local scheme. So all of these factors are helpful facts in terms of driving switched transaction growth. Those are, I think is which -- I would keep a close eye on as it relates to what's the trajectory of growth would look like on a going forward basis." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Lisa Ellis with MoffettNathanson." ] }, { "name": "Lisa Ellis", "speech": [ "Hi, good morning guys. Ajay, I wanted to follow up on your call out that Mastercard designed an issuing agreement with Paytm in India. It seems like we're seeing an increasing number of examples of this where the digital wallets are issuing debit cards against the balances, which seems like a pretty significant competitive shift in the environment relative to a couple of years ago where many of these players would have been at least aspiring to compete with Mastercard. So can you just talk about this competitive dynamic has it in fact shifted like this, are you seeing this more broadly across the developing markets and how is working with these players a little bit different than your traditional banking customers? Thank you." ] }, { "name": "Ajay Banga", "speech": [ "So Lisa, lot of these guys, at the end of the day, some of them start out by trying to find a way to use bank account to account rails, as we have generating payments. The factors that in so many markets around the world, debit interchange -- our MDRs are regulated, and therefore the economic benefit of going account to account versus going on a debit card has changed quite dramatically over the last decade. And in order used to be in 1 or 2 market incident of regulation has spent quite far on debit. A lot of the Asian markets, India as an example has regulated debit card MDR. And therefore the benefits -- the economic benefits have moved around. As we have in the US, where debit interchange is regulated. And so as that economic benefit has changed, the tonality of the conversation has changed vis-a-vis card rails versus account to account rails.", "Meanwhile, we ourselves as the company have adopted the view that offering choice to consumers and merchants and customers about both account to account and card is a good idea. And that's why the investments in Vocalink, that's why the investments in building out infrastructure with real-time payments in the Nordics, or in parts of Asia, or in parts of Latin America or in the Middle East, Africa region, and that's why all our efforts to build applications and services on top of real-time payment rails as well. I believe out over the next decade, you will see more and more of us being sort of rail agnostic, if that's what our customers and consumers and merchants prefer, because I believe that's the best way to cater to the changing payments landscape." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Moshe Orenbuch with Credit Suisse." ] }, { "name": "Moshe Orenbuch", "speech": [ "You'd kind of talked a little bit about the acquisitions and there are a number of them. What might be different about this round of acquisitions. They're more platform I guess, then perhaps just getting a specific amount of revenues. And maybe could you just talk a little bit about how you think they factor in kind of over the course of the next several years?" ] }, { "name": "Ajay Banga", "speech": [ "Well, first of all, I would say most of our acquisitions, even over the past few years have been platform oriented, or in a couple of cases oriented toward skill sets we didn't have. So years ago, we bought a company called C-SAM, which give us access to 450 mobile technology engineers, which would have been quite a challenge to hire organically. But the majority of our deals beat merchant loyalty programs a pinpoint from Australia or these last ones have often platform or some service-oriented of that time. So take Applied Predictive Technologies of the data and services space that gave us a testing in learning platform or take new leaders that gave us AI platform for cyber security. So I'd say most of our acquisitions tend to connect back who wanting to be the order of a platform. So we can add into what we have and then sell as a bundled service in our system. That's kind of what we're trying to do.", "So I don't see these are being dramatically different on that logic. I think what's getting interesting is that we are seeing more deal flow than we ever did. We've always seen a lot of deals and expect 1 or 2 or 3 out of [Indecipherable]. We see many more deals with last 2 years than we saw in the first 5 years. I think part of that is, we have seen away credible acquirer who tries to develop the company we acquired and stringent into the kind of businesses we have and then give people opportunities to grow and their career to grow. So we don't seen as an acquirer who comes into plant the Mastercard we are doing things. I would tell you the things like APT and new data and Brighterion has taught us a great deal that we didn't even know before we bought them. So I think they're benefiting enormously from our acquisitions both culturally for our mother company we're also in the cross flow of successes between the 2 of them. I don't see that very different for an Ethoca, or a Transactis, or a Transfast or a Vyze. I can see all of these referring in similar patterns." ] }, { "name": "Moshe Orenbuch", "speech": [ "Okay, thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Bob Napoli with William Blair." ] }, { "name": "Robert Napoli", "speech": [ "Hi, thank you and good morning. A question on B2B payments, Ajay, you'd mentioned that you haven't even scratched surface internationally. I was wondering, if you could maybe, Sachin, give an update on trends in that business in the US growth rates, any signs of acceleration, the AP automation piece. And is there -- is the international market far behind the US in the growth of B2B payments?" ] }, { "name": "Sachin Mehra", "speech": [ "And so our B2B business, Bob, as you know, you should think about as things we've been doing for many, many years on the commercial side catering to the small business universe, the T&E side of the business, our fee card -- Fleet Card management side of the business, that business continues to grow well. There still remains a lot of opportunity from a secular shift standpoint, I would tell you, and that part of the business we continue to grow that nicely. We've got some very solid platforms, which you're familiar with, which support the growth of that commercial business. The more recent stuff which we've done as it relates to the B2B Hub, again, we're seeing good interest from our customers in that. So like we've said previously, those things take time. The adoption curve on those things is something which is a multi-year adoption curve process, but still showed a lot of promise, because it's solving for European points in the business.", "Then I think about the new and different stuff. For example, we announced just in Ajay's comments earlier today, we talked about the partnership we've established for our Mastercard Track capabilities with OpenText. Again early days, but shows a lot of promise because it's solving for real gain points on the B2B side as it relates to compliance and on boarding of customers in this instance, in the automotive segment. But I think you should think about our B2B business across multiple spectrums, this business we've been in, which continues to grow healthily, which delivers revenue right now, the other businesses we have invested in over the last few years, which are starting to show good trajectory and traction. And then the other new things, which we're doing such as Mastercard Track, which are just getting going, which would pay-off over the longer term. And not much has changed in terms of our views on the opportunity there both in the US as well as from a global market standpoint." ] }, { "name": "Robert Napoli", "speech": [ "Is the international market further behind the US market? I would imagine the opportunities are similar?" ] }, { "name": "Sachin Mehra", "speech": [ "Yes. Bob, the answer to that question is, yes. The answer to that question is clearly yes. We announced last quarter, our partnership with MYOB for example in Australia, that would be an example of again taking the lead from what we did at the B2B Hub in the US, and taking it overseas for an opportunity which exists there as well. This quarter we talk about our agreement with nationwide, which is primarily catering toward the small business space in Europe, again a big opportunity there. So I think the answer really is, yes, things typically start-up in the US and there's opportunity globally on this as well." ] }, { "name": "Robert Napoli", "speech": [ "Okay. Thank you. Appreciate it." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please?" ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Jason Kupferberg with Bank of America Merrill Lynch." ] }, { "name": "Jason Kupferberg", "speech": [ "Hey, good morning guys. Just one for Sachin, and one for Ajay. I'm just starting on the domestic assessments, it looked like the revenue growth there decelerated about 300 points in constant-currency. So just wanted to get some color on the drivers there and maybe what moving parts we should be considering for the second half in that revenue line? And then maybe Ajay, if you can just go little further on SRC, now that we're getting closer to actually live implementations. What the plan in terms of educating consumers there, what we see actual targeted advertising kind of like what we had seen historically with MasterPass?" ] }, { "name": "Sachin Mehra", "speech": [ "So Jason, I'll take the first one. Domestic assessments, right, they grew at 13% this quarter in line with our GDV growth rate of 13%, that's down sequentially from a 16% domestic assessments growth rate in Q1, that is primarily due to the lapping of certain pricing that was put in place last year. And from a trajectory standpoint you would continue to see the pricing effect of that marginally come down as the year progresses." ] }, { "name": "Ajay Banga", "speech": [ "And the part of on SRC, yeah, once we get the testing completed and we get the current MasterPass merchants uploaded into SRC, and we start rolling SRC out for the broader marketplace, you will probably see the whole industry making substantial effort banks, networks, acquirers, making substantial efforts on marketing and promotion to get consumers used to the idea of the fact that this one button has the simplicity of checkout that you would expect in today's digital world, you would see that coming. But I'm talking, it's still a few months away before that kind of stuff starts." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please?" ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Don Fandetti with Wells Fargo." ] }, { "name": "Warren Kneeshaw", "speech": [ "Don?" ] }, { "name": "Operator", "speech": [ "Mr. Fandetti. Your line is open." ] }, { "name": "Donald Fandetti", "speech": [ "Yes. Ajay, on cross-border, can you parse out a little bit the different trends in e-commerce versus T&E, in terms of growth. And then just a follow-up on the commercial. I know there has been some talk in the industry that may be it's been a little bit or some concerns around growth in commercial. Can you just clarify how you're feeling on commercial spend overall?" ] }, { "name": "Ajay Banga", "speech": [ "Getting good on commercial spend overall. So that part is exactly where Sachin just answered. The part of our cross-border, e-commerce cross-border growth is in the high-double-digits, high-teens kind of thing. And that's a good number for us. Remember, it's stronger because -- you remember the whole cryptocurrency purchases stuff that we talked about. Well, that's left. So some part of the cross-border growth improvement quarter-over-quarter is the lapping of the cryptocurrency effect, that you saw back in 2018. And that's the real benefit we're getting out of that.", "The travel kind of expense cross-border tourism, by and large transport and tourism is still alive and well. You'd find changes in where people are going. So take China. In China, cross-border growth from Chinese cardholders is actually up this quarter over the prior quarter, but it's primarily due to increased travel, not just to when it begun to happen which is Japan and Australia, but this quarter you're seeing some travel to Europe to Germany to Canada to the United States as well. And I -- that goes in and out depending on which quarter and what's going on, but by and large travel, tourism is still intact to bring OK." ] }, { "name": "Sachin Mehra", "speech": [ "And I'll just add here, which is, we continue to see double-digit growth in cross-border volumes across all regions and for full-year 2019, we continue to expect cross-border growth rates to be in the mid teens." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please?" ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Bryan Keane with Deutsche Bank." ] }, { "name": "Bryan Keane", "speech": [ "Hi, guys. Just wanted to ask about Ajay, your comment about now seeing 55 or so percent of transactions that you guys are switching. Can you just talk a little bit about where that percentage can go over time. Obviously, there is an economic lift there for you as well, maybe you can talk about that throughout the model maybe higher yields and then it sounds like it pushes services revenues, higher. So just thinking about the different implications there? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "Well, what I can tell you is that, I expect 55% to keep growing, but I'm not sort to be able to tell you what number I expect this year, next year, the year after. The reason for its continuing growth, there are multiple reasons. One reason is that local payments schemes as I was mentioning, struggled to keep pace with innovation technology with cyber security, with regulations and that gives opportunities for companies like us to come in part or happened to show that our transactions are better predicted or better service to have more analytics behind them and that allows us to grow. That's happening all across Europe as an example. It also happens when regulatory environments change like some years ago, they changed in Brazil, and they are beginning to change in Colombia, they are changing in Argentina. And as they change there, you tend to begin to see more of your transactions because the locally formulated scheme either no longer has control, ubiquitous control and where the transaction is routed and the control choicing now goes to merchant or issuers are going to changes the dynamic in the market. That's behind some of this growth in what you're seeing. And then obviously certain kinds of technologies allow you to see more transactions. Contactless in many markets allows you to see more transactions than the old bank strength or chip cards could do. And so there's a number of things behind the 45% becoming 55% or 40%-something, I forget the exact number, 10 years ago, I think it was 42%, 43% coming up to 55% odd percent now. I expect to see that continuing to grow. And yes, the implication of that is that it does help us with predictive power of our data both in cyber and in our data and services businesses. And that does allow us to bundle our solutions better for merchants and banks. That is correct." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please?" ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of David Togut with Evercore." ] }, { "name": "David Togut", "speech": [ "Thanks, good morning. Good to see your P27 partnership in the Nordics leveraging Vocalink. Can you talk more broadly about Vocalink's positioning on the European continent ahead of the launch of SCA on September 14th and when we go live on September 14th with secure customer authentication, what do you expect to happen in terms of transaction authorization and approvals in continental Europe?" ] }, { "name": "Ajay Banga", "speech": [ "I expect a lot of fun. So let me walk you, first on September 14th is an important date, but also been some announcements that there will be some flexibility in the enforcement of SCA at a national level from the European Banking Authority. I think 1 month or 2 back they gave out some clarification on that. That will be interesting because you will get some degree of friction caused by the fact that there'll be different enforcements in different countries. And I think that could lead to some consumer confusion, some merchant confusion, some issuer confusion. So we're going to have to work our way through this over the next few months as this happens.", "We are trying to do focus on our customers, help them better understand their requirements, provide them with solutions to help assist with their compliance on SCA. I continue to believe that, that will be very well-advantaged during this process, if we stand by them as they try and meet the needs of what the regulation of PSD2 requires. Remember, there's connected stuff around Open Banking there, which is everything from connecting to protecting to resolving for disputes. We are working that through with a number of countries, we've launched in the UK, launched in Poland, we're in the process of doing that kind of work in different parts of Europe. The Vocalink is not the only entity that is helping us to that, it's card rails, account to account rails, it's actually more to do with the cyber intelligence and data services businesses that there were lot of opportunity in PSD2 in Europe. Vocalink as a whole in Europe, and in Continental Europe, only the Nordics will give us the first physical presence once it's fully implemented across Continental Europe, because otherwise we were in the UK, in the case of Europe and no one knows where the UK will be under number one. So this gives us a foothold on Continental Europe as well by the time we get this implemented over the next few years." ] }, { "name": "David Togut", "speech": [ "As my follow up --" ] }, { "name": "Ajay Banga", "speech": [ "In the UK, all our contracts have been extended out by a substantial number of years on what Vocalink provides both the tax [Phonetic] contract, the link contract and the faster payment contract. And of course some years later there will be RFPs and all of those, but we're busy making sure we are well-positioned for those." ] }, { "name": "David Togut", "speech": [ "Understood. And then as my follow-up, what is your expectation for the adoption of a Pay by Bank in Continental Europe or consumer ACH payments, once we go live September 14th?" ] }, { "name": "Ajay Banga", "speech": [ "Yeah, I don't know yet, like I said, remember September 14th is into rails switch on date. It's got some switch on angles and it's got a bunch of dimmers attached to it. So the light may or may not come on fully on September 14th. Do I think of Pay by Bank is a great opportunity? Yeah, just remember this, that comment I was making to Lisa earlier, the incentive to switch to paying by a bank account direct debit, the economic incentive for a merchant to help advance that or for a merchant to therefore give better benefits to their consumers to choose that as the way to pay as compared to paying by some of the method has reduced as the economic difference between the MDR and debit cards and the cost of a fully loaded account to account payment are taken into account. And so this is less of an economic argument as compared to a preference argument. I consider lots of Europeans who would think of paying with debit as a natural way of paying as compared to paying with credit. They think of debit as safer. I suspect a number of them will adopt Pay by Bank or pay by a bank account as something they understand and appeals to their way of planning for their financials. I think that's the way this will grow as compared to some very strong economic opportunity [Phonetic] benefit to consumers or merchants, which means it will be a slower build." ] }, { "name": "David Togut", "speech": [ "Thank you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Next question, please?" ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Darrin Peller with Wolfe Research." ] }, { "name": "Darrin Peller", "speech": [ "Hey, guys. Thanks. Ajay, more broadly, I mean, your volume trends continue to remain really strong even to the July period, and you still maintain a pretty good spread versus competition across a lot of volume growth metrics. Can you just comment, I mean, is this just solid macro trends, or how much of this is actually market share in your mind, or other than technology innovation driving growth. Just maybe you can try to parse out, and if you think there's anything of this -- in the economy you're seeing that would change that trend on volume anytime in the next half. And then just quickly, Sachin also cross-border revenue, it was up a little more card-to-card through the underlying cross-border volume growth rate. Is there an element of pricing there? Should we expect that to continue? Thanks guys." ] }, { "name": "Ajay Banga", "speech": [ "Do you want to answer the cross-border one, first?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So, you're right. The cross-border assessments were up 19% in the second quarter, which is about 3 ppt more than what you saw on the driver at 16% growth and that was due to pricing, which was partially offset by mix. And you would -- you'd see that pricing continue for a few quarters going forward. So nothing more really on that, Darrin." ] }, { "name": "Ajay Banga", "speech": [ "So on transaction growth and GDV growth and the like, first there's 2 broad pictures; one, of course macro spending environment by consumers in the B2B business is still good. Is it moderated toward of compared to the prior year, yes, but it's still relatively healthy. There are pockets of concern on macro spending, I think China is something that everybody has now begun to talk about, which is a challenge, and it's stressed. Mexico is slower. But there are other markets that are doing better. So Brazil is doing better. The US is holding strong. And the UK is holding up. Parts of Northern Europe are doing fine. India is doing, OK. And Japan and Australia are doing OK. So there are markets doing OK, that's the macro trends.", "Are we growing share? Absolutely. And we've been growing share consistently for a while across product categories. But growing share -- this business doesn't change share growth from you don't grow share by 300 basis points in the quarter, you grow share by incrementalism mostly. Even if you win big deals in one country, the combination of that country contributing to the total world spend is still a smaller number. And so share growth and share gives you a consistent tailwind, but it's first the macro and secular and second share growth. And third, remember we are smaller than some of the other competitors in some of these overall numbers because of our position in different markets and that tends to make the percentage number look better. It's a combination of all 3. I believe it's a little bit of all 3 going on. So you should take that into account." ] }, { "name": "Warren Kneeshaw", "speech": [ "Brandy, I think we have time for one last question." ] }, { "name": "Operator", "speech": [ "And your last question comes from the line of Craig Maurer with Autonomous Research." ] }, { "name": "Craig Maurer", "speech": [ "Hi, good morning. Thanks. Considering my peers have circled the wagons on all the enormous positives, I thought I'd ask some of the -- some of the few controversial items. First, can you discuss the Australian proposal to completely eliminate error change by year-end? And if you can comment on the fact that the UK Supreme Court has agreed to hear the class action case against Mastercard? Thanks." ] }, { "name": "Ajay Banga", "speech": [ "So first of all, Craig, Tim Murphy is delighted to get a chance to speak on the UK, so I'll let him go ahead with that." ] }, { "name": "Timothy Murphy", "speech": [ "Sure. Great, thank you. So we feel very good about the decision of the Supreme Court to look at -- to improve our appeal. We'll take that forward in the next couple of months. Just a context on that issue, this is one of the first major cases in the UK, looking at their new collective action or class action law. We think the appellate court set a too low a standard and that would produce an outcome in the UK that is -- was not intended under the law. So we think this is great opportunity for the Supreme Court to come to a more balanced decision and then we'll proceed on that basis, but we're very pleased with that approval." ] }, { "name": "Ajay Banga", "speech": [ "And then the Australian proposal, it's not just Australia, where ever you come to 0 interchange or MDR in a country, I continue to believe that no economic incentive for increasing either acceptance or digitization of payments doesn't make sense to me. At the end of the day, if there is a value being derived by an entity, be it a consumer, be it a merchant, be it a bank from doing something and somebody else providing the capability for that value to be derived. In this case, specifically, if merchants are driving some value from digitized payments, be it ticket sizes, be it lower theft, be it, better cash management, be it, lower expenses and collecting, there's a series of studies around the world that demonstrate what digitization does for the merchant community in terms of benefits for them. And I believe that in some way, incenting the providers who enable that digitization, acquirers, processors, issuers, who take on risk, expense and the capital allocation that is required to enable this is a sensible business model.", "So going to 0, just says I'm not going to do it and you need to find a way to do it anyway. And I suspect that's not the smartest way to go about it, but you know what, at the end of the day countries will make decisions. Our job is to help illustrate to them through research, through logic and through experience in other markets what we believe to be conducive regulatory systems. And then when they make that decision, our job is to work with them the best we can. That's been our approach for years. That's the approach we'll take in Australia, as well. I consider Australia to be a very important market for our company. We are market leaders there in a number of categories. With the Westpac trip recently, we are definitely market leaders in more categories. And I consider our presence in Australia to be that of a responsible payments partner for the Australian government and ecosystem. And I will keep trying my best to work with them." ] }, { "name": "Craig Maurer", "speech": [ "Thank you very much." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. A few closing parts. We continue to execute well against our strategy. We just had another strong quarter of revenue and earnings growth. We are really pleased to further extend the reach of our real-time payments capabilities with the P27 being in the Nordics. And we look forward to working with all our new colleagues from our recent acquisitions. And with that, thank you for your continued support of the company. Thank you for joining us today." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
MA	2022-10-27	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "AllianceBernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Tsin Huang -- JPMorgan Chase and Company -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Ashwin Shirvaikar", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Rayna Kumar", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Tim Chiodo", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Andrew Jeffrey", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "William Blair and Company -- Analyst", "name": "Bob Napoli", "position": "Analyst" }, { "description": "Susquehanna International Group -- Analyst", "name": "Jamie Friedman", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Audra, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Mastercard Inc. Q3 2022 earnings conference call.", "Today's conference is being recorded. [Operator instructions] At this time, I'd like to turn the conference over to Warren Kneeshaw, head of investor relations. Please go ahead." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Audra. Good morning, everyone, and thank you for joining us for our third quarter 2022 earnings call. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data, and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis, unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website for 30 days. With that, I'll now turn the call over to Michael." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren. Good morning, everyone. Let's get right into it. So the headline is that consumer spending remained resilient, and cross-border travel continues to recover.", "With this backdrop, we delivered strong revenue and earnings growth through the focused execution of our strategy. Third quarter net revenues were up 23% and adjusted operating income up 27%, both versus a year ago on a non-GAAP currency-neutral basis, excluding special items. Now the macroeconomic and geopolitical environment remains uncertain. Inflationary pressures have remained elevated and central banks are continuing to take aggressive steps to bring inflation in line.", "Tensions remain high with the war in Ukraine and the supply of natural gas to Europe is a concern. Despite all of this, unemployment rates remain low, wages are rising, consumer savings levels remain elevated and credit is readily accessible. In this setting, overall consumer spending has remained resilient, although we are seeing some shifts in what consumers are buying. Looking at our switched volume trends.", "Domestic volumes remained steady, showing growth relative to 2019 levels relatively consistent to the second quarter 2022. The trend toward spending on experiences continues. We saw notable strength in airline, lodging, and restaurant spend with a shift away from categories like home furnishings and appliances. The current mix between retail, T&E, and other categories of spend is now broadly similar to pre-pandemic levels.", "Cross-border. Cross-border continues to recover as border restrictions are progressively relaxed. Cross-border travel in the third quarter has reached 124% of 2019 levels. Relative to 2019 levels, most regions are up sequentially, including a notable improvement in Asia.", "Cross-border card-not-present ex travel continued to hold up well. Notwithstanding the continued strength in consumer spending, we will continue to watch the environment closely, including fiscal monitoring and other policy actions taken in response to events. This will inform our actions as it always has. Should the market outlook weaken, we are prepared to act quickly to modulate our expenses.", "As we demonstrated during the pandemic, we have the flexibility to respond quickly across a number of levers and will do so while maintaining focus on our three key strategic priorities. The focus on these areas will create new opportunities for growth that starts by solidifying our positions and payments, complemented by our differentiated services lines and our expansion into adjacent activities like open banking and digital identity. Moving on to some examples of how we are progressing against each of these. First, we are expanding in payments by enabling digital transformation with our customers, putting volume growth, expanding acceptance, and capturing new payment flows.", "There are now over 3 billion Mastercards in circulation supported, in part, by programs, such as our digital-first initiative. A digital-first solution starts with the ability for a consumer to acquire and then use a new card digitally in near real time. It's helping customers create a best-in-class digital experience, leading to increased approval rates on average by 2 percentage points; reduce fraud, on average, by 4 basis points; and increase spend per active account, on average, by 10%. To date, we have launched over 200 digital-first customers around the globe.", "Santander in Mexico, Chase in the U.K., Citibanamex, Hague in Spain, and Nubank in Brazil are among the latest customers to partner with Mastercard to deliver an end-to-end digital-first customer journey. Also, we're driving growth in volume with new and renewed wins across a broad set of partners. In the U.S., we recently extended our exclusive deal with KeyBank's debit, credit, commercial and small business, as well as deepened our relationship on services. This quarter, in partnership with Chase, we will launch a new co-brand program with DoorDash.", "This deal further expands our presence in the digital food delivery space. We also went live with the Uber Pro Card and enhanced loyalty and payments experience that will help drivers in Korea save on gas, fees, and other expenses. In Europe, we have seen momentum in Italy with IGT securing an expanded deal that includes a credit and prepaid flip, as well as securing the current Mastercard portfolio. And in Latin America, we have renewed our exclusivity agreement with Mercado Libre and secured incremental credit share with Banco Scotiabank Colpatria.", "Overall, another great quarter with notable wins. That shift to one area that is sometimes underappreciated, that is how we are enabling growth in payments by giving people and businesses more places to use the MasterCard. We have added more acceptance locations in the last five years than the previous 50, and we have now accepted at more than 90 million merchant locations. The preferential contactless payments that grew over the last two years continues.", "More than half of the in-person switch purchase transactions are now tapped up from approximately one-third pre-pandemic. And this trend will be bolstered by the adoption of new technologies, such as Tap on Phone. Further, our technology and global reach enable growth and acceptance while helping our partners drive their digital strategy. For example, we have signed with McDonald's to use our gateway capabilities, enabling them to easily offer more solutions to new markets beginning in Middle East and Africa.", "Finally, we're driving growth in payments while leaning into innovation to capture a prioritized set of new payment flows. We continue to make progress in going after flows in the disbursements and remittances space by expanding into new use cases and geographies. For example, in the U.S. gig economy, we signed a new global agreement with Airbnb to facilitate host payouts using Mastercard Send in select markets.", "We've also expanded with gaming payouts, launching our Gaming Fast payout program. To address account-to-account, cross-border, and domestic payments, we have signed a deal with Pagero, a leading global B2B network and solutions provider that provides accounts payable automation to some of the world's largest corporate brands. We're also growing commercial point-of-sale transactions by targeting small business, corporate T&E, purchasing, and fleet flows. In the U.S., we announced our exclusive co-brand partnership with First National Bank of Omaha to issue the Hello Allice small business card.", "This product offers small business owners industry-leading access to tools, benefits, and services with a focus on equitable access to credit, very important. We also continue to target B2B accounts payable flows by expanding access and reach, leveraging our virtual card capabilities. We signed a deal with Marqeta to enable our next-generation virtual card solution, Instant Pay. This solution intelligently and automatically sends instant payments to suppliers.", "We have also signed an agreement with SAP Taulia to integrate our virtual card solutions into Taulia and SAP solutions, enabling their customers to facilitate virtual cost payments. We're also well-positioned to capitalize on the return of travel with our Mastercard wholesale travel program. In Bahrain, we signed a deal with Infineon for their online travel agency and travel management company, Volumes. And in Europe, we signed a deal with the fintech Swile while going after B2B travel flows in Europe and Latin America.", "As you can see, we continue to make steady progress in addressing our prioritized set of new payment flows. Now turning to services, where we delivered another quarter of strong revenue growth. Our services deliver a diversified revenue stream for Mastercard beyond payments. We accomplished this by adding new service capabilities, as well as extending existing service offerings into new and existing customers.", "There continues to be a tremendous growth opportunity in this space. First off, we're excited about Dynamic Yield's unique personalization platform, which offers a great example of how we're adding new service capabilities. Since complementing the acquisition earlier this year, we have added dozens of new retail and commerce customers. A great example is [inaudible], a German fashion store.", "I always share German examples, if I can. They have more than 1,400 stores in Europe. We have deployed our content personalization capabilities to additional markets. In addition, we are expanding our capabilities to financial institutions.", "Now beyond adding new services, there's an opportunity to grow by extending existing offerings into new and existing customers. In the third quarter, we signed an agreement with Sky Italia, part of Sky Group, one of Europe's leading media and entertainment companies, to enrich and commercialize a new service to support small businesses. Imburse, a technology provider to insurance companies, is implementing our card-linked services for their micro savings programs with Generali Insurance in Switzerland. And in Spain, we have grown our relationship with CaixaBank with one of our largest European Africa deals.", "The deal enables them to provide a more efficient charge backflow for all the card portfolios. Beyond expanding in payments and extending in services, our third key priority area is embracing new networks. As a reminder, our current focus is on two areas: open banking and digital identity. This quarter, I'll touch on open banking.", "While open banking is early in the game, it is a tremendous opportunity. We are engaged with a broad set of financial institutions and fintechs who are increasingly interested in a wide range of use cases. And what's unique and interesting here is that we are the partner that brings what is needed to scale and it's still confidence in this space, things like responsible data practices, consumer protections, and deep compliance, all on top of our robust technical capabilities, broad connectivity, and extensive applications. So just to give you a flavor in the U.S., Quicken, a leading provider of financial management solutions, has selected Mastercard as a provider of consumer permission data for its popular simplified budgeting platform.", "We're also working with Fidelity with their innovation in student loan repayment for organizations that want to help their employees improve their financial wellness. And then there's Jack Henry, which will enable community and regional financial institutions to be at the center of their account holders' financial lines. They will do this providing the ability to securely see all of their financial accounts within and outside the primary financial institution in a single view. This will help enable consumers and businesses to make more informed financial decisions.", "This is just the beginning much more to come in open banking. Before wrapping up, I'd like to share an example of how we are incorporating our capabilities across all three strategic pillars. Our strategy to engage in the crypto economy leverages assets across payments, services, and new networks, a combination that yields a truly differentiated value proposition. Here, we're deploying our payment capabilities to enable consumers to spend their crypto holdings on card and cash out their crypto wallets via Mastercard Send.", "This quarter, we partnered with Ebonex who will become our first partner in Australia to issue crypto-funded cards. We're enabling off-ramp solutions with Mastercard Send and recently added five new players in North America and Europe, including Binance supported by Checkout.com and Uber. In all instances, we do not handle crypto but rather take delivery of fiat currency. Our services and new networks capabilities are providing identity, cyber, and consulting services for market participants.", "Crypto Secure is an innovative solution designed to bring additional security and trust to this digital ecosystem by helping card issuers address regulatory risks. We also recognize the interest people continue to have buying and holding crypto through trusted businesses like their banks. So last week, we announced Crypto Source, which is designed to give our financial institution partners access to a comprehensive suite of buy, hold, and sell services for select crypto assets. This will be augmented with our proven identity, cyber security, and advisory services.", "To support these upcoming pilot programs, Mastercard is expanding its partnership with Paxos Trust Company to leverage their crypto asset trading and custody services. As you can see, our crypto strategy is bringing together best-in-class capabilities at scale, all built on our core principles of providing strong consumer protections, safety, and security. In summary, we delivered another strong quarter of revenue and earnings growth, aided by a resilient consumer and a continued recovery in cross-border travel. We continue executing against our three strategic priorities.", "We have strong momentum with our customers, offering a diverse set of innovative solutions. We will continue to manage our expenses carefully within this macroeconomic environment, and our well-diversified and flexible business model positions us well for the future. Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. Turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis, excluding special items and the impact of gains and losses on our equity investments. Net revenue was up 23%, supported by resilient consumer spending and the continued recovery of cross-border travel relative to 2019 levels. Acquisitions contributed 1 ppt to this growth.", "Operating expenses increased 17%, including a 3-ppt increase from acquisitions. Operating income was up 27%, which includes 1-ppt decrease related to acquisitions. EPS was up 22% year over year to $2.68, which includes a $0.06 contribution from share repurchases. During the quarter, we repurchased $1.6 billion worth of stock and an additional $505 million through October 24, 2022.", "So let's turn to Page 4, where you can see the operational metrics for the third quarter. Worldwide gross dollar volume or GDV increased by 11% year over year on a local currency basis. On the same basis, if you exclude Russia from the prior period, GDV increased by 18%. In the U.S., GDV increased by 10% with credit growth of 20%, reflecting, in part, the recovery of spending on travel.", "Debit increased 2%. Excluding the impact of the roll-off of a previously discussed customer agreement, debit increased approximately 5%. Outside of the U.S., volume increased 12% with credit growth of 15% and debit growth of 9%. Cross-border volume was up 44% globally for the quarter, reflecting continued improvement in travel-related cross-border spending.", "Turning to Page 5. Switched transactions grew 9% year over year in Q3. Excluding Russia from the prior year, switched transactions grew 19% year over year in Q3. Card present and card not present growth rates remained strong.", "Card present growth was aided, in part, by increases in contactless penetration in all regions when excluding Russia. Contactless now represents 54% of all in-person switch purchase transactions. In addition, card growth was 5% or 10% if we exclude cards issued by Russian banks from the prior-year card count. Globally, there are 3 billion Mastercard and Maestro-branded cards issued.", "Now let's turn to Page 6 for highlights of the revenue line items, again, described on a currency-neutral basis, unless otherwise noted. The increase in net revenue of 23% was primarily driven by domestic and cross-border transaction and volume growth, as well as growth in services, partially offset by growth in rebates and incentives. Acquisitions contributed 1 ppt to this growth. Looking quickly at the individual revenue line items.", "Domestic assessments were up 9%, while worldwide GDV grew 11%. The difference is primarily driven by mix. Cross-border volume fees increased 57%, while cross-border volumes increased 44%. The 13-ppt difference is primarily due to favorable mix as higher-yielding ex intra-Europe cross-border volumes grew faster than intra-Europe cross-border volumes this quarter.", "Transaction processing fees were up 22%, while switched transactions grew 9%. The 13-ppt difference is primarily due to favorable mix, FX-related revenues, and pricing. Other revenues were up 22%, including a 2-ppt contribution from acquisitions. The remaining growth was driven primarily by our cyber and intelligence and data and services solutions.", "Finally, rebates and incentives were up 26%, reflecting the strong growth in volumes and transactions and new and renewed deal activity. Moving on to Page 7. You can see that on a non-GAAP currency-neutral basis, total adjusted operating expenses increased 17%, including a 3-ppt impact from acquisitions. Excluding acquisitions, the remaining increase was primarily due to higher personnel costs to support the continued execution of our strategic initiatives.", "Turning now to Page 8. Let's discuss the operating metrics for the first three weeks of October. For your reference, to help you understand the trends in the business ex Russia where we suspended operations in March 2020, we have included an appendix later in the stack to show all the data points from the schedule if you excluded activity from Russian-issued cards from prior periods. As a general comment, our metrics are holding up well in October.", "As expected, the year-over-year growth metrics faced tougher comps as we began lapping periods in 2021 when COVID-related restrictions eased and spending levels started to rebound. However, it is important to note that all metrics continue to hold up well relative to 2019 levels. Going through the metrics, in turn, starting with switched volumes. For the first three weeks of October, we grew 17% year over year, down 1 ppt versus Q3.", "Switch transactions grew 9% year over year through the first three weeks of October, consistent with Q3. As a reminder, Russia has a relatively low average ticket size which results in a larger relative impact to this metric. Overall, cross-border volumes through the first three weeks of October grew 36% year over year, down 8 ppt versus Q3. Cross-border travel had another quarter of strong growth as water restrictions continued to be lifted.", "In the first three weeks of October, cross-border travel was up 62% year over year, down 11 ppt versus Q3 due to more difficult year-ago comps, as I just noted. Cross-border travel is now at 125% of 2019 levels, up 1 ppt from Q3 levels. Cross-border card not present, excluding travel, was up 12% year over year in October, which includes the impact of significant e-commerce promotional activities, and is down 1 ppt from Q3. This metric continues to hold up well in relation to 2019 levels.", "Turning to Page 9. I wanted to share our thoughts on Q4. Let me begin by saying that the execution of our strategic priorities is translating into expanded and deeper customer relationships and the broader adoption of our material solutions and differentiated services. Consumer spending remains resilient in the face of macroeconomic headwinds, and cross-border travel continues to recover as border restrictions ease and consumers shift their spending back toward travel.", "Just to update you on some metrics we are tracking. Asia, which represented approximately 14% of cross-border inbound travel pre-pandemic in 2019, is at approximately 76% of 2019 levels in Q3, up from about 60% in Q2. We continue to believe there is more room to grow as several travel corridors, particularly in Asia, still remain restricted, and airline industry capacity continues to build back up. We remain well-positioned to capitalize on this growth with our travel-oriented portfolios and service offerings, including access to an extensive airport lounge network and concierge services and our global Mastercard Travel Rewards program, which allows issuers and merchants to connect -- to provide consumers with unique benefits through a simple digital experience.", "As we have laid out, there are a number of factors that could influence future economic growth. These include elevated inflation and rising interest rates, and geopolitical tensions balanced against low unemployment, rising wages, and high savings levels in particular. We are monitoring each of these. As Michael just said, we are prepared to act quickly to adjust our expenses to reflect any meaningful change to top-line growth.", "With respect to the fourth quarter, we expect year-over-year net revenue to grow at the high end of a mid-teens rate on a currency-neutral basis, excluding acquisitions. This is consistent with prior expectations and sequentially reflects, one, generally resilient consumer spending relative to 2019 levels; two, stable to slightly improved cross-border travel growth relative to 2019 levels with some continued improvement into Asia and some moderation within Europe; three, higher rebates and incentives as a percent of gross revenues due to elevated deal activity consistent with seasonal norms; and finally, the lapping of a strong year-ago quarter as border restrictions were lifted in the U.S., U.K., and Canada during Q4 2021. Acquisitions are forecasted to add about 1 ppt to this growth, while foreign exchange is expected to have headwind of approximately 6 to 7 ppt for the quarter. As a reminder, the euro has depreciated significantly year over year and is the primary driver of this headwind.", "From a sensitivity standpoint, based on the current mix of the business, the annual impact of net -- to net revenue of a $0.01 change in the value of the euro relative to the U.S. dollar is approximately $55 million. From an operating expense standpoint, we expect Q4 operating expenses to grow at a low double-digit rate versus a year ago on a currency-neutral basis, excluding acquisitions and special items. Acquisitions are forecast to add about 3 ppt to this growth.", "Foreign exchange is expected to be a tailwind of approximately 4 to 5 ppt for the quarter. Other items to keep in mind, on the other income and expense line, we are at an expense run rate of approximately $100 million per quarter given the prevailing interest rates. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics. And finally, we expect a tax rate of approximately 19% in Q4 based on the current geographic mix of our business.", "And with that, I'll turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Audra, we're now ready for the Q&A session." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] We'll take our first question from Sanjay Sakhrani at KBW." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. Sachin, I was just wondering if you could just parse out a little bit at the fourth quarter net revenue expectations. It was a little bit lower than we were thinking.", "I'm just curious, is it incentives kind of spiking up in the fourth quarter? Or is it just the gross number? Any color there would be helpful. Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. First, I'm just going to kick it off by saying the fourth quarter thoughts that I've just shared with you are very consistent with what we have shared in our implied fourth quarter numbers when we gave you our full year guidance at the last earnings call. So very consistent in terms of what we'll be sharing with you in terms of fourth quarter. But just a few things I want to kind of emphasize as to what our key assumptions going into the fourth quarter are: one is we continue to believe that there will be a resilient consumer and spending from the consumer relative to 2019 levels will be generally resilient; number two, we are expecting stable to slightly improve cross-border travel growth relative to 2019 levels.", "In terms of rebates and incentives to your question, as a percentage of gross revenues, we expect them to be higher in the fourth quarter. This is very consistent with our seasonal norms. So nothing unusual as far as I'm concerned there. And then also, again, if you look at it on a sequential basis back to comparing fourth quarter to third quarter, there is the lapping effect which I kind of talked about.", "So really, I mean, the summary of what I guess I'm sharing with you is our fourth quarter thoughts are very consistent to what we had actually shared with you previously." ] }, { "name": "Sanjay Sakhrani", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "We'll move next to Lisa Ellis at MoffettNathason SVB." ] }, { "name": "Lisa Ellis", "speech": [ "Oh, terrific. Good morning, guys. Thanks for taking my question. I wanted a question about business resilience, I guess, looking forward in the face of a potential economic downturn.", "I'm just thinking about the fact that over the last several years, Mastercard increased the diversification of the business significantly with more debit, more fast ACH, more services, etc., more B2B. So how do you think about kind of where you are now in terms of resilience of the business if we do, at some point, see a slowdown in the consumer side of spending? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Good morning, Lisa. Thank you for your question. So let me kick off on that one. You imply the answer in your question actually.", "It is the nature of our continued diversification. I mean, just to remind everybody on why are we diversifying, it is to give us a diversified revenue stream, but it's also to differentiate our payments. And all of that plays hand in hand with better services. We're going to see payment volumes come out with better services, it's easier to get into some of the new payment flows.", "For example, our safety security solutions are well sought-after in the B2B space, whether there is fraud issues all over the place. So all that, I think, is a good starting point for us. If I just look back over the last two years where we certainly had a slowdown on the payment side in the macroeconomic overall and services carried today very significantly for us. So we're just going to continue to push harder there.", "And then new flows, and I gave you a whole range of examples earlier on how we are building out the new flows. And if you just put some light on to commercial POS. So here is, this is existing tools that we have. We don't need to build a lot for it.", "It's a space that we haven't penetrated significantly in the past, and we're ready and we're going in. This is a $14 trillion opportunity that we're going after, which is payments diversification going on, in addition to our services diversification. And earlier on, with the stats on acceptance, just more places where people can spend. In the end, then people will spend, even in a downturn.", "It doesn't actually matter for us what they spend on, that they spend on a MasterCard, we give them more opportunities to do so. So diversification is the name of the game." ] }, { "name": "Lisa Ellis", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll move next to Darrin Peller at Wolfe Research." ] }, { "name": "Darrin Peller", "speech": [ "Hey, guys. Thanks. Your model is clearly still showing benefits of inflation. And if you could just kind of remind us, again, the sensitivity in the areas you see in the basis points driven inflation impact.", "But also whether or not there's any pricing changes you guys are interested in employing on the non-basis-point side, whether it's transactions or services, probably more importantly, just given what we've seen or if you've done so already? And then maybe just on a side note on that, on the other side would be the expense management and the willingness, just how willing you are on, for example, marketing to flex there if necessary? Thanks, guys." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, Darrin, I'll take that question. I guess to your point around inflation. Look, I mean, persistent in place for long periods of time, which causes for a shift in share of wallet away from carded categories into non-product categories would be the one area I would actually flag as a potential headwind as it relates to our business model. But putting that issue aside, the reality is you're very correct about the fact that we charge our basis points in cents per transaction.", "Our basis points are of nominal value of spend and that reflects the impact of inflation in there. So the reality is, as we've said in the past, modest inflation and inflation in carded categories, we're generally -- we kind of -- our business model accounts for that because depending on if it's carded, it doesn't matter, like Michael said, whether it's happening in travel or it's happening in food and building, those are carded categories, and you kind of get the benefit of that come through. Look, I mean, as it relates to your question on expenses, we've always remained disciplined on expenses. The thing which we always keep in mind is a few things.", "One, we want to make sure that we're investing in the long-term growth of our business along the three strategic priorities, which Michael talked about. We will continue to do that. That being said, as we demonstrated during the COVID environment, we do have the opportunity to flex our expenses whether it's around marketing, whether it's around professional fees, whether it's around T&E, it all is a function of making sure we are keeping an eye on the top line, keeping an eye on the bottom line while we're actually delivering what we need to do from an expenses standpoint, and we'll continue to do that going forward. The reality is we keep a close eye on to what are the things which are in demand from our customers, what is it that the consumer wants, and we are bouncing our expenses in that regard.", "An example would be, as you remember in COVID, when travel was out of favor, we started to pull back on A&M-related travel. It just didn't make sense for us to be doing at that point in time. So we'll remain flexible on that. And then there are initiatives which we've got which are longer-term initiatives, which will pay off over many, many years in the future, where we have the opportunity to actually pulse the pace at which we're incurring expenses on those to the event -- in the event we start to see a little bit of a slowdown in terms of top line.", "You asked the question on pricing. Our philosophy around pricing is very consistent as it's always been. We price for the value we deliver. And our assumption from a pricing standpoint, whether it's pricing in basis points or cents per transaction is very tightly correlated to the value we're delivering to our customers and to the end consumers, and to our merchant partners.", "So all of that is very consistent at the end of the day. We assume minimal net pricing, net of rebates from a pricing standpoint." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. I just want to -- Darrin, just want to add one point here. And that is looking back at the last -- over two-and-a-half years now, back to the second quarter of 2020 when revenue was severely impacted by a truly unprecedented event out there. So to the power of the levers that we have and a range of levers that we have to modulate our expenses, hiring, AMM, professional fees, T&E, and your market appetite and all of that, it just showed that we did not have to make any compromises when it comes to driving our strategic priorities.", "We pulled through it on new flows, we pulled through service expansions, and so forth. The model is wide and flexible. That helps us a lot. And as I look forward, there is optimism in how we're going to navigate that." ] }, { "name": "Darrin Peller", "speech": [ "Thanks, guys." ] }, { "name": "Operator", "speech": [ "We'll take our next question from Harshita Rawat at Bernstein." ] }, { "name": "Harshita Rawat", "speech": [ "Good morning. Michael, Sachin, can you talk about online debit routing in the U.S. that very recently put out clarification approvals? If I recall correctly, last time you ended up gaining market share, but debit was implemented. So how does it impact Mastercard with online debit routing now? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Hey, Harshita. Thanks for the question. There's always something in debit routing going on. So here, we have the clarification of the rule by the Fed.", "And it takes us all the way back to a decade ago when there was this requirement to have two networks on every debit card. And basically, what the Fed here clarified is that this is applying to whether it's a debit transaction that's made online or in-store. So pretty simple, pretty straightforward implementation by mid of 2023. So we have some time, but we will be ready and we'll be implementing.", "I think really what that does is we will just continue to compete with all the assets that we have in debit. I'm not really sure what this will do to the market, but we will certainly be there leveraging our technology to win more debit in the United States." ] }, { "name": "Sachin Mehra", "speech": [ "Harshita, I'll just add one additional comment to what Michael just said, which is, as you know, we've been investing pretty heavily in our services capabilities some of which relate to cyber intelligence. And in an environment where our partners, whether it's the merchants or the issuers need more of our services to better manage their product capabilities in the online environment, we stand ready to do that as well." ] }, { "name": "Harshita Rawat", "speech": [ "Thanks very much." ] }, { "name": "Operator", "speech": [ "We'll take our next question from Tien-Tsin Huang at J.P. Morgan." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey, thank you. Good morning. Just you mentioned nothing unusual on rebates and incentives, but I just wanted to ask as I sometimes always do with deal activity versus 90 days ago. Any change there? Is your appetite to drive program growth versus maybe more disciplined growth on their side? Or are there changes in timing of deals and implementation, things of that nature? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Tien-Tsin. I can take that. Tien-Tsin, I think you know that we've been active in the marketplace. We've been winning share globally, and that's just part of the strategy of what we want to do, which is on a disciplined, profitable basis, we want to win share and deliver more in the nature of services on that share to optimize and grow our overall net yield.", "I'll start with that as kind of the headline. But on your specific question on Q4, on rebates and incentives, nothing unusual. It's a rich pipeline. We continue to be active in the marketplace.", "We're not seeing any changed kind of behavior as it relates to how our issuing partners are in the marketplace. And we just remain active, and that's really the essence of what we're seeing there." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Thanks for the update." ] }, { "name": "Operator", "speech": [ "Next, we'll move to Ashwin Shirvaikar at Citi." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Thank you. Michael, if I can ask about cross-border now that we've seen some normalization in travel? If you could kind of talk about how much more travel improvement there is yet to come in your view and the mix of cross-border now that some of the normalization has happened as we look to travel versus non-travel?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Ashwin. I can take that question. So first, I kind of mentioned that -- as we said in the last earnings call, we saw opportunity in terms of further recovery in travel. We saw some of that come through in our Q3 numbers.", "We still believe there's potential from a cross-border travel recovery standpoint, in particular, in Asia Pacific. I shared a metric about how Asia Pacific inbound cross-border travel is approximately 76% in Q3 of 2019 levels. So that just goes to show there's some more room to grow there. I mean, there are several markets in Asia Pacific which still remain to be opened.", "Also, airlines are bringing more capacity back on. And as you know, from our personal experiences, getting seats on planes is hard, and it's expensive. And so the reality is all of that should be helpful in terms of the potential for cross-border travel recovery. The other point, which I think you alluded to, Ashwin, is as it relates to the mix and the mix is also important because the mix of cross-border has not reverted back to historical mixes.", "So said differently, if you remember, as we were going through COVID, we first saw recovery take place in intra-Europe. And you know intra-Europe is generally low in yielding. We've recently been seeing a stronger growth of a pattern in ex intra-Europe cross-border. And so the reality is that makes us go back to the pre-pandemic levels at this point in time." ] }, { "name": "Michael Miebach", "speech": [ "And just one thing to add, it wasn't exactly your question, but that whole space has been in focus for us, pre-pandemic, during the pandemic, and now. While airlines were struggling with really no flights taking off, we were a strong partner, and it showed in how the engagement with airlines and travel-oriented portfolios work now. So we stand well-positioned to benefit from the trend that Sachin just talked about on the services side, as well as in the payments and the co-brand side, so exciting space. I think our bets are paying off." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll go next to Rayna Kumar at UBS." ] }, { "name": "Rayna Kumar", "speech": [ "Good morning. Thanks for taking my question. You continue to see very strong growth in Latin America, 29% GDV growth in the quarter. Can you discuss some of the key drivers of that growth and how sustainable you think it could be going into 4Q and into 2023? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Rayna, let me start off on that. Latin America, fascinating region for us, highly diverse from a super well-developed Brazil to markets at the other end of the spectrum, high travel markets with the Caribbean, so Mexico. So you have all of that in the mix. It's really interesting when you peel the onion of it and you look at some of these markets and you compare them, two of the largest markets, for example, Brazil and Mexico.", "If you look at the digital penetration in Mexico compared to Brazil, there is so much more potential to go. So there's upside in digitization. There's other issues that require some of our solutions. The region has experienced some fraud issues generally in payments.", "So our safety and security solutions are in great demand and a great driver for growth for us in the region, while the underlying digitalization continues. So you put those trends together, it's all fairly attractive. And then I talked to you about our engagement in the crypto economy. If there's one place in the world where crypto is really in focus, it's in that part of the world, historic pain through high inflation, and so forth.", "People were thinking crypto might be an answer. A lot of innovation in the space. So across all payments, services, and new payment flows and innovation, this is a region that has -- is showing full momentum for us." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. Rayna, I'll just bring to life one of the points which Michael talked about in terms of increased trends toward digitalization. As it relates to our performance in Latin America in Q3 and going forward, the reality is we've been very focused on the conversion of Maestro to debit Mastercard. And this has been part of what we as a company have been doing for a very long time.", "You're seeing the fruits of that come through because as you know, as you go down the path of converting Maestro to debit MasterCard, whether it's a companion digital debit Mastercard or it's an actual conversion of the card, it now becomes enabled for online transactions back to the regional trend, which Michael is talking about. So it's all about us trying to enable those cards and we've been seeing good migrations take place from Maestro to debit Mastercard." ] }, { "name": "Operator", "speech": [ "We'll go next to Jason Kupferberg at Bank of America." ] }, { "name": "Jason Kupferberg", "speech": [ "Thanks, guys. Good morning. I wanted to see if you can unpack a little bit what you're seeing in terms of consumer spending across different parts of Europe. And then, Sachin, I wanted to see if you could make just a quick comment around what you guys are envisioning the potential FX headwind to revenue in 2023 just based on current rates.", "Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So, Jason, I'll give you on your first, and then I'll get into the FX question, which you're talking about. So in terms of Europe, we continue to see good Mastercard performance in Europe. Remember, in terms of what you're seeing in our metrics, you're seeing not only what the underlying economies are doing, but also the impact of our share growth, which has been taking place in Europe.", "So it's kind of the amalgamation of all of that, which is coming through. In terms of regional patterns, I would tell you that we're not necessarily in any meaningful change in terms of trends across the continent, in terms of how the spending patterns are taking place. The consumer generally -- back to our comment earlier around consumer being resilient and strength in consumer, that's certainly the case. Now as you think about different markets, in markets like the U.K., we're seeing stronger growth.", "A large part of that is being driven by the fact that we've had recent share wins in the U.K. And then there are share wins we've spoken about in the past in Continental Europe, which are still to come to effect, right? So for example, we talked about our win with Deutsche Bank in Germany, that's still to come to effect. So anyway, there's a mix of all of that, which is kind of taking place at this point in time. On your question around FX.", "I shared with you in my prepared remarks what the annual impact to net revenue of a $0.01 change in the value of the euro would be relative to the U.S. dollar, which is about $55 million on an annual basis. We wanted to put that out there. So you have a sense on what the potential headwind or tailwind could be depending on what happens with FX rates.", "The hard part is predicting FX rates. And so given the current mix of our business, that's the sensitivity I've just shared with you as it relates to how you should think about what the impact could be for 2023." ] }, { "name": "Operator", "speech": [ "And we'll go next to Tim Chiodo at Credit Suisse." ] }, { "name": "Tim Chiodo", "speech": [ "Great. Thank you for taking the question. I want to dig in a little bit on Mastercard Send relative to Visa Direct. I was wondering if you could call out for us and investors, any of the different maybe strategic focus areas, if there are any pricing differences, if there are any mechanical differences or maybe use cases where you seem to be getting traction relative to Visa Direct? That would be extremely helpful." ] }, { "name": "Michael Miebach", "speech": [ "All right. Let me take that. So all the Visa-related stuff, you should ask them, obviously. So I'm not going to do a direct comparison here, but I can tell you how we are thinking about it.", "So first of all, just earlier on, I talked a lot about the crypto space. To just give you one example. Here is an interesting new technology and a growing ecosystem. And what's the way to get out of your crypto wallet balances is, you turn it into fiat and you use Mastercard Send.", "We were right on it from the first day, and we have all ownerships that do exactly that. Then you go around and basically there is new flows. There's geographies, there's use cases. So those are the dimensions on how we are looking at this.", "We're very systematic about it. This has to have ubiquity. We're looking at all regions from a coverage perspective. We're looking at the key use cases.", "We're very selective on the use cases because here you could get lost in 1,000 flowers bloom. The examples that I gave to you on partnering with large global firms like Airbnb, that is the approach, where you're going to say, you partner with somebody, that is in all the regions and covers a use case that just matters to people out there. So that's essentially the approach on Mastercard Send, it has a domestic angle to it. It has a cross-border angle to it.", "It grows at significant rates. We're very happy with it across all of these aspects that I just said. So one thing to add. Earlier, we were talking about the numbers, ex Russia.", "So Russia was a huge success on Send from day one, that's in fact, where a lot of our learnings came from and so we exited Russia, as you know, in March this year. So that is skewing the numbers a little bit, but the learnings are not going away. We're putting that into a whole set of other markets and to the earlier question around Europe. Particularly in Europe, we see some of those learnings translate in other parts of Eastern Europe countries and so forth." ] }, { "name": "Sachin Mehra", "speech": [ "And just to add to what Michael said, particularly on the remittance side, where you're seeing very good traction take place in terms of cross-border remittances and the capabilities we've got there and the capabilities we are building there. Our global reach out there is holding us in really good stead as it relates to how we are able to tap our partners to generate more and more volume down that path. So that's a -- it's a bright spot in terms of the broader remittances piece as well." ] }, { "name": "Tim Chiodo", "speech": [ "Excellent. Thank you for all that context." ] }, { "name": "Operator", "speech": [ "We'll go next to Andrew Jeffrey at Truist Securities." ] }, { "name": "Andrew Jeffrey", "speech": [ "Hi. Good morning. Thank you for taking the question. Michael, I wonder if you could give us an update on your processing efforts globally, maybe with an emphasis in Europe, whether you're taking share and winning business in processing and how you think that can affect over time both the net revenue yield and maybe the profitability of the business, too?" ] }, { "name": "Michael Miebach", "speech": [ "All right. So Andrew, thanks for that question. So starting with Europe, but then we could extend this conversation looking at the Middle East or in Asia. So we have processing assets in those parts of the world.", "And just to illustrate how this matters, so there is obviously a whole new set of players that are entering the payment space who are -- whose prime zone isn't really the process. They want to have a great financial app. So they're looking downstream for a whole set of solutions that complete what they do, make it relatively easy out of one hand, and that's what we provide. This is really the explanation for some of our progress on the fintech side, on the Neobank side.", "Those guys where we have those partnerships, 70% win rate, I'd like to add here is really, to a large extent, coming down to our processing capabilities, which are state-of-the-art modern fintech-oriented processing capability. So it's been a joy for us to watch. In some parts of the world we do partnerships, for example, with Network International, parts of Africa, and so forth. So it's a combination of our own assets where we feel there is scale and differentiation and sometimes it's through partners.", "So overall, there's a good play here in processing, and it's one of the services that we have in our portfolio." ] }, { "name": "Sachin Mehra", "speech": [ "I'll just add some color as the rates to beyond the processing fees on our efforts around switching and the proportion of our total MasterCard branded transactions, which, as you know, we've been pushing hard to actually get more switching share. And the reality is that is working very nicely. We are seeing growth in our proportion of switch transactions, which now stands at greater than 60% of total transactions worldwide. And that's super important.", "Particularly where we're seeing improvements and progress is in Latin America and in Asia Pacific, both of which have been generally low-index markets from a switched transaction share standpoint in the past. So lots of good effort going on there, and we're seeing good progress come through." ] }, { "name": "Andrew Jeffrey", "speech": [ "Thank you very much." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "Our next question comes from Bryan Keane at Deutsche Bank." ] }, { "name": "Bryan Keane", "speech": [ "Hi. Good morning. Sachin, just wanted to go through the yield improvements again. It sounds like it's a lot of mix and some pricing in there.", "How do we think about the yield going forward into the fourth quarter and into next year? Does -- is there some comps get a little tougher as we get into next year for these yields? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So, Bryan, what you're seeing in the nature of yield improvement quarter over quarter, this is net revenue yield divided by GDV. You can attribute a large part of that to just mix. As you know, our inter cross-border has come back pretty nicely.", "And as that has come back nicely, that is higher yielding and that gives us the benefit and the tailwind you're seeing on a sequential basis. I will point out that as it relates to Q4, you should expect that the yield will decline some, which is very consistent with what you see every year. That is just the nature of how the business works just because Q3 happens to be a large cross-border quarter and you still tend to see the benefit of that come through and in Q4, you start to see some of that slowdown. Now you asked a question about 2023.", "I would tell you, we, as a business continue to remain very focused on driving and maximizing our net revenue yield. And there's multiple factors which are going to influence that, some of which is the mix of cross-border and domestic certainly, but also things around just like we just talked about how we're increasing our proportion of switch transactions, the more the switching we do, the greater the yield gets, and that's what we're focused on. How we talked about the shift from Maestro to Debit Mastercard. Again, lots of focus around that, and so we're very focused on driving that.", "All of which, when you overlay all the services we've been bringing to the market, you get the benefit of that coming through as well. So generally speaking, as I look forward, I kind of feel like our focus as a business from a driving yield standpoint continues. And I don't see anything necessarily which is going to change dramatically going into 2023 from a yield trajectory standpoint." ] }, { "name": "Michael Miebach", "speech": [ "Yes. And Sachin kind of explained the strategy again. And that's what -- we're trying to be in the payment transaction and you're at profitable levels, but then use our services to continue to improve the overall revenue yield. And that is that combination that makes us look at the future very optimistically.", "So I don't really see anything changing here. These are the tools that we have and we're using them effectively." ] }, { "name": "Bryan Keane", "speech": [ "Great. Thank you both." ] }, { "name": "Operator", "speech": [ "Next, we'll move to Ramsey El-Assal at Barclays." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi. Thank you for taking my question. I had one on rebates and incentives. And more specifically, kind of how the mix of those rebates and incentives have changed over the past several years.", "I guess the underlying question is, are you having to incentivize an expanding number of value chain players, fintechs, merchants to kind of support consistent growth? How has that mix evolved over time? And how do you expect it to evolve in the future?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. So in terms of rebates incentives, the mix in terms of how we're actually incentivizing to generate incremental revenue has not changed fully. We've historically been more focused as we have actually delivered higher levels of rebates and incentives to our issuing partners. That continues to be the case as to where we are actually expanding most of our rebates and incentives dollars, and that really hasn't changed.", "And as it relates to the mix between rebates and incentives for domestic volumes versus cross-border, I'd say, that mix also hasn't really changed. As you know, cross-border has generally been indexed lower from rebates and incentive standpoint, and that continues very much to be the pattern right now as well, Ramsey." ] }, { "name": "Ramsey El-Assal", "speech": [ "OK. So pretty stable environment is what it sounds like. I appreciate it. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Yes. Absolutely." ] }, { "name": "Operator", "speech": [ "We'll move next to David Togut at Evercore ISI." ] }, { "name": "Michael Miebach", "speech": [ "David, are you there?" ] }, { "name": "Operator", "speech": [ "And, sir, you may have your line on mute. We're not hearing you." ] }, { "name": "Michael Miebach", "speech": [ "Audra, maybe we go to the next, please." ] }, { "name": "Operator", "speech": [ "Yes. We'll move next to Bob Napoli at William Blair." ] }, { "name": "Bob Napoli", "speech": [ "Hi. Thank you, and good morning. Just would like an update on your B2B -- your thoughts around the B2B payments market and the opportunities there? I know you called out a commercial POS of $14 trillion. And what inning are we in? What is -- any thoughts on the changes of that market, the growth of that market? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Right. Yes. So I'm really not into baseball analogies. So that's why -- earlier, I was talking about the first half of the game.", "But to your question, very specifically, B2B, huge opportunity from a volume perspective. We called it out and we cut it down into very distinct types of flows at our investor day at the end of last year to focus on B2B accounts payable on one hand, but there's other B2B flows which we're very active in. For example, through all the illustrations I gave you earlier on virtual card use cases. So virtual card is the current and most immediate answer to go after B2B flows.", "There's the commercial POS piece somewhere which is kind of an in-between space between B2B and small business. That's a huge space with a lot of cash and checks. So you build it up over those into the accounts payable piece. And you know the long-range vision that we have on accounts payable is really the Mastercard Track business payment service piece, where we say over time, we're building a two-sided network here.", "That continues to grow, but that takes time. But we have the large -- we have large players around the table, HSBC, JP, and so forth. So a good initiative for us. But for now, we are very active on virtual cards to solve the issues of buyers and suppliers in the space.", "So we have not moved away this by any stretch of the imagination, this is a huge opportunity, and we're going to go after it." ] }, { "name": "Bob Napoli", "speech": [ "All right. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Audra, I think we have time for one last question." ] }, { "name": "Operator", "speech": [ "We'll take that question from Jamie Friedman at Susquehanna Financial Group." ] }, { "name": "Jamie Friedman", "speech": [ "Hi. Sachin, transaction processing fees increased 15%, but switched transactions increased 9%. I know you called out in your prepared remarks mix changes. I was just wondering if you could elaborate on that." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So there are a few things going on right there where our transaction processing fees are growing faster than the underlying driver, one of which is the mix change. And really, remember, when we make cross-border revenues, we make cross-border revenues on a basis-point basis, as well as on a sales per transaction. And the component, which is on basis points since and cross-border volume fees and there's some component of cross-border related sales per transaction that sits in terms of the number of transactions which we process with the same transaction processing fees, which is where the mix effect comes through.", "Because as you've seen, inter cross-border grow at a rapid pace. That's contributing to that delta between what we're seeing in the revenue line and what we're seeing in the driver because cross-border is high-yielding than is domestic. There are a couple of other factors which calls for that differential as well. I talked about FX-related revenues and some level of pricing.", "Those are the two other contributors which go into that chain." ] }, { "name": "Jamie Friedman", "speech": [ "Thank you." ] }, { "name": "Michael Miebach", "speech": [ "All right. Let me bring the call to a close. First of all, thanks for your questions. And to all of our investors, thank you for your support.", "This morning, I sent a note to all colleagues here at Mastercard, thanking them for a strong quarter because they are the ones who make all of this happen. So a shout-out to them as always. And with that, we'll talk to you in the next quarter. Thank you very much." ] }, { "name": "Sachin Mehra", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2021-10-28	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Don Fandetti", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Cowen and Company -- Analyst", "name": "George Mihalos", "position": "Analyst" }, { "description": "Tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Sanford C. Bernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Mizuho Securities -- Analyst", "name": "Dan Dolev", "position": "Analyst" }, { "description": "William Blair -- Analyst", "name": "Bob Napoli", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good day, and thank you for standing by. Welcome to the Mastercard third quarter 2021 earnings conference call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions] I would now like to hand the conference over to your speaker today, Mr.", "Warren Kneeshaw, head of investor relations. Please go ahead." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Jumaria. Good morning, everyone, and thank you for joining us for our third quarter 2021 earnings call. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the investor relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis, unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to their GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website for 30 days. With that, I will now turn the call over to our chief executive officer, Michael Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren. Good morning, everyone. So let me start by giving you the highlights of the quarter. Strong revenue and earnings growth continued.", "The net revenue up 29% and EPS up 48% versus a year ago, as always, on a non-GAAP currency-neutral basis. On this same basis, Quarter 3 net revenues are now 11% above pre-COVID levels in 2019. We're seeing continued strength in domestic spending and overall cross-border volumes are now back at 2019 levels, though there still remains significant room for growth in cross-border travel. We're continuing to execute against our strategic priorities with good progress on the product and deal fronts this quarter.", "And we're excited about our acquisition of CipherTrace in the crypto services area and our planned acquisition of Aiia in open banking. So those are the highlights. Looking at the broader economy, domestic spending levels continue to improve, even though economies are facing supply chain constraints, rising energy prices and some other inflationary pressures. According to our Quarter 3 SpendingPulse report, which is based on all payment types, including cash and check, U.S.", "retail sales ex auto, ex gas were up 5% versus a year ago and 12% versus 2019, reflecting the return to in-person shopping and the ongoing e-commerce strength. SpendingPulse also indicated that the overall European retail sales in Quarter 3 were up 5% and 6% versus 2019. As it relates to COVID specifically, the outlook continues to get better with case numbers generally improving, new therapeutics in the pipeline, progress on vaccinations and businesses becoming more agile in the face of remaining restrictions. We're also seeing a general trend toward the opening of travel corridors, notably inbound into the U.S.", "and some easing of restrictions in Asia. Now, turning to our business. While the pandemic is not fully behind us, we're now in the growth phase in most markets domestically and in many markets in cross-border spending as well. We will, therefore, turn the page and move beyond the four-phased framework that guided us through the last 19 months and focus on managing the business for the growth opportunities ahead of us.", "Looking at Mastercard's spending trends. Switched volumes improved quarter over quarter. We saw particular strength in consumer and commercial credit. Debit spend remains elevated, although it has moderated in recent weeks in part due to waning stimulus benefits.", "In terms of how people are spending, card-present volumes continue to improve as people are getting out and shopping more while we are still seeing sustained strength in card-not-present spend. So regardless of whether people want to shop online or in-person, our solutions support that choice and position us well to participate in both trends. Now, let's take a look at cross-border. Overall, cross-border returned to 2019 levels in August, driven by improvements in consumer and commercial travel, as well as the ongoing strength of cross-border card-not-present spending ex travel.", "Our cross-border travel improved from 48% of 2019 levels in the second quarter to 72% this quarter with substantial upside potential still remaining as and when borders open. Against this backdrop, we're investing in the growth of our business, including the enhancing end of our leading technology capabilities, like expanding our network edge to connect directly with our customers through the cloud, providing faster and easier access to our products and services. And of course, we remain focused on our strategic priorities: number one, rolling out core products while driving the shift to digital; two, differentiating and diversifying with our services; and three, leveraging our multi-rail capabilities to offer choice across payment applications. Now, let's take them one-by-one and turn to how we're growing our core products and driving the shift through digital: through Mastercard Installments, by winning core deals and by continuing our momentum in the fintech space.", "First, let me tell you about our recently announced Mastercard Installments, our scalable, open loop, buy-now-pay-later solution. Mastercard Installments is differentiated in that it enables banks, lenders, fintechs and wallets to seamlessly bring buy-now-pay-later solutions to consumers and merchants at scale and in a secure, tokenized manner. With little to no integration for merchants, our solution avoids the need for lenders to engage merchants one-by-one to roll this out, enables them to deliver more payment options to more consumers faster. Our solution brings choice at scale, delivered through the Mastercard network.", "Our consumers will be able to access buy-now-pay-later offers through their bank's mobile banking app at the point of checkout and soon directly through Click to Pay. The embedded power of Finicity will help lenders with credit positioning and enable consumers to easily choose different repayment options. Mastercard Installments will power our core payments and enable us to provide additional value through services, such as data analytics, loyalty and fraud tools. We've seen strong interest from players on all sides of the ecosystem and look forward to growing our partnerships in this area.", "As always, we remain focused on continuing to grow share. And we've won deals across the globe this quarter. In the U.K., we're partnering with Chase as the preferred debit partner of their new digital retail bank. In Canada, we've extended our exclusive co-brand with Costco Canada.", "And in Brazil, we signed a deal with Autopass to issue more than 10 million cards to mass transit users in the Sao Paulo area, and along with that, open, contactless acceptance across their subway trains and city buses. We're also building our leading position with fintechs and mobile money providers. Here are a few recent examples. PayPal has extended its PayPal Business Debit card into our four markets in Europe.", "PayPal will also directly leverage Mastercard Send for domestic wallet cash-outs and P2P transactions in the U.S. We're partnering with Vodafone in Egypt across all of their mobile money use cases, including cash-outs, P2P and bill payments. We expanded our strategic partnership with Yandex in Russia and we'll be their preferred international partner for all of their fintech initiatives. And Finterra, an innovative market leader that connects U.S.", "banks and fintechs to get cards and financial products into the market, will leverage our digital-first Finicity, Mastercard Send and cybersecurity assets. Now, shifting to services. Our services support and differentiate our core products and have played a critical role in enabling many of the wins I just mentioned. They, of course, also diversify our business.", "We had many wins in this area this quarter. Starting with the cybersecurity space. Ethoca is helping multiple players, including AT&T and Mercado Libre, reduce charge-backs through collaboration, thereby creating purchase transparency. Banco de Bogotá is using our artificial intelligence capabilities to improve consumer experiences, increase profitability and identify new opportunities.", "And in Europe, the term is leveraging NuData's behavioral biometrics to help thousands of new banks authenticate online transactions. Data analytics. The tourism agencies in Greece, Hungary and elsewhere are using services like tourism insights and managed services to gather greater visibility of trends and drive deeper insights to support their tourism campaigns. In the UAE, HSBC is leveraging our test-and-learn capabilities to innovate, experiment and roll out new products for better customer engagement.", "And we're having success in the loyalty space with our innovative digital solutions, driving wins with players like the global fitness chain, Barry's and First and Saudi National Bank. Now, let's turn to the progress we've made in offering choice to consumers across payment applications with our multi-rail capabilities, including open banking, B2B and crypto. In open banking, we're happy about our planned acquisition of Aiia. Aiia is a leading European open banking player, whose platform expertise, strong API connectivity and payment capabilities complement our existing open banking assets.", "We will combine Aiia's European footprint with Finicity's connectivity in the U.S. and our expansion into other markets like Australia. This will allow us to extend each organization's best-in-class capabilities, such as credit decisioning, credit scoring, account information services and payment applications across markets. Talking about markets.", "We continue to make progress with our open banking product in Europe with players like Entercard, one of Scandinavia's leading credit card companies. And in the U.S., Finicity is working with UGO to enable account opening verifications, along with future plans to expand into payments. In B2B, we continue to expand the Track Business Payment Service network with key partners like J.P. Morgan Chase, as well as merchant acquirers such as Moneris, the largest acquirer and leading processor of B2B transactions in Canada, and Priority Commercial Payments, a leading payments technology company in commercial payment solutions in the U.S.", "We're also adding new functionality to Track DBS and are partnering with Demica to launch a supply chain finance capability. This functionality empowers payment agents to provide their business customers with access to affordable working capital directly through the Mastercard Track DBS platform. And in the U.K., HSBC will be the first to issue a Mastercard Track Card to Account Transfer product, an innovative B2B payment solution that allows businesses to use their commercial card program to make payments to any supplier, even if that supplier does not accept card payments. Again, a true multi-rail offering.", "And finally, in the crypto space, we're making it easier for crypto players to connect to our network. We signed up a number of new crypto wallet providers and exchanges this quarter, including Bit2Me, [Inaudible], Kanga by ZEN.COM, Coinmotion and CoinJar. Our crypto program, which is based on [Inaudible] principles of engagement, allows consumers to easily buy crypto assets with their Mastercard, spend their crypto balances wherever Mastercard is accepted, cash out their proceeds with Mastercard Send and earn rewards in the form of crypto or even NFT. We're also seeing a growing services opportunity in this space.", "Earlier this month, we acquired CipherTrace, a security and fraud monitoring company with expertise, technologies and insights into more than 900 cryptocurrencies. Our recently announced agreement with Bakkt will also add to our expanding crypto services portfolio. So let me sum this up one more time. We delivered strong revenue, earnings growth this quarter.", "We are seeing continued strength in domestic spending in most markets. And while overall cross-border volumes are back at 2019 levels, there remains significant room for growth in cross-border travel. We're executing against our strategic priorities with good progress on the product and deal front, as you heard, we're doing all of that while carefully managing our expenses. That's it for me.", "Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael, and good morning, everyone. So turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis, excluding special items and the impact of gains and losses on our equity investments. Net revenue was up 29%, reflecting the continued execution of our strategy and the ongoing recovery in spending. Acquisitions contributed 3 ppt to this growth.", "Operating expenses increased 23%, including an 8 ppt increase from acquisitions. Operating income was up 34% and net income was up 45%, both of which include a 1 ppt decrease related to acquisitions. Further, net income growth was also positively impacted by 6 ppt due to the recognition of higher one-time discrete U.S. tax benefits versus a year ago.", "EPS was up 48% year over year to $2.37, which includes $0.02 of dilution related to our recent acquisitions, offset by a $0.04 contribution from share repurchases. During the quarter, we repurchased $1.6 billion worth of stock and an additional $361 million through October 25, 2021. So now, let's turn to Page 4, where you can see the operational metrics for the third quarter. Worldwide gross dollar volume or GDV increased by 20% year over year on a local-currency basis.", "We are seeing continued strength in both debit and credit. U.S. GDV increased by 20% with debit growth of 9% and credit growth of 36%. Outside of the U.S., volume increased 20%, with debit growth of 23% and credit growth of 16%.", "To put this in perspective, as a percentage of 2019 levels, GDV is at 121%, up 2 ppt sequentially, with credit at 111%, up 4 ppt sequentially, and debit at 131%, flat quarter over quarter. Cross-border volume was up 52% globally for the quarter with intra-Europe cross-border volumes up 47% and other cross-border volumes up 60%, reflecting continued improvement and the lapping of the pandemic last year. In the third quarter, cross-border volume was at 97% of 2019 levels with intra-Europe at 112% and other cross-border volume at 83% of 2019 levels. Notably, cross-border volumes averaged at or above 100% of 2019 levels in the months of August and September.", "Turning now to Page 5. Switched transactions grew 25% year over year in Q3 and were at 131% of 2019 levels. Card-not-present growth rates remained strong and card-present growth continue to improve. Card-present growth was aided in part by increases in contactless penetration in several regions.", "In Q3, contactless transactions represented 48% of in-person purchase transactions globally, up from 45% last quarter. In addition, card growth was 8%. Globally, there are 2.9 billion Mastercard and Maestro-branded cards issued. Now, let's turn to Page 6 for highlights on a few of the revenue line items, again described on a currency-neutral basis, unless otherwise noted.", "The increase in net revenue of 29% was primarily driven by domestic and cross-border transaction and volume growth, as well as strong growth in services, partially offset by higher rebates and incentives. As previously mentioned, acquisitions contributed approximately 3 ppt to net revenue growth. Looking quickly at the individual revenue line items. Domestic assessments were up 21% while worldwide GDV grew 20%.", "Cross-border volume fees increased 59% while cross-border volumes increased 52%. The 7 ppt difference is primarily due to favorable mix as higher-yielding ex intra-Europe cross-border volumes grew faster than intra-Europe cross-border volumes this quarter. Transaction processing fees were up 26%, generally in line with switched transaction growth of 25%. Other revenues were up 35%, including a 10 ppt contribution from acquisitions.", "The remaining growth was mostly driven by our cyber and intelligence and data and services solutions. Finally, rebates and incentives were up 34%, reflecting the strong growth in volume of transactions and new and renewed deal activity. Moving on to Page 7. You can see that on a currency-neutral basis, total operating expenses increased 23%, including an 8 ppt impact from acquisitions.", "Excluding acquisitions, operating expenses grew 16%, primarily due to higher personnel costs as we invest in our strategic initiatives, including -- sorry, increased spending on advertising and marketing and increased data processing costs. Turning to Page 8. Let's discuss the specific metrics for the first three weeks of October. We are seeing continued strength in growth rates across our operating metrics versus 2020, in part due to the lapping effects related to the pandemic that began last year.", "To provide you better visibility into current spending levels, we are, once again, showing 2021 volumes and transactions as a percentage of the 2019 amounts, when we were not experiencing the impact of the pandemic. So if you look at spending levels as a percentage of 2019 for switched volumes, through the first three weeks of October, the recent trends have continued with overall switched volumes at 134% of 2019 levels, up 3 ppt versus Q3. The U.S. has held steady with some moderation in growth from earlier levels due to the roll-off of stimulus.", "And outside the U.S., we have seen continued improvement. Trends in switched transactions remain steady and are generally tracking the trends we are seeing in switched volumes. In terms of cross-border, as I noted earlier, spending levels as a percentage of 2019 were back to pre-pandemic levels, starting in August. That improving trend has continued through the first three weeks of October.", "And we are now at 105% of 2019 levels. This improvement is driven by increases in both travel and non-travel cross-border volumes. As it relates to travel, we have seen it picking up in all regions, notably within and to Europe and recently into Canada as well. Turning to Page 9.", "I wanted to share our current thoughts looking forward. First off, our deal momentum and service lines continue to position us well for growth and diversify our revenues. And we continue to make strong progress against our strategic objectives. Domestic spending levels remain healthy.", "And we are encouraged by the recent resurgence in international travel. We are optimistic about the announced relaxation of border restrictions in places like the U.S. and the U.K., given that we have seen travel pickup when borders have opened in the past. Further, the airlines have recently reported increased travel bookings, including long-haul travel.", "With this as context, assuming domestic and cross-border spending trends relative to 2019 continue to improve, we would expect Q4 net revenues to grow at a low 20s rate year over year on a currency-neutral basis, excluding acquisitions. As a reminder, spending recovered progressively in 2020, so we will be facing a more difficult comp of approximately 7 ppt in the fourth quarter relative to the third quarter. It is also important to point out that this is just one potential scenario as the level of uncertainty remains related to the pandemic and therefore the pace of recovery may not be linear. In terms of operating expenses for the fourth quarter, we expect operating expenses to grow at the low end of low double digits versus a year ago on a currency-neutral basis, excluding acquisitions.", "This reflects our disciplined approach to expense management while advancing our innovation agenda across payments, services and promising new adjacencies and continued investment in brand and product marketing. With respect to acquisitions, we are pleased to now have closed on the CipherTrace transaction. And we expect acquisitions will contribute about 2 to 3 ppt to revenue and 8 ppt to operating expense growth in Q4. This reflects the integration of several acquisitions in the open banking, digital identity and real-time payment areas.", "Other items to keep in mind. Foreign exchange is expected to be about 0.5 ppt headwind to both net revenue and operating expenses in Q4. On the other income and expense line, we are at an expense run rate of approximately $120 million per quarter, given the prevailing interest rates. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics.", "And finally, we expect a tax rate of approximately 18% to 19% for the fourth quarter. Thanks, and I hope you will be able to participate in our virtual investment community meeting on November 10. We look forward to discussing our future plans with you at that time. And with that, I will turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Jumaria, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question will come from the line of Lisa Ellis from MoffettNathanson. Please proceed with your question." ] }, { "name": "Lisa Ellis", "speech": [ "Hi, good morning. Thanks for taking my question. Since you launched Mastercard Installments now a few weeks ago, can you give some color on what kind of reaction you're seeing from your fintech and bank partners? And also, are you expecting that some of the specialized BNPL providers may use elements of Mastercard Installments? Why or why not? Like what would be the trade-offs that they would be making there? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Lisa. Let me take that question first. So buy-now-pay-later, exciting space. We talked about it for years, invested with our own installment proposition, facing off to banks five, six years ago, the partnerships, and now as of late Mastercard Installments as you said.", "You saw a strong lineup of initial partners, bank partners initially. I mean, the thought is to remind everybody again here is a proposition that we have built into our network. So this is really delivered with no hassle for merchants or for lenders at the point of sale. So the reaction from banks are strong.", "Here in the U.S., that's where our lineup of U.S. partners, lending partners was. But I've spent time on the roads over the last three weeks in Europe and similar conversation emerged there. It was just a couple of days after the announcement over Italy and banks were saying, \"Wow, this makes a lot of sense.", "It's really avoiding a significant headache for us and get into a space that we all believe is important from a consumer perspective.\" On the fintech side, fintech lenders, novel lenders, we lean in with fintechs, some call them disruptors. We feel these are partnerships, we should enable anybody who wants to come on our network. And we are certainly marketing this to ensure that we have the full breadth of what the market has in terms of lending offering. That's gonna be good for consumers and merchants.", "So watch this space, more to come. But I think, it's a very compelling proposition." ] }, { "name": "Lisa Ellis", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question will come from the line of Don Fandetti from Wells Fargo. Please proceed with your question." ] }, { "name": "Don Fandetti", "speech": [ "Hi, good morning. Michael, I was wondering if you could talk a little bit about disintermediation. And it seems like investors are more focused on it after the Square-Afterpay deal. Can you talk about that and your thoughts on more direct payments out of consumer accounts in the U.S.?" ] }, { "name": "Michael Miebach", "speech": [ "Right. So Don, great question. Choice in payments has been a theme for Mastercard now for, I think, basically always, but specifically with our investments in the account-to-account space over the last six years. So we see the demand from merchants and from consumers.", "For the consumer, it makes sense because you get all your spend into -- you can see it all on one bank account. That would be one aspect to why consumers might like that. Merchants like it for choice and higher baskets of more sales. So the interest is clearly there.", "We've been on this journey for a while, and we don't necessarily see this as a disintermediation opportunity. I mean, that's certainly something to watch. But we look at it as an opportunity. We say this could be additional volumes that we've not been involved with.", "This could be what was historically the consumer finance business. This would be something that was just the direct debit business that we've seen in some European countries and so forth. So that's broadly how we look at it. We built a full stack around this that helps to get your money from A to B.", "But that's just half of the story. Probably not even half of the story because it's the whole experience that really matters. You got to have the security. What happens if you do a push payment and you want your money back? Some of those best practices that we've learned over the last decades in cards is what we are intending to build here.", "So it's interesting to see blogs out there on how account-to-account might look like. We have four years now in Pay by Account in the U.K. We've got those learnings. We're ahead of the market here, very clearly knowing what works, what the economic model should look like, what the proposition that would really make a difference for merchants, for acquirers who will be all playing in this space.", "So I don't see a disintermediation risk. I see an opportunity for us to extend our partnerships and gain new flows." ] }, { "name": "Sachin Mehra", "speech": [ "And I'll just add on to what Michael just said. As it relates to your question around specifically on the threat of closed loops, look, we're big believers in the benefits of the open loop system, which we believe is very powerful. I mean, for the reasons Michael just mentioned, we bring consumers at scale. We bring global acceptance.", "I mean, we have north of 80 million merchant acceptance points. And this is growing rapidly. And the cost of acceptance is very competitive. And when you take that, along with what Michael talked about around the various technologies and the expertise we bring, everything from digital solutions, fraud solutions, merchant support, processing assets, now most recently, Mastercard Installments, that's a very compelling proposition to go and look in our view, which is why we believe that if people wish to scale, the best way to go on is open loop, which is why we've kind of given investment in the business very heavily to drive down that back." ] }, { "name": "Don Fandetti", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Bryan Keane from Deutsche Bank. Please proceed with your question." ] }, { "name": "Bryan Keane", "speech": [ "Hi, good morning. I wanted to ask about cross-border travel. Visa yesterday was talking about cross-border travel, not getting to 100% on the two-year until summer of calendar year '23. Just wanted to get your thoughts on when do you think we'll get to reach back to 100% on cross-border travel.", "And then, secondly, it looks like you guys are running a little bit fast or a little bit ahead of Visa's number for cross-border travel. I'm just wondering what might be some of the factors that are driving a little stronger demand for you guys so far? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So Bryan, I'll go ahead and take that. First, I know you're asking specifically about cross-border travel, but I just want to kind of put the headline out there, which is for cross-border as a whole, we have seen very strong growth in Q3, as you've seen. And yes, travel has been a big component of that, specifically, travel between Q2 and Q3 has gone from what was 48% of 2019 levels to 72% in Q3.", "And now, in the first three weeks of October is tracking more like at 77%. And look, what this signals to us very clearly is if people can travel, they will travel. And I think, that's really, really important to recognize. And then, when you overlay that with what's going on in the nature of announcements, around opening of borders, more specifically, the U.S.", "has recently talked about inbound travel into the U.S. In fact, I think, just a couple of days ago, they laid out the actual details around how people can come into the U.S. I mean, you combine that with the fact that Europe has opened up, the U.K. is showing good signals of opening up.", "Even in Asia, we're starting to see corridors between Singapore and Australia, Singapore and India. These corridors are all starting to open up. These are all encouraging signs for us from a cross-border travel standpoint. And we remain optimistic on that front, especially given that if those borders open up and they come with what would be light burdens from a quarantining standpoint, which is what we are seeing right now.", "People have said that they will travel and they've demonstrated that through Q3. So net-net, here is what I'll tell you, I think travel is something which people want to do. They're showing their willingness to do it. Now, it's a question of which are the other countries which will open up in addition to the borders I've just talked about.", "And you're reflecting -- you're seeing this to be reflected in the bookings, which airlines are reporting as well. So we remain optimistic on this front. I can't really tell you specifically which day or which month it's going to reach to 100% of 2019 levels. But generally, the trend is more moving in the right direction there." ] }, { "name": "Michael Miebach", "speech": [ "Right. And coming back to being on the road for quite a few weeks, you start to see also the mix changing. While initially, this was leisure travel, you start to see business travel really kicking in. So that gives us another signal that really the pent-up demand is coming across all channels.", "People want to see their customers. They wanted to see their family first, now they want to see their customers. It's happening." ] }, { "name": "Sachin Mehra", "speech": [ "And just one final point I'll make. You remember over the last few quarters, we've talked about how, in anticipation for the return of travel, we have been investing in bolstering our capabilities from a travel standpoint. And we've been doing this actually for many years now. But even through the pandemic, we've been winning deals in travel as also our teams have been very focused on the ground in terms of making sure we are optimizing our travel portfolio the best that we can.", "So we're ready to actually jump on this as soon as we start to see this trend come back, which we are seeing now." ] }, { "name": "Bryan Keane", "speech": [ "Great. Thanks for taking the question." ] }, { "name": "Michael Miebach", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "Our next question will come from the line of George Mihalos from Cowen. Please proceed with your question." ] }, { "name": "George Mihalos", "speech": [ "Great. Thanks for taking my question, guys. Maybe dovetailing a little bit on to Bryan's question. I just wanted to focus a little bit on how we should be thinking maybe about rebates and incentives going forward.", "Sachin, should we be thinking this level as sort of similar -- for 4Q, a similar level to 3Q? And then, again, not asking for guidance for next year, obviously, but as you have cross-border revenues coming back strongly and actually eclipsing 2019 in aggregate, should that sort of put a cap on rebates and incentives as a percentage of revenue, meaning should it kind of be flattish, if not maybe even a little bit down from '21? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So George, a couple of things I kind of just point out on rebates and incentives. And I think, you know all of this, but I'll just kind of state it here. A few things, we think that incentives is very dependent on the timing of deals and how volume and mix plays out.", "And it goes to your point around what the mix is between domestic and cross-border and how you model that and bring that in there. In Q4, we expect rebates and incentives as a percentage of growth to be up sequentially due to increased deal activity. This is pretty normal for us in Q4. And that's what you should expect also going into Q4 of this year.", "Look, at the end of the day, a lot is going to depend upon, like I said, what the mix is going to look like. We have said in the past that cross-border revenues are less indexed from a rebates and incentive standpoint. So again, depending on mix between domestic and cross-border, that will inform our kind of views around where rebates and incentives will go on a going-forward basis. Of course, new and renewed deals, which we remain very active in the market, are also gonna be a contributing factor." ] }, { "name": "George Mihalos", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question will come from the line of Tien-Tsin Huang from J.P. Morgan. Please proceed with your question." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey, thanks so much. Good morning. Just wanted to ask on the Europe front with the discontinuance of the 400 million Maestro cards that's been in the press here. What are the implications there from -- I'm trying to think from a P&L perspective as you look to convert at a time when open banking is really heating up here? Just trying to better understand that.", "Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Tien-Tsin, let me start on that and then Sachin can comment on the P&L side of things. So we've been on this journey of Maestro to Debit Mastercard conversion around the world. You heard us talk about this for a number of years. In Europe, we've really made substantial progress on that front over the years, and we felt it would be important to put a stake in the ground and give assurance to consumers, as well as other ecosystem participants, banks, sales force, banking associations of when we see the end of life for the Maestro product.", "Why are we doing that? We're doing it because here's the 450 million consumers who cannot use a Mastercard -- a Maestro card online because it doesn't work online. Debit Mastercard is, now in its latest form, available in a digital-first form. You don't even need a physical card any longer, if that's what you want to do or you want it with contactless. It gives you the full breadth of choice.", "So that is why we are doing this. The timing is right. The reaction was essentially OK. It had to do -- in some of the leading European tabloids, we made it onto the front page with that news.", "It is big news in Europe, as you rightly said. But it's just the right thing to do. And what we've seen from a performance perspective, it is a more engaging payment tool in your hands and people use it across all channels. And that's what we want.", "So we're very encouraged about that. And then, Sachin, if you can look at the P&L side of that?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So Tien-Tsin, this will not take effect until 2023. And Michael talked about approximately 400 million Maestro cards globally. Again, this is Europe-specific.", "There's been a trend which has currently been underway for some time now. And the reality is it's about not issuing new Maestro cards. Existing Maestro cards will continue to be in operation. We've been on this migration path.", "It makes sense. It just provides better utility for our products in an increasingly digital world. So the reality is I kind of view this as a step in the right direction. And we've been on this journey, we'll continue down this path." ] }, { "name": "Michael Miebach", "speech": [ "Right. And one last aspect here is this -- what we've learned here is over the last couple of years as we are moving the shift from Maestro to Debit Mastercard is how do we use this as an opportunity to not only retain our business that we have on the debit front but also to expand our business on the debit front. So we don't have any concerns on that front." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Understood. Thanks for the colors." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Darrin Peller with Wolfe Research. Please proceed with your question." ] }, { "name": "Darrin Peller", "speech": [ "Thanks, guys. Nice job. Listen, when we look at -- or a couple of quick ones is -- first, on inflation and what the impact to your business model would be. Thinking about it from a perspective of how much is, obviously, basis points volume-driven, but also where you see pricing power in your model to change? And then, second question would be when you think of the structural impacts from the pandemic and where you are now and thinking ahead of the investor day a minute, I mean, is the long-term or medium-term growth potential similar, different, better, worse than it was last time we had an investor day, out of curiosity?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So Darrin, I'll take your question on inflation. So look, I mean, there's been, obviously, a lot of talk recently about high inflation levels, whether it's permanent, whether it's long term, whether it's just transitionary. The reality is the structure of our business model is quite conducive because of the way we price, right? I mean, we've got basis points.", "We've got cents per transaction as it relates to how we kind of price. So we kind of view the following, which is to the extent that inflation is moderate, right, we think that -- of that to be a positive tailwind kind of to our business. Again, gradual and moderate inflation is gonna be helpful. And the reason I bring that up is any sort of shock to the economy, i.e., any sort of hyperinflationary event, oftentimes comes with drastic measures from an interest rate standpoint and comes with cost pressures which come along with that.", "So to the extent it's moderate, it's moderately kind of positive for our business. The other thing I would say is it's important to actually see in the basket of goods and services what are the products and services which are subject to inflation and what is the amount of electronification of the flows, which have taken place and relevance to our business. So to the extent there's inflation, general inflation taking place in categories which are unrelated to card payments, I mean, that kind of is a net nonevent for us. To the extent it's on things which relate to consumer spending, which have been electronified, it goes back to my point around moderate inflation being a mild positive here." ] }, { "name": "Michael Miebach", "speech": [ "All right. Now, Darrin, on your second question, structural changes, are they here to last, what makes a trend? Fascinating question. I don't want to upfront the investor day, but since you asked the question, I'll give you a couple of highlights on how we're thinking about that. So the first thing is it helps to understand the psyche of the changing consumer of the small business, so everybody who's kind of in the payment space as an end user.", "And we now have 19 months of studies looking at this. And the numbers have really not changed. Somewhere around 70% of people and business are saying more digital banking will be what they will be doing going forward. More online shopping is what they will be doing going forward and more contactless.", "So the secular trend that was playing in our favor for years has clearly accelerated. And if you just look at this quarter's numbers, we talked about sustained e-commerce strength while in-person shopping is coming back. So behavior is truly sticking. So that is -- I think, that's the most fundamental point that we are seeing coming through.", "The race to this digital economy is on. And what that also means is a lot of players want to come in. So there are structural changes in the sense of that the competitive playing field is opening up. More partners are coming in, which for B2B2C player like us is a great opportunity to facilitate the entry of all of these partners.", "So that's what we're doing. Then you start to look around and say, \"Well, who else is looking at this, these kind of trends and these kind of developments?\" Most notably governments. Governments are looking at this, and they have found that over the last 19 months, that payments is indeed a national critical infrastructure. So that comes with government engagement, which is not always necessarily positive.", "But what we are seeing is there's this real drive to modernize payment infrastructure. And that is where we are invited to the table because we're a true multi-rail network. And they're saying, \"Hey, you're locally invested, you're a locally relevant partner. Let's talk about how do we make this better in our country.\" So that is certainly a structural change as in -- Tien-Tsin asked earlier about new payment flows coming in, open banking, etc., in Europe, so we're playing on all of those trends going forward.", "So I think, that is what is happening. You could -- I could go on for a while longer. B2B, clearly digitizing supply chains is a drive that is in focus. We're seeing that.", "Data analytics and cybersecurity, that's the last point I want to make on this. With the race toward a more digital economy, there's gonna be more data that is available, more business will seek to use that data and run their business in a better way, find more customers. Our test-and-learn capabilities and our data analytics capabilities help on that. So again, that's a structural trend that's helpful.", "And the same applies for cyber and security, more digital transactions need to be made safe, more people need to be authenticated as they use these tools. Again, that plays into our offering. So structural change is really driven by COVID accelerating the race to digital." ] }, { "name": "Operator", "speech": [ "Our next question will come from the line of David Togut from Evercore ISI. Please proceed with your question." ] }, { "name": "David Togut", "speech": [ "Thank you. Good morning. What are your expectations over the next year for the pace of European adoption of account-to-account payments under open banking, especially given the shift online that you've really underscored during COVID? And in particular, I'm wondering if you see strong customer authentication, which is really a key to account-to-account payments in Europe, being rolled out broadly enough to really affect, let's say, broader adoption of account-to-account payments throughout Europe." ] }, { "name": "Michael Miebach", "speech": [ "David, let me start on that. And maybe Sachin wants to chime in. So the journey toward account-to-account in Europe, I think it's still early days. If you look at how PSD2 has rolled out in Europe, starting in September 2019, including the strong customer authentication, has been a long journey.", "Dates have been moved on multiple occasions to give time to the industry to get this right. And get right means that the transaction isn't so secure that nobody can use it any longer. So the trade-off between consumer experience and security is actually found in a balanced way. And what we are seeing in our engagements in Europe is that balance is starting to be struck.", "So we will reach a point where such strong customer authentication in cards, as well as in other forms of payments will be actually a reality in Europe. So that's the first thing I want to say. When it comes to open banking specifically, so there has been, over the last two years, really a focus on driving connectivity in Europe in terms of getting the open banking ecosystem stood up. That's exactly why we put out a connectivity product in June 2019.", "That was the first lead into the region, and we've been quite busy with that. Use cases emerging on the basis of that really started in 2020, the U.K. being ahead of Continental Europe on that while this was still one Europe. And U.K.", "is still pushing ahead. You heard us talk about Lloyd's on card repayments, about our partnership with Tesco. So the payment capability part of open banking is really leading in the U.K. And here, our proposition is very well-positioned.", "So we start to see that. And I see the wave coming over to Continental Europe as connectivity is now there. Our acquisition of Aiia is perfectly timed here. We expect to close this by the end of the year to not bring in additional -- not only bring in additional connectivity but also additional payment capabilities.", "Because I do see this is not just a data capability, it's a big data -- kind of a data play, account obligation, personal finance management and so forth. But it's also a payment opportunity." ] }, { "name": "David Togut", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Harshita Rawat from Bernstein. Please proceed with your question." ] }, { "name": "Harshita Rawat", "speech": [ "Hi, good morning. Thanks for taking my question. Michael, I want to follow up on your comments on crypto. This year, you've made several announcements, including the recent one with Bakkt and the acquisition of CipherTrace.", "Can you talk about how you see the overall ecosystem evolving? And what ways Mastercard can participate here in the growth of crypto and potentially CBDC, when they become live? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Yes, Harshita, so always an exciting topic. And we could not have an earnings call without talking about crypto, so I'm happy you brought it up. Looking at this from a number of perspectives, other than that there's a lot going on in the space. We are pretty clear on how we want to play in this.", "So the first is we see significant volumes in terms of people actually investing in crypto and selling crypto. So as an asset class, there's a lot going on. And I think, we have a role to play to facilitate consumers wanting to do that if that's what they choose to do. So these partnership programs on exchanges, crypto exchanges and wallet partners and so forth, have been quite important for us and that is good from a volume perspective.", "There's real activity. When it comes to crypto as a payment tool, then we take a somewhat differentiated view on that versus the -- we just stepped into that. We're saying at this point in time, the most likely chance of this kind of technology to work for payments is issued through a government in the form of central bank digital currency. We've said that on a couple of calls before.", "And we said we will make our network ready to do that as and when a government is ready to put out a central bank digital currency, then it will exist alongside the dollar or the euro settlement currency in our network. So we've done that. But that's easily said. How will the government test that? How will a country figure out between the private sector banks and the government how to do this? That's where our sandbox comes in.", "So we can provide a safe space for government and private sector banks to figure out how that would actually work. Questions like the last mile, how do you bring utility into the hand of your citizens if you put out a central bank digital currency, acceptance questions and so forth. So facilitating investments as an asset class, we do that and we get ready for CBDC. Should there be a private sector stable coin, we might also do that.", "But we have very strict principles on when to do this and when not. Now, let me talk about CipherTrace for a moment. Because this space is a really interesting space in so many ways. Questions on data privacy, questions on authentication, we just touched on that in the context of Europe and strong customer authentication.", "We have to expect the Europeans will say, \"Well, strong customer authentication will, of course, play a role in crypto transactions as well,\" which is where we always lead with security and trust. I mean, that is really synonymous with the name of Mastercard when it comes to payments that we have to do the same role. So it's a massive services opportunity. CipherTrace, 900 cryptocurrencies, what does CipherTrace actually do? They drive compliance and AML checks into crypto transactions.", "We can't run fast enough right now to get into the space because a lot of other people are deep into crypto and these questions are not resolved. So asset class, CBDCs and a services opportunity, those are the three ways that we feel we want to play and we need to play and we have the differentiated assets to do so." ] }, { "name": "Harshita Rawat", "speech": [ "Thanks, Michael." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Dan Dolev from Mizuho. Please proceed with your question." ] }, { "name": "Dan Dolev", "speech": [ "Hey, thanks for taking my question." ] }, { "name": "Sachin Mehra", "speech": [ "Hello." ] }, { "name": "Dan Dolev", "speech": [ "So how does the new offering by Plaid with the acquirers or any of that sort of potential disruption there impacting Mastercard and the networks in general? What is the kind of general strategy around it? We're getting a lot of calls on this topic. Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Right, Dan. So I think, I touched a little bit on an earlier question that we had on this topic. So here's a blog post that describes the account-to-account. We have account-to-account technology really since the acquisition of Vocalink.", "And we've learned how that works. We like it because it's an additional choice that is provided to consumers and to merchants. But we also have all the learnings. And the learnings go around like how do you create acceptance into that? How do you make it easy for a merchant? How do you actually convince a consumer that actually likes the card proposition? So all of that, it is about standing up an ecosystem.", "So what we believe is this should be something that is built into our network, into our multi-rail capabilities, and it's actually how we are approaching it. So we're leaning into this. I don't see it as a disruption. That's been our stated strategy.", "And we have five years of learnings. And I think, that puts us ahead of the curve to make this a reality. I think, this is a interesting alternative when it comes to consumer payments in store. And we have it.", "We build it. It's for us to really figure out whether the economics settle, what other capabilities that are currently built into our card franchise can we extend into the world of account-to-account payments, for example, charge-backs, those kind of data protection and so forth. So that's the direction that we're taking. Not really a disintermediation question, an interesting blog, the good things we've done in reality." ] }, { "name": "Sachin Mehra", "speech": [ "Yes. And Dan, I'll just add to that. Just we've got to remember, right, there's a sizable TAM out there. And a fair amount of that TAM is likely not gonna be able to be reached by card products.", "This is where our multi-rail philosophy and strategy, as well as our ability to provide choice across various rails, one of which would be an open banking rail used for payment services, it's very helpful because it helps open up the TAM, which is available to us from what used to be primarily card-focused to much more than card-focused. And we do see that opportunity come through here in open banking as well." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Bob Napoli from William Blair. Please proceed with your question." ] }, { "name": "Bob Napoli", "speech": [ "Thank you, and good morning. A follow-up on the cross-border business. I mean, obviously, a very important business for Mastercard. As you look at that business and as we get to full recovery, do you think that the economics of that business will be similar to what they were prior to the pandemic? I mean, the continued development of blockchain and other technologies or account-to-account, is that going to pressure the economics of that business?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Bob. Why don't I take that? So look, I mean, the value prop we used to deliver through cross-border payments on our card products, pre pandemic and post pandemic, is exactly the same. So we don't expect that the economic returns, which they will generate, should be any different, given that the value we delivered previously, if anything, has only gotten better over a period of time with more electronification of flows taking place. To your point around several other account-to-account capabilities, which are there in the cross-border space, the reality is we are participating in them today.", "But it happened to be going after flows, which are not carded flows. They're not point-of-sales flows. They happen to be more in the nature of business-to-business payments. We do that with our -- if you remember, we acquired a company called Transfast, in addition to the fact that we have our capabilities from HomeSend.", "The combined capability of that is our cross-border Send capabilities, which is account-to-account cross-border payments. And we'll participate in those flows, but those are separate and distinct from what goes on at the point of sale with our card products today. So net-net, I kind of view the whole cross-border space as a positive for us as and when travel comes back from a card standpoint. And in the meantime, we continue to actually plant flags in different parts of the world with the reach we've established on our B2B flows from a cross-border standpoint." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Jason Kupferberg from Bank of America. Please proceed with your question." ] }, { "name": "Jason Kupferberg", "speech": [ "Good morning, guys. Just a follow-up on cross-border. I guess, in the third quarter, the volume growth ex intra-Europe was 60%. It was again a very, very good proxy for the overall cross-border revenue growth in the quarter.", "So now, if we just look at October month-to-date trends, if those hold hypothetically through the rest of Q4, it would seem like cross-border revenue growth could again be around 60% this quarter. And arguably, that would be even before most of the potential benefits of the U.S. reopening kicks in. So is all that a fair characterization? Are there other moving parts should we be aware of? And can you just comment on which cross-border corridors are the highest-yielding in your system?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, so I think, the answer to the first part of your question, I think you kind of touched upon on the second part of your question, which talks about how revenues are realized on cross-border is very much a function, even in that ex intra-Europe kind of category. It will depend on every corridor. Every corridor has got a different yields. And depending on which ones come back first, which ones come back after, the numbers from a cross-border revenue standpoint will kind of move around.", "As it relates to what we're seeing, look, I mean, I'll tell you pre pandemic, important corridors for Mastercard included, obviously, U.S. to Canada, the U.S. to the U.K., the U.K. to various parts in Continental Europe.", "These are all very important corridors. We've seen intra-Europe come back pretty nicely. The U.S. inbound is still to happen.", "I mean, there's a little bit happening, but there's more to come as borders open. Canada has started to open up. As you know, Canada opened up in the third quarter. We've seen signs of recovery take place in terms of inbound into Canada as well.", "And these are important corridors for our business. The one area which I will say is still a little bit kind of yet to be seen is Asia Pacific, right? In Asia Pacific, recovery in cross-border has still been kind of somewhat muted. We'll see how borders open up there and what that kind of shapes up to be. But net-net, here is what I'll tell you from a yield standpoint, intra-Europe, low-yielding, ex intra-Europe, high-yielding.", "In the ex intra-Europe bucket, the yields vary by corridors. Jumaria, I think, we have time for one last question." ] }, { "name": "Operator", "speech": [ "Our next question will come from Sanjay Sakhrani from KBW. Please proceed with your question." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. good morning. I think, Michael mentioned the waning impact of U.S. stimulus.", "I mean, we've seen the U.S. volume sort of stabilize here in terms of the growth. I'm just curious how you guys feel about the other side, which is credit rebounding. And I'm just thinking through the economic impact as lending comes back, lending-related volumes come back.", "Thanks." ] }, { "name": "Michael Miebach", "speech": [ "OK, yeah, Sanjay, let me just start on the rebound of credit. Back to changing on how people spend, start to see more in-person and more in-person certainly includes T&E, discretionary. Those are all use cases that are very much oriented toward credit. So that is what is driving that.", "The impact of stimulus on the debit side, we still see an elevated use of sustained use of debit going forward. So it's not a zero-sum game yet again. It's balancing out in a way that one is coming back and the other remains elevated. It really comes down to the size of the available wallet that consumers have.", "And Sachin, you have any other thoughts on that one?" ] }, { "name": "Sachin Mehra", "speech": [ "Sanjay, I think, it's interesting. If you take us back to a couple of quarters ago, maybe three or four quarters ago, we talked about the same question as to what our views around credit and debit mix is going to look like. And we had kind of maintained that we think that there will be a reversion to the mean as economies come back and as discretionary spending picks up. And that's exactly what you're seeing right now, right? I mean, as people are spending more in discretionary categories, lodging, travel, restaurants, credit is definitely coming right back to the top of wallet.", "And we expect that as the economy continues to recover in different parts of the globe, that reversion to mean will continue. And that's kind of our view as it relates to how credit plays out over the near to medium term." ] }, { "name": "Michael Miebach", "speech": [ "All right. Good. Thanks, everybody. Thank you for your questions.", "We are going to close the call now. I hope to see you at the investor community meeting. Generally, on these calls, it's not only the analyst community listening, the investor community, it's also our staff. So I want to thank our staff for everything they have done through this quarter again.", "It feels like a bit of like a marathon as we turn out of COVID. See you at the ICM, please do tune in. Thank you very much, everybody. Bye-bye." ] }, { "name": "Sachin Mehra", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2022-01-27	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "Rayna Kumar", "position": "Analyst" }, { "description": "Sanford C. Bernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "Tsin Huang -- J.P. Morgan -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "Mizuho Securities -- Analyst", "name": "Dan Dolev", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Moshe Orenbuch", "position": "Analyst" }, { "description": "Robert W. Baird and Company -- Analyst", "name": "Dave Koning", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Andrew Jeffrey", "position": "Analyst" }, { "description": "Susquehanna International Group -- Analyst", "name": "Jamie Friedman", "position": "Analyst" }, { "description": "Cowen and Company -- Analyst", "name": "George Mihalos", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good day, and thank you for standing by. Welcome to the fourth quarter 2021 and full year Mastercard earnings conference call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions] I would now like to hand the conference over to your speaker today, Mr.", "Warren Kneeshaw, head of investor relations. Please go ahead." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Jemiria. Good morning, everyone, and thank you for joining us for our fourth quarter 2021 earnings call. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the investor relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis, unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I'd like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website for 30 days. With that, I'll now turn the call over to our chief executive officer, Michael Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren. Good morning, everyone, from New York. I'm starting off with the key highlights for the quarter. We delivered strong revenue and earnings growth as we saw further improvement in our underlying operating metrics.", "Quarter 4 net revenues were up 28% and EPS up 46% versus a year ago on a non-GAAP currency-neutral basis. On the same basis, Quarter 4 net revenues are 19% above pre-COVID levels in 2019. So with that, let's take a look at the macroeconomic front. The outlook remains positive despite the recent supply chain constraints, geopolitical uncertainties and inflationary pressures.", "Although there has been a recent surge in COVID cases, there are signs that these may be peaking. By each of these areas, merit monitoring, underlying spending trends remain strong as consumers, businesses and governments have become more adaptable to a changing environment. In the U.S., economic growth remains solid with low unemployment and healthy consumer confidence. According to our Quarter 4 SpendingPulse report, which is always based on all payment types including cash and check, guest retail sales ex auto, ex gas were up 6.4% versus a year ago and up 10.9% versus 2019.", "In Europe, GDV growth has been strong, although recently impacted by mobility restrictions. If the impact of the Omicron variant reduces, we expect the economic growth to pick up in the coming quarters, in large part, thanks to considerable pent-up demand from the past year. SpendingPulse shows that overall European retail sales in Quarter 4 were up 3.3% versus a year ago and up 1.3% versus 2019. In Asia Pacific, vaccination rates continue to improve, and we expect the economic recovery to pick up pace as both government and businesses ramp up investment.", "The travel recovery in Asia Pacific has lagged that of the rest of the world and has significant growth potential. The growth in Latin America is expected to moderate a bit following the rebound in 2021. As it relates to COVID specifically, there are early signs that the Omicron will be relatively short-lived. The reality is that the tools we have to deal with the pandemic are more advanced than ever.", "60% of the world's population is now at least partially vaccinated, effective therapeutics are becoming available, and governments are using more targeted measures to limit the spread. More bodies have opened and have stayed open despite the recent variant. Although we've always said the path forward will not be linear, there are signs we are moving toward the endemic phase of the disease. Looking at Mastercard's spending trends, switch volume growth continued to improve quarter over quarter.", "Both consumer credit and debit continued to grow well. Turning to cross-border. The recovery has continued with overall Quarter 4 cross-border levels now higher than those in 2019. Cross-border travel continued to show improvement relative to Quarter 3 levels, aided by border openings in the U.S., U.K.", "and Canada. While Omicron has had some recent impact on cross-border travel, we continue to believe that cross-border travel will return to 2019 levels by the end of this year. Cross-border card-not-present spending ex travel continued to hold up well in the quarter. So overall, the spending trends are moving in the right direction with some near-term travel-related headwinds as a result of the variant.", "Now turning to our business highlights. As outlined at our investment community meeting in November, we remain focused on our growth, diversified build strategy and our three strategic priorities, which are expanding in payments, extending our services and embracing new networks. Here's an update on how we're progressing against each of those priorities. First, we're expanding in payments, a growing person to merchant payments, scaling across other payment flows and leaning into innovation in new payment technologies.", "In aggregate, these targeted flows represent $115 trillion in opportunity. First off, we're driving growth in person to merchant payments through new wins across the globe. In the U.S., I'm excited to announce that we're partnering with Chase and Instacart, a leading online grocery platform in North America on a new Instacart Mastercard co-brand program. This partnership marks an additional co-brand win with Chase, quickly following the recent launch of the Chase Aeroplan World Elite Mastercard.", "In addition, with First Interstate Bank's planned acquisition of Great Western Bank, we will flip Great Western's consumer debit, credit and commercial portfolios to MasterCard. And I'm happy to note that the consumer credit portfolio of Merix Bank, over 3 million customers will transition to Mastercard beginning in the second quarter. Merix Bank plans to leverage several Mastercard solutions, including our fraud prevention, consulting, open banking and loyalty services. Over in the Netherlands, we've renewed our partnership with Rabobank, which includes the migration of 8 million Maestro cards to debit Mastercard.", "We signed an exclusive deal with Westpac in Australia for the new Banking-as-a-Service platform. This platform will allow new players to leverage Westpac's banking capabilities. Afterpay, the first partner on the platform will connect debit Mastercards to their money by Afterpay app. And in the U.K., the Net West debit migration is progressing to plan as in the early stages of consumer rollout.", "We're also expanding in payments by capturing new payment flows, including commercial, B2B accounts payable, bill pay and cross-border remittances. For example, in the commerce space, we've expanded our relationship with Bank of America, where we'll be the lead brand for new commercial card issuance. We've also renewed and expanded our relationship with WEX, including the chosen as their strategic partner, and adding open-loop functionality to their millions of closed-loop fleet cards. For accounts payable, we continue to scale Mastercard tracks, WEX, BMO, BOK Financial, [Inaudible] will connect to the platform.", "We also launched the launch -- we also announced the launch of Mastercard Track Instant Pay, which uses machine learning to analyze and initiate automatic virtual card payments, streamlining processes for buyers and improving cash flow for suppliers. And we're driving new B2B acceptance through a global partnership with Boost Payment Solutions with an initial focus on expanding the use of commercial card in seven key markets. We're addressing new payment flows in consumer bill payments as well. We recently announced the acquisition of Argus to help deliver bill pay solutions and other real-time payment applications in Latin America.", "Argus enables digital payments for the majority of households built in Mexico and its connections with banks, fintechs and digital wall providers across the region. And finally, we continue to capture new flows in cross-border remittances. This quarter, we established a partnership with Travelex in Brazil, who will use Mastercard's cross-border services, send P2P transfers to the U.S. and Europe.", "For domestic disbursements in the U.S., we partnered with fintech processor, TabaPay, to make Mastercard Send easily available to fintechs and merchants across multiple use cases. Now shifting gear. We're also expanding in payments by leaning into payment innovation in areas like installments, contactless acceptance and crypto currencies. Here are a few examples.", "Our open-loop Mastercard installment program that we announced last quarter has been very well received. The U.S. launch is on schedule for Quarter 1. We're actively bringing new partners into the program as we announced in the Middle East, Africa earlier this week, watch this space.", "Now we're making great progress in expanding contactless acceptance by turning the world's billions of active smartphones into potential acceptance devices, enabling people to buy and sell whenever, wherever they want. We now have 100 deployments of Tap on Phone in over 50 markets with leading partners globally. Contactless penetration increased to one and two of our in-person switch transactions globally this quarter. This is up from approximately one and three prior to the pandemic.", "And with that, the potential for accelerated acceptance growth, financial inclusion and consumer convenience is substantial. We're also bringing capabilities, experience and reach to help enable the crypto ecosystem. Our new collaboration with Coinbase will allow consumers to use their Mastercard to purchase NFTs, try that myself. Our work with consensus will make it easier for software developers to increase the scale, efficiency and speed of transactions on Ethereum and finishing blockchains.", "And our CPC Sandbox Test Platform, which we launched in 2020, continues to gain traction. We're helping central banks, financial institutions and fintechs simulate the issuance and distribution of CBDC along with the integration of CBDDs with our card network, our real-time payment modules and native blockchain wallets. Now shifting to services. Our services support can differentiate our core products and have played a critical role in having many of them I just mentioned.", "The group services revenue at 25% in 2021 on a currency-neutral basis. We will continue to extend our service capabilities to enhance the value of payments. We even further accelerating our growth by expanding into new areas and new use cases, particularly through our data and services and cyber intelligence propositions, again, a few examples for you. In December, we announced an agreement to acquire Dynamic Yield from McDonald's.", "Dynamic Yield uses enhanced AI to deliver customized product recommendations, offers and content to consumers. Their customer set includes over 400 global brands ranging from financial services companies like Synchrony to retailers like Lens End. When combined with SessionM's loyalty platform and our Test & Learn experimentation software, we will be able to offer a unified consumer engagement and loyalty hub to our customers. McDonald's is a great example of a company who's using all three of these platforms today with plans to further scale and integrate Dynamic Yield's capabilities globally.", "In addition, our Ethoca platform continues to experience strong traction in preventing unnecessary chargebacks, a real pain point. We added new customers in every region in 2021 for Ethoca. Recently, we launched Ethoca Consumer Clarity, which gives consumers detailed information about purchases on their mobile banking app. Submission is live with issuers across the U.S., U.K.", "and several European markets, including OTP Bank, central Cooperative Bank and Paybox Bank. Now beyond expanding in payments and extending in services, our third strategic priority area is embracing new networks. Specifically, we are leveraging our expertise and payments to build out new networks for the current focus on open banking and digital identity. On the open banking front, we have closed the acquisition of Aiia in November, which brings strong API connectivity to over 2,700 banks across Europe.", "And combined with Finicity's North American connection, which covered more than 95% of deposit accounts in the U.S. market, Mastercard has an unparalleled footprint in the key open banking regions, upon which we are building solutions to solve a wide range of these cases. One example is in the mortgage verification space, where Finicity has signed deals with several new partners, including loan people. And in the digital identity space, we're helping our customers with fast, frictionless identity verification services.", "Ethoca has performed strongly over the last quarter, expanding through strategic partnerships with companies such as ZIP and Equifax, as well as growing its global footprint with leading frack providers Tonga and Air Click in Asia Pacific. Combined, open banking and digital identity extend our value before and after the payment transaction. These are large, attractive and growing opportunities, and we are uniquely positioned to be a leader in both. So in summary, we delivered strong revenue and earnings growth this quarter.", "The macroeconomic outlook remains positive with a few areas of the monitoring, and we're executing against our three strategic priorities: spanning and payments, extending our services and embracing new networks. And all that with substantial progress on the product and deal front this quarter. Now Sachin, over to you and the numbers." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. So turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis, excluding special items and the impact of gains and losses on our equity investments. Net revenue was up 28%, reflecting the continued execution of our strategy and the ongoing recovery in spending. Acquisitions contributed 3 ppt to this growth.", "Operating expenses increased 19%, including a 7 ppt increase from acquisitions. Operating income was up 37%, which includes a 1 ppt decrease related to acquisitions. Net income was up 44%, which includes no impact from acquisitions as the impact of acquisitions on operating income was offset by a onetime acquisition-related tax benefit. EPS was up 46% year over year to $2.35, which includes a $0.04 contribution from share repurchases.", "During the quarter, we repurchased $1.3 billion worth of stock and an additional $528 million through January 24, 2022. So let's turn to Page 4, where you can see the operational metrics for the fourth quarter. Worldwide gross dollar volume, or GDV, increased by 23% year over year on a local-currency basis. We are seeing continued strength in debit and credit.", "U.S. GDV increased by 23% with debit growth of 15% and credit growth of 34%. Outside of the U.S., volume increased 23%, with debit growth of 25% and credit growth of 20%. To put this in perspective, as a percentage of 2019 levels, GDV is at 125%, up 4 points quarter over quarter with credit at 116%, up 5 points sequentially and debit at 134%, up 3 points sequentially.", "Cross-border volume was up 53% globally for the quarter, with intra-Europe cross-border volumes up 45% and other cross-border volumes up 63%, reflecting continued improvement in travel-related cross-border as several borders opened during the fourth quarter. In the fourth quarter, cross-border volume was 109% of 2019 levels, with intra-Europe at 122% and other cross-border volume at 98% of 2019 levels. Turning to Page 5. Switched transactions grew 27% year over year in Q4 and were at 132% of 2019 levels.", "Card-present growth continued to improve while card-not-present growth rates remain strong. Card-present growth was aided in part by increases in contactless penetration in several regions. In addition, card growth was 9%. Globally, there are 3 billion Mastercard and Maestro-branded cards issued.", "Now let's turn to Page 6 for highlights on a few of the revenue line items, again described on a currency-neutral basis unless otherwise noted. The increase in net revenue of 28% was primarily driven by domestic and cross-border transaction and volume growth, as well as strong growth in services, partially offset by higher rebates and incentives. As previously mentioned, acquisitions contributed approximately 3 ppt to net revenue growth. Looking quickly at the individual revenue line items.", "Domestic assessments were up 24%, while worldwide GDV grew 23%. Cross-border volume fees increased 61% while cross-border volumes increased 53%. The APPD difference is primarily due to favorable mix as higher-yielding ex intra-Europe cross-border volumes grew faster than intra-Europe cross-border volumes this quarter. Transaction processing fees were up 28%, generally in line with switched transaction growth of 27%.", "Other revenues were up 30%, including a 9 ppt contribution from acquisitions. The remaining growth was mostly delivered by our cyber and intelligence and data and services solutions. Finally, rebates and incentives were up 38%, in line with our expectations, reflecting the strong growth in volumes and transactions and new internode deal activity. Moving on to Page 7.", "You can see that on a currency-neutral basis, total operating expenses increased 19%, including a 7 ppt impact from acquisitions. Excluding acquisitions, operating expenses grew 12%, primarily due to increased spending on advertising and marketing, higher personnel costs to support the continued investment in our strategic initiatives and increased data processing costs. Turning now to Page 8. Let's discuss the specific metrics for the first three weeks of January.", "First, as a point of process, we continue to provide volume and transaction metrics both on a year over year and as a percentage of 2019 basis. However, it is important to note that as we turn the calendar and move into 2022, the index versus 2019 metric now looks back three years and, therefore, includes a compounding improvement relative to the 2021 index metric. This compounding impact must be taken into consideration when considering the sequential trend from Q4 to January. So at the highest level, omicron has had a minimal impact on overall switched volumes and transactions and has called some moderation on cross-border panel.", "Going through the metrics in turn. Starting with switched volumes. Through the first three weeks of January, we are now at 149% of 2019 levels, up 13 points versus Q4. This increase is primarily driven by the compounding effect I just referred to.", "After adjusting for this compounding effect, switched volumes are tracking similarly to what we saw in Q4. The underlying trends in switched transactions adjusted for the compounding effect are generally tracking the trends we are seeing in switched volumes. In terms of cross-border volume growth, as I mentioned earlier, spending levels as a percentage of 2019 in Q4 are now above pre-pandemic levels. The Omicron variant, which hit partly through December, impacted the strong cross-border travel momentum we saw in November.", "That impact has carried over into January. This has been partially offset by an increase in cross-border card-not-present ex travel. Overall, cross-border volume through the first three weeks of January is now at 116% of 2019 levels, up 7 points versus Q4. In this case, the compounding effect is partially offset by the impact of the Omicron virus on cross-border travel in January.", "Turning to Page 9. I want to share our thoughts on the upcoming year. While there is some uncertainty related to Omicron and potential future variance, our overall expectations for 2022 are positive. The macroeconomic outlook is for continued growth and domestic spending levels have summed up well despite the recent surge in cases.", "The recovery in cross-border travel was progressing well prior to Omicron and we expect the recovery in cross-border travel to resume as the surge passes. As Michael just noted, the tools available to deal with the pandemic have improved with time. And although the path forward may not be linear, there are signs we are moving toward the endemic phase of this disease. Many countries have relaxed their border restrictions and we continue to expect cross-border travel to recover to 2019 levels by the end of 2022.", "Our recent deal wins, travel-oriented portfolios and diversified set of services position us extremely well to capitalize on these trends. Turning to our expectations for the full year 2022. Our base case scenario is for net revenues to grow at the high end of a high teens rate on a currency-neutral basis, excluding acquisitions. Acquisitions are forecasted to add about 1 ppt to this growth, while foreign exchange is expected to be a headwind of 1 to 2 ppt for the year, primarily due to the strengthening of the U.S.", "dollar relative to the euro. In terms of operating expenses, we continue to carefully manage our spending as we invest in our payments, services and new network priorities to drive short- and long-term growth. For the year, we expect operating expenses to grow at the low end of a low double-digit rate on a currency-neutral basis, excluding acquisitions and special items. Acquisitions are forecast to add about 4 to 5 ppt to this growth, while foreign exchange is expected to be a tailwind of approximately 1 ppt for the year.", "Turning now to the first quarter. Year-over-year net revenue growth is expected to be at the high end of a high teens rate, again, on a currency-neutral basis, excluding acquisitions. This reflects some sequential improvement in cross-border travel spending trends within the quarter relative to 2019 as the impact from Omicron starts to recede as the quarter progresses. Acquisitions are forecast to add about 2 ppt to this growth, while foreign exchange is expected to be a headwind of 2 to 3 ppt for the quarter.", "From an operating expense standpoint, we expect Q1 operating expense growth to be at the high end of high-single digits rate versus a year ago on a currency-neutral basis, excluding acquisitions and special lines. Acquisitions are forecast to add about 6 ppt to this growth, while foreign exchange is expected to be a tailwind of approximately 1 ppt for the quarter. As a reminder, we discretely disclosed the impact of acquisitions for the year-end, which it closed and the subsequent year after which time we do not split them out. For instance, Finicity, which closed in November of 2020 is now folded into the base.", "We are pleased to have closed the acquisitions of both Aiia and Argus in November and anticipate closing the pending acquisition of Dynamic Yield in the first half of 2022. Other items to keep in mind. On the other income and expense line, we are at an expense run rate of approximately $115 million per quarter given the prevailing interest rates and debt levels. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics.", "And finally, we expect a tax rate of approximately 17% to 18% for the year based on the current geographic mix of our business. With that as a backdrop and turning now to Slide 10, I would like to update you on our three-year performance objectives for the 2022 to 2024 period that we first introduced in November at our Investment Community Meeting. The bottom line is that there is no change, although our jumping off point for earnings is slightly higher due to our Q4 2021 overperformance. As a reminder, these objectives are on a currency-neutral basis, exclude special items, gains and losses on equity investments and acquisitions closed after 2021.", "Using 2021 as our base over the 2022 to 2024 period, we expect to deliver a net revenue compound annual growth rate in the high teens. This assumes an annual target market volume growth rate of 10% to 11%, cross-border travel returning to 2019 levels by the end of 2022 and doing our services revenues at a 20%-plus CAGR. From an operating margin perspective, we will continue to operate with the philosophy of delivering a minimum annual operating margin of 50%. Having said this, I would like to emphasize that we continue to believe that it is important for us to invest with a long-term growth while delivering positive operating leverage, and we continue to dive with this philosophy in mind.", "And finally, we expect to deliver an EPS CAGR in the low 20s range on a currency-neutral basis, excluding the impact of special items, gains and losses on equity investments and future acquisitions. And with that, I will turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Sachin. Dermira, we're now ready for the question-and-answer session." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Your first question will come from Rayna Kumar with UBS." ] }, { "name": "Rayna Kumar", "speech": [ "Good morning. Thanks for taking my questions. So with cross-border spending now above pre-pandemic levels, are you anticipating any pent-up demand in travel spend in your financial guidance particularly as we get to the travel month in the summer?" ] }, { "name": "Michael Miebach", "speech": [ "Hi, Rayna, this is Michael. Let me kick this off. So as I said in my remarks earlier, we do see pent-up demand. We see pent-up demand in the last year and the year before, and it continues.", "People will wanna travel and get out whenever they can, and it has been proven again and again, so there is an assumption there. And we've been pretty vocal about that that we do continue to believe that cross-border travel will return to pre-pandemic levels by the end of the year. Sachin?" ] }, { "name": "Sachin Mehra", "speech": [ "Yes. Michael, you pretty much covered it. So the only thing I'd just add is we just need to go back to 2021 where we saw that when people have the ability to travel, they express their intent of travel. And we do believe that the impact of Omicron is gonna be short-lived.", "And as borders start to relax a little bit more and people get a little bit more comfortable around this, people will get out there and express the demand for travel, back to what Michael was just saying." ] }, { "name": "Michael Miebach", "speech": [ "In fact, I'm heading to Europe tonight so there you go." ] }, { "name": "Rayna Kumar", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question will come from Harshita Rawat with Bernstein." ] }, { "name": "Harshita Rawat", "speech": [ "Good morning. Thank you for taking my question. Michael, I want to ask about Fed now. It looks like it has been allies with the U.S.", "in 2023. Domestic RTP system in many countries is user payments other than consumer to business, but then you have examples like the ones in India with UPI, which used for retail payments. How do you see that playing out with FedNow? And how can you participate in terms of services enablement for that? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Right. Thank you, Harshita Rawat. So FedNow, we'll have to see when it actually comes live. But broadly speaking, if we go with our experience in other countries, we believe there is, in real-time payments, like the real alternative payment solutions.", "There's demand by government, there's demand by businesses and consumers. The 2022 standard allows to carry more data. So there's all sorts of reasons why this might make sense. To your question on how participation looks like, yes, when we bought Vocalink in 2016, I promise I won't take you back five years now.", "But that was a conscious decision realizing exactly what I just said and that we want to play and we have to have those alternatives. If I look at it from a use case perspective, there are some use cases where cards is just simply an excellent answer today. It's an ecosystem drives huge value and there is -- yes, there might be alternatives, but we continue to invest in that and focus on that. At the same time, there's a whole range of use cases where real-time payments account and account makes a lot more sense than basic ACH or cash, and that's a displacement opportunity that we certainly want to engage in cross-border remittances, bill pay and the likes.", "I think, where our participation and our differentiation comes in is we have tools across the whole gamut of the payment solutions. That's our multi-rail strategy. We have advanced this quite significantly over the last couple of years to true multi-rail solutions, not like that we have one in the other in parallel. It's one single solution.", "If you look at Mastercard Track, that's exactly what it is. You can pay any which way through -- any which way you like through Mastercard Track, but the payment optimization, the security, the pricing, the predictability of the Mastercard good is all the same across all of these options. So I see it as a fundamental opportunity to participate in new flows rather than anything else." ] }, { "name": "Harshita Rawat", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question will come from Darrin Peller with Wolfe Research." ] }, { "name": "Darrin Peller", "speech": [ "Thanks, guys. Michael, when we think about the parts of your business that are outperforming partly because of the panic but partly given where we are the acceleration on spending on electronic payments, can you just walk through that in terms of what kind of sustainability you see to the parts of the business that have sustainable upside now? In other words, debit volumes now probably bigger than you would have otherwise thought it would be. Services is another piece that's probably higher than it otherwise could have been. Are those sustainable? And then, maybe remind us of the parts of the business besides just cross-border that can catch up as we see the recovery again.", "Thanks, guys." ] }, { "name": "Michael Miebach", "speech": [ "All right. Thanks, Darrin. So I'll start that off and then maybe Sachin can kick in. So first of all, the secular shift has gotten a real push out of COVID.", "I mean, we had to spend online and when I look at that, I think that is a fundamental structural trend, more online commerce, more online banking, more online, everything. And what has really come out over the last two years that this is a lasting trend. So every bit of consumer research that we do, market research that we do, people will say, I learned to like it. So I'm going to continue to do that.", "So I think that is an accelerated growth opportunity. And it's a big assumption in our three-year long-term guidance that we gave that we continue to believe that the race toward a more digital economy will be a positive driver for us. So sustainable growth driver. You see it come through in how we build out acceptance, 19% acceptance growth.", "We continue to find pockets and opportunities and flows in segments that are just not penetrated with our solutions yet. And so, I see the underlying secular growth, I see us show up in more places. I mean, I use the term, I think, at the investor day, leave no white space. So that is why expanding in payment is a Pillar 1 of our strategy.", "You pointed to services, now services in a world that is more digital, that throws up more data, in a more digital world, a lot more people need to be safe in that digital world. So our C&I services, our security service solutions. We -- basically, we can't run fast enough. That has been outperforming.", "I gave you the growth rate for 2021 and services at 25%, that's for sure, an elevated growth rate and we continue to see that very, very positive. On data and analytics, more data, more people will want to do something with the data. A merchant will understand now that they have more merchants are entering into the digital space, how do they find customers in an easy way, how do they retain customers? That's where Dynamic Yield comes in, a perfect tool to really make more of that. And then, all of that data in the end will fuel the world of open banking, which is part of our whole new network strategy is essential and of course, the need for digital identity solutions.", "So all of that is sustainable. The catch-up opportunity, back to your question, is for sure travel. It is travel -- domestic travel has been leading, leisure travel has been leading. Cross-border travel and corporate travel over different curves over time, there's significant catch-up opportunity for us.", "So I think those are the headlines." ] }, { "name": "Darrin Peller", "speech": [ "Helpful. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Your next question will come from Lisa Ellis with MoffetNathanson." ] }, { "name": "Lisa Ellis", "speech": [ "Hey, good morning, guys. I was hoping to ask about net yields. Just looking back, pre-pandemic, Mastercard net yields were steadily increasing about past a bit -- about a basis point a year. But then over the last two years, have dropped first in 2020 then again, somewhat over in 2021.", "Can you just help parse for us a bit how much of the pressure on yields recently is due to cross-border travel weakness versus perhaps competitive pressure or something like that? And kind of what gives you confidence in one versus the other? And I guess, looking out into 2022, are you now expecting yields to move back the other direction? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Lisa. I'll take that question. So look, I think the short answer to your question is the vast majority of what you've seen in terms of net yields has been driven by the changing mix of the business over the pandemic, primarily cross-border volumes coming down and the impact of that. As you know, cross-border volumes and the revenues are less indexed from rebates and incentive standpoint.", "So you have the impact of that playing through. I would say fundamentally, we've always operated in a competitive environment. We see no real change in the level of competition relative to what we've seen over the past few years. So candidly, I would tell you, our assumption going into our planning cycles and going into 2022, as well as our three-year performance objectives has been one of the impact of having minimal net pricing, which is net of rebates and incentives.", "And we still continue to believe that to be the case. That was very much the case a couple of years ago as well. So the point really is a lot of what you're seeing on the net revenue yield is being driven by the changing mix primarily cross-border. Services continues to do really well and has been accretive to our yield in the past, and we expect that given the opportunity in services.", "That could be the case going forward as well." ] }, { "name": "Lisa Ellis", "speech": [ "Terrific. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question will come from Sanjay Sakhrani with KBW." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. I have another follow-up question on the cross-border. I guess, when we think about Omicron, I know there's been a small impact, but I'm just curious if there's any learnings from it.", "Do you feel like the resiliency of the consumer, and obviously, the tools that we have put us in a better position than what where we were maybe when you guys provided your expectations, understanding your expectations haven't changed? And then, I'm just curious, as we've seen the U.S. inbound travel improved, were there any learnings from that. Thanks." ] }, { "name": "Michael Miebach", "speech": [ "All right, Sanjay. I'll kick that off. So clearly, there have been learnings and there have been learnings across the whole industry. You may have followed some of the airlines during the earnings season, this whole thought about that the time period between a surge, a case surge and how bookings are coming back as narrowing.", "So the first learning is that consumers just become more adaptable, I said that earlier. It's not just consumers, it's actually businesses, consumers and governments. Now governments have also learned and governments have learned in terms of how broad-based social distancing measures and quarantine rules and the likes are. And those are much more targeted these days.", "As I said, more borders stayed open. When the U.S. opened in November, surges were going on in Europe, and there are no entry hurdles at this point. I said I'm traveling to Europe.", "There's no really -- there's no hurdle at all. It's just pretty easy to get back. So I think the combination of vaccination rates going up, learnings and governments and so far makes a much more benign mix to deal with whatever might be coming there. So that is a significant assumption that we took as we looked at the rest of the year.", "You also see that, yeah, more routes are being opened, more people want to get out whenever they can. So there's a desire and there's the ability to go out, I think, together, make the kind of right package for us that gets us pretty positive." ] }, { "name": "Sachin Mehra", "speech": [ "Yes. And Sanjay, I'll just add to what Michael just said. I think, you'll remember at our November investment community meeting, we had shared with you that the U.S., U.K. and Canada inbound cross-border travel corridors represented -- in Q3 of 2019, they represented roughly 20% of total cross-border travel volumes, which we have said and we said they were tracking at roughly 50% of 2019 levels.", "This is the data we shared with you at ICM. Well, just as an update, as we progress through the quarter in November, we saw these borders open, which Michael talked about, U.S., U.K., Canada. And the same metric, which is the U.S., U.K. and Canada in Q4 is now at 70% of 2019 levels.", "So that's just an expression of our confidence about how -- when people can travel, they will travel." ] }, { "name": "Michael Miebach", "speech": [ "And I just want to add one more point. So these are some -- I shared some of the macro learnings. Sachin just talked about the upside potential. Now taking both of that, what we have learned from our customers that are active in the travel space is that everybody is of the same opinion, and hence leaning into the travel sector and winning more co-brands, engaging consumers so that they book with our partners versus somebody else, all that is going on.", "You see the whole range of wins. The JetBlue renewal was one of the more recent one, the Aeroplan launch with Chase, IAG last year, etc., etc. So there's a lot of learnings by the travel industry themselves on how to engage and really make these co-brands or co-brand programs worthwhile, which we like a lot." ] }, { "name": "Sanjay Sakhrani", "speech": [ "That's perfect. I have my fingers crossed. Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Yeah." ] }, { "name": "Operator", "speech": [ "Your next question will come from Tien-Tsin Huang with J.P. Morgan." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Thank you. Good morning, Michael and Sachin. I wanted to ask about just -- well, it sounds like your macro view, it hasn't changed too much from what you guys talked about at ICM aside from some of the near-term travel headwinds. But I just want to check your 1Q outlook here for high teens revenue growth when -- it looks like your January trends are growing above that, nicely above that.", "Any call-outs there? Or is that just conservatism?" ] }, { "name": "Sachin Mehra", "speech": [ "So look, I mean, Tien-Tsin, here's what I would say. I think, in what I shared with you in terms of our Q1 thoughts, you've got to factor in -- there is the headwind, which is coming in from the strengthening U.S. dollar, which I kind of talked about what our estimate around that is. So that would be one kind of call.", "But other than that, all we're kind of expressing is where we're seeing our current metrics and how we're assuming the recovery of Omicron to come through over the course of the first quarter, which I kind of shared with you in my prepared remarks. So really nothing else going on there. I will emphasize one more time. What you're seeing in terms of the first three weeks of January, index back to 2019, has got a compounding effect.", "And that, you have to take into consideration when you're checking -- when you're looking at the sequential trends, which is why I was giving that additional color around what the impact of Omicron was adjusted for the compounding effect on switched volumes, switched transactions and cross-border." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Understood. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question will come from David Togut with Evercore ISI." ] }, { "name": "David Togut", "speech": [ "Thank you. Good morning. What are your expectations this year for the pace of account-to-account payments rollout in Europe under open banking? And how do you see this affecting credit and debit card growth in Europe? And as a follow-up, I would appreciate your perspective on Amazon's very public negotiation with Visa over credit card acceptance at Amazon U.K. and whether this reflects more payment options, for example, account to account? Or is this a one-off negotiation between two corporates?" ] }, { "name": "Michael Miebach", "speech": [ "All right. Let me start, David, with that. So account-to-account in Europe. When you look over the last years in Europe, it's been relatively slow paced in terms of consumer adoption and rollout.", "We have invested -- we're heavily invested across that with IR on the open banking side of account-to-account, with Nets, with Vocalink. So we're deep in the space. We like -- generally like what we see in terms of direction. Take up, I think it's -- I would call it paced.", "So that's the first thing I would say. Initiatives like EPI, you look at that and say their initial focus is actually on the card side, and they're thinking account to account in the longer run, that reflects the same that I just said. So continued significant opportunity for cards in Europe, but we see the long-term growth opportunity in account-to-account. And we've kind of covered our basis there.", "And with our open banking investments at our initial use cases there, particularly in the U.K., I think we can be pretty optimistic about that. Our partnership with Tesco, with Lloyd's, are looking very positive. So your question around Amazon, that's fundamentally a question for Visa, I would say, and for Amazon. We have seen these kind of negotiations in the public domain now and then over the years, relatively short-lived and were resolved.", "These particular news did not involve us at all. We have a strong and long-standing relationship with Amazon, and we agree that consumer choice matters. That's why we have a multi-rail strategy, and we're going to continue to work with Amazon delivering a whole differentiated set of products. So nothing particularly to worry about from our perspective." ] }, { "name": "David Togut", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question will come from Bryan Keane with Deutsche Bank." ] }, { "name": "Bryan Keane", "speech": [ "Hi, guys. Good morning. Just two quick ones for Sachin. Just looking at switched volume on the January month to date in the U.S.", "At 15%, that's down a little bit from where it was running before. I don't know if that's just an anniversary-ing of some of the comps. I know the three-year percentage still increased to 139. But just thinking about on a year-over-year basis, that 15%, anything to call out there? And then, secondly, on rebates and incentives, any guidance you can give us for fiscal year '22 as a growth rate or as a percentage of revenue? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Bryan. On the first point, you're referring to the 15% year-over-year growth in the first three weeks of January, and you're looking at the sequential trends there. Well, that is a tougher comp ratio. And this goes back to the impact of the economic stimulus, which was enabling better spending back on -- in the comparable period last year, and that's what you're seeing happen there.", "So that's kind of the answer to the first part of the question. On your second point, look, I mean, the whole rebates and incentives thing, I need to just emphasize one more time. Look, I know people are focused on the competitive environment. Trust us, we too are, because we operate in that competitive environment, and we want to make sure that we compete effectively with our products, capabilities, services, whatever the case might be.", "We have not seen a meaningful shift in the competitive environment relative to what we've been used to operating in the past. So that's kind of just to level set where we are. But specifically, to your question, on rebates and incentives. It's dependent on the timing of deals and how the volume and mix plays out through the year.", "In Q1, we expect rebates and incentives as a percentage of growth to be similar to Q4. That's kind of the extent. And all of this is contemplated in what I've shared with you on our full year thoughts, as well as on Q1." ] }, { "name": "Bryan Keane", "speech": [ "Got it. Thanks so much." ] }, { "name": "Operator", "speech": [ "Your next question will come from Ramsey El-Assal with Barclays." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi. And thanks for taking my question this morning. I wanted to ask about supply chain pressure and whether you're seeing any changes and with that pressure abating and that might be contemplated in your full year guidance. And separately, I just was wondering if you could help us contextualize your exposure to Russia and what we should expect there if sanctions, in fact, tighten due to political unrest in Ukraine.", "Potential --" ] }, { "name": "Michael Miebach", "speech": [ "All right. Yeah, Ramsey. Let me start with the supply chain and touch on Russia quickly. Supply chain pressures are clearly there.", "You're looking at chip shortages. There's all sorts of things affecting the supply chain. We continue to believe that these are rather short-lived as the supply chain actually bounces out, so that's first thing I would say. So there's not a huge assumption in our outlook around that.", "What we've also seen is particularly through the holiday season, pretty significant holiday spending, positive season and people spend what they can spend on. So if you can't buy something, they buy something else. So we've seen shifts in categories. So from that perspective, again, the pent-up demand is an important aspect here.", "On Russia, very, very early to tell how this is going to play out. This is certainly -- it was one of the points that I referred to earlier, geopolitical uncertainties that we have to keep in focus. We have seen sanctions applied in previous years and we basically manage through that. We'll have to see what it is.", "Russia is a substantial and important -- and strategically important market for us. We'll have to see how that plays out." ] }, { "name": "Ramsey El-Assal", "speech": [ "All right. Thanks so much." ] }, { "name": "Michael Miebach", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question will come from Dan Dolev with Mizuho." ] }, { "name": "Dan Dolev", "speech": [ "Hey, good morning. Thanks for taking my question. There was a question before on overall yield. I want to ask about domestic assessment specifically.", "If I look at Q4, I think you're running at about 13.1 basis points. Historically, the number was higher, more closer to 14. Is there anything to call out on that front? Thank you very much." ] }, { "name": "Sachin Mehra", "speech": [ "Dan, look, I mean, on domestic assessment, I think what you've seasonally -- I mean, what we've seen is that typically, in Q4, we see the yield of domestic assessments to actually drop off a little bit. That's just what we have historically seen. There's a bunch of moving parts which are going on in that and really nothing unusual to call out, out there. The trajectory of what we've seen historically still holds true on a going-forward basis." ] }, { "name": "Dan Dolev", "speech": [ "Got it. Thank you so much." ] }, { "name": "Operator", "speech": [ "Your next question will come from Moshe Orenbuch with Credit Suisse." ] }, { "name": "Moshe Orenbuch", "speech": [ "Great. Thanks. And you did discuss the account-to-account side of things a little bit. But I'm just wondering, given how often this comes up in discussions with investors.", "We've seen some issues that some of the domestic players have had from a regulatory standpoint. Any thoughts about how that could affect kind of the evolution of that product advantages perhaps that being part of Mastercard might be for and Aiia other kind of thoughts about just the growth of that, both in Europe and the U.S.? Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Right. Moshe, excellent question. The -- we see there is clearly an interest of regulators in new forms of payment. Regulators are always keen on security, on data protection, on consumer protection that is always in focus.", "We have most recently seen this with an interest in buy now, pay later. U.K. regulator is doing a consultation. Various regulators have shown interest to regulate the space.", "In account-to-account, you should expect something similar. We do know that from a Vocalink and Pay by Account in the U.K. that is very much in focus. And I think it differentiates an established player like us to basically come in.", "We have very clear data principles. We have -- we don't sell data to anybody. We believe in the consumer -- strong consumer consent, the likes and the likes. All of that is codified in the Mastercard franchise.", "So a company that goes beyond just being a fintech and providing a connection and getting money from A to B, but doing it in an organized fashion with very clear rules that people sign up that partner with us, I think is gonna be a differentiator." ] }, { "name": "Sachin Mehra", "speech": [ "And I'll just add to what Michael said. I think, you're going to remember that when we talked about what we were doing in the open banking space, we were very deliberate about how we went about our activities there, particularly as it relates to how we got data from the banks, and that was all through APIs. It has been our philosophy. And the idea being, you've got to do it in the right way.", "You cannot be scraping, you should be doing it through APIs, not only because it's the right thing to do from a safety and security standpoint, but also the data elements you can actually get by virtue of doing it in that manner help you create a much more sustainable long-term product, which you can offer. So very much part and parcel of what the philosophy has been from the get-go in this space for us." ] }, { "name": "Moshe Orenbuch", "speech": [ "Great. Thank you, Michael and Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question will come from Dave Koning with Baird." ] }, { "name": "Dave Koning", "speech": [ "Yeah, hey, guys. Thank you. I noticed U.S. average ticket size in Q4, I think it was only up 2%.", "The prior three quarters, up 6% to 7%. So you would think with inflation, it would be accelerating, not decelerating. Is that just consumers returning to card-present maybe lower transaction sizes or just splitting transactions? And what's the impact? That seems positive to you, right?" ] }, { "name": "Sachin Mehra", "speech": [ "Yes, Dave, again, I want to make sure I got the question, but what we've observed -- if you look at our trends for how switched volume and switched transactions are trending, you'll see effectively that the improvement quarter over quarter in switched volumes from 131% of 2019 to 136% of 2019 is a 5-point improvement, compared to switched transactions, which have improved from 131 to 132. That should signal to you that there is a higher ticket size, which is happening, which you would expect because as people get out and travel more, they do so, that's higher ticket in general. They do it on credit products, which are higher ticket size. As also there is -- as e-commerce happens, that happens to be higher.", "So you've seen that come through in the Delta on a sequential basis." ] }, { "name": "Dave Koning", "speech": [ "Yeah. And I was referring more toward -- it looked like it's decelerating in the U.S., which seems positive. It seems good to have splitting transactions possibly happening is what it just seems like or different types somehow?" ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. No, I wouldn't see anything materially different in our U.S. trends than what I just shared globally in terms of what we're seeing from a ticket size standpoint." ] }, { "name": "Dave Koning", "speech": [ "All right. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question will come from Andrew Jeffrey with Truist Securities." ] }, { "name": "Andrew Jeffrey", "speech": [ "Hi, good morning, everybody. One of the more discussed topics in the market generally today is inflation. And I wonder if you could just touch on if we do see persistent embedded global inflation, whether or not that's a positive for your business from a volume and/or yield standpoint?" ] }, { "name": "Michael Miebach", "speech": [ "Right, Andrew. So definitely a significantly discussed topic, all sorts of views on it. So here's our take. First of all, where it happens, we generally distinguish to look at it first at the macro level, what is happening across a particular market? What's the policymakers response? We heard the U.S.", "policymaker talk about this yesterday. Then there's broader impacts that go beyond our immediate business, wage growth. How does all of this, in the end, affect the consumer's ability to spend. So there's a lot of macro things to consider.", "On the micro side, yeah, it basically is not homogenous. So inflation is affecting our business in a different way than it would be the overall CPI. So if you have inflation expecting rent, while that's generally not running through our rails to a large extent. So that could again be a very different picture.", "Taking all of that into account, fundamentally, notwithstanding the impact that inflation has that it could be negative on consumers, on businesses and so forth. There is an impact on GDV if it's moderate inflation that would be showing in our numbers." ] }, { "name": "Andrew Jeffrey", "speech": [ "OK. I assume that's been taken into account to your guidance." ] }, { "name": "Sachin Mehra", "speech": [ "Right." ] }, { "name": "Andrew Jeffrey", "speech": [ "Appreciate it. Thanks." ] }, { "name": "Operator", "speech": [ "Your next question will come from Jamie Friedman with Susquehanna." ] }, { "name": "Jamie Friedman", "speech": [ "Hi, thank you for taking my question. I just wanted to ask about the difference between other revenue and services revenue. I know services did great, up 28% -- 25% for the year, 28% for the quarter. But other actually grew a little bit faster.", "So Sachin, maybe if you could remind us what the nuance difference is. I know one is a subset of the other." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. So in other revenue, we have a bunch of our services revenue would sit there, but there's other stuff going on in that as well. So you've got, for example, some of our Vocalink revenues sits in there, the Nets' acquisition would sit in there. Some of the -- and so if you're looking at the other revenue growth rate of 30%, remember, 9 points of that growth came from acquisitions, which is just basically a lapping effect of the fact that we didn't have those acquisitions last year at this time than we do at this point in time.", "So on services, services continues to grow very nicely. A large part of that sits in other revenues. Some of it is in transaction processing. But the growth you're seeing in other revenue is being -- is a combination of strong services growth, plus some of the acquisitions, which you're seeing come through in that growth rate there." ] }, { "name": "Jamie Friedman", "speech": [ "Got it. Thank you for the clarification." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "Your next question will come from George Mihalos with Cowen." ] }, { "name": "George Mihalos", "speech": [ "Great. Thanks for taking my questions, guys. Just very quickly, Sachin, I'm curious, as you look through the weekly trends year to date here through January, are you seeing a lot of variability, meaning are you seeing sort of a bigger pickup as we go through the month? And then, somewhat related to that, if you could talk a little bit about what you're seeing in the rest of the world." ] }, { "name": "Sachin Mehra", "speech": [ "Sorry, what are we seeing in the rest of the world, did you say?" ] }, { "name": "George Mihalos", "speech": [ "Rest of the world versus U.S. I mean, it looks like if I look at your volumes, for credit at least, the worldwide volume is now starting to accelerate a little bit and pick up. So I'm just wondering if you're starting to see that really come into the numbers over the last couple of weeks." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. OK. So I got your question. So look, I mean, in terms of weekly trends, they bounce around, right? I mean, there's so much which goes on in the nature of weekly trends.", "It varies depending on the month in question. I'm not seeing anything which is highly unusual in terms of what we're sharing with you on our first three weeks of January in terms of weekly trends. But there is volatility week over week, and you would expect that to be the case. And sometimes, it's a comp issue as well.", "So you got to remember that you've got to kind of go back to what you're comparing the comp to and to see if there's differences in growth rates, which is emanating from that. When we look at spend levels, that's kind of generally the case. As it relates to rest of the world versus the U.S., look, the U.S. on a growth rate basis has a tougher comp this year in the first three weeks of January, just by virtue of the fact that we had a whole bunch coming from the economic stimulus last year.", "Conversely, in the rest of the world, particularly in Europe, right, when you really think about what's going on there, there was a lockdown in Europe which took place last year and in January. So you have an easier comp on Europe from a growth rate standpoint. So you have to factor those in when you're looking at the growth rates there." ] }, { "name": "Warren Kneeshaw", "speech": [ "I think, we have time for just one final question." ] }, { "name": "Operator", "speech": [ "And we'll take our final question from Jason Kupferberg with Bank of America." ] }, { "name": "Jason Kupferberg", "speech": [ "Thanks, guys. Just wanted to ask a question about how we should think about quarterly cadence here of net revenue growth. Obviously, you told us about Q1. It sounds like Omicron and FX and rebates are somewhat of a headwind there.", "Your year-over-year comp, obviously, is much harder in the second quarter than the first quarter, but arguably, you won't really have Omicron headwind at that point. So just wanted to try and get things calibrated from a modeling standpoint, at least through the first half of the year directionally as we work toward the full year target." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, Jason, so I'd say, obviously, we've given you some thoughts around Q1 and for the full year at this point to get you started. We'll talk a little bit more about other quarters as the year progresses. But just stepping back a bit, as we said in our remarks, we expect that cross-border travel recovery will resume as the surge passes and that will reach the cross-border travel back to the 2019 levels by the end of 2022. Look, we continue to be very active on the deal front, and so that needs to be taken into account.", "But overall, here's what I would say that the pace of cross-border travel recovery will be a key determinant as to how that cadence plays out. And more to come as we go through the year. I'll share a little bit more about what we think about ensuing quarters. But right now, that's the extent of what I'm going to share with you." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Michael, any final comments?" ] }, { "name": "Michael Miebach", "speech": [ "Yeah. I was hoping the last question would be for me. Anyway, so thank you for all your questions. As you see, we're optimistic with the outlook.", "We reaffirmed our three-year guidance that we gave you in November. I don't think there's any need to repeat anything we said. I'd just like to thank you for your support. And as usual, a call out for people that make all off this happen.", "Thank you and speak to you next quarter." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2023-07-27	[ { "description": "Head of Investor Relations", "name": "Devin Corr", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "Tsin Huang -- JPMorgan Chase and Company -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "AllianceBernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Timothy Chiodo", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Rayna Kumar", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Ashwin Shirvaikar", "position": "Analyst" }, { "description": "Mizuho Securities -- Analyst", "name": "Dan Dolev", "position": "Analyst" }, { "description": "William Blair and Company -- Analyst", "name": "Bob Napoli", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Dan Perlin", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mastercard, Inc. Q2 2023 earnings conference call.", "[Operator instructions] Mr. Devin Corr, head of investor relations, you may begin your conference." ] }, { "name": "Devin Corr", "speech": [ "Thank you, Audra. Good morning, everyone, and thank you for joining us for our first quarter 2023 earnings call. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data, and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis, unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I'd like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website for 30 days. With that, I will now turn the call over to our chief executive officer, Michael Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Devin. Good morning, everyone. So starting with the big picture, our momentum continued into the second quarter with net revenue up 15% and operating income up 16%, both versus a year ago on a non-GAAP currency-neutral basis, once again demonstrating the strong fundamentals of our business. Consumer spending has remained resilient with spend on experiences and travel remaining a focus.", "On the macroeconomic front, we continue to monitor a number of factors. First, the overall labor market remains strong, including wage growth, and consumers continue to be supported by credit and savings. These are key factors of consumer spending. Second, the efforts of central banks to curb inflation are showing signs of progress.", "Despite this, inflation remains elevated, and we are in a period of tight monetary policy across many countries. Economic growth will continue to vary country by country and sector by sector. Looking at our switched volume trends. Domestic volume growth remains healthy.", "We continue to see strength in T&E with some recent moderation in both inflation and spend in select international markets. Cross-border travel continues to show strength, reaching 154% of 2019 levels in the second quarter. We remain well-positioned to capitalize on this trend with our travel-oriented portfolios and our initiatives in areas like loyalty and marketing. Cross-border card-not-present, ex travel, continues to hold up well.", "We're monitoring the environment closely and are ready to adjust investment levels, as appropriate, while maintaining focus on our key strategic priorities. As a reminder, these priorities are, one, expanding in payments; two, extending our services; and three, embracing new networks. First, we're expanding in payments by continuing to win deals with a diverse set of customers, powering growth and acceptance, capturing a prioritized set of new payment flows, and exploring new ways to ensure payment choice by leveraging multiple alternatives, including card rails, ACH, blockchain, and open banking. Back to the top of this list.", "We are winning deals across the globe through a combination of our innovative products, differentiated services, and our solution-selling approach. I'll share a few examples from each region. Let's start in Europe, where we announced a significant win with UniCredit across all card products. We expanded our partnership and put in place a first-of-its-kind, single-card, multi-market strategy spanning 13 banks, 12 markets, and 20 million cards.", "UniCredit selected Mastercard due to our innovative digital capabilities, shared focus on sustainability, and proven ability to support their client needs. In Germany, the previously announced conversion of approximately 10 million of Deutsche Bank's credit and debit cards to Mastercard has now started. These wins build on our prior success in the U.K., where there are now 16 million NatWest Debit Mastercards live in market. When combined with the Santander and First Direct migrations, approximately 27 million debit cards have now shifted to Mastercard across these three portfolios in the U.K.", "Turning to North America. Mastercard will partner with Fiserv's Money Network for all U.S. state and federal government benefit and wage disbursement debit programs. Up north, Coast Capital, Canada's largest federal credit union, will be converting their consumer and small business portfolios to Mastercard.", "The partnership highlights our shared commitment to local communities with issuance through Collabria Financial Services. In addition, we have a new agreement with Tim Hortons, the largest quick-service restaurant brand in Canada. Tim Hortons will launch a new Mastercard credit card and will be using a broad set of Mastercard's digital analytics and fraud services and technologies. Our relationship with Santander in Latin America continues to grow.", "In Mexico, we established a long-term exclusive deal with Openbank, their new digital bank. We also renewed the Fiesta Rewards co-brand credit card, Santander's key offering within their consumer portfolio. In Brazil, we will be Santander's exclusive partner across their commercial portfolio. And we've expanded our partnership with Pioneira Sicredi, one of Brazil's largest credit unions.", "In Asia Pacific, we've extended our relationship with Standard Chartered Bank, which will enable us to grow our consumer credit presence across key markets in the region. We've also expanded our partnership with HSBC through the launch of the Travel One Card in Singapore, Malaysia, and Vietnam. Travel One will provide instant in-app rewards redemption powered by the Mastercard Rewards system. With all of these cards, people do need a place to use them.", "We continue to power growth and acceptance by establishing new partnerships and scaling new technologies. This quarter, we announced partnerships with both Alipay and WeChat Pay to enable international travelers to easily link any Mastercard credit or debit card to Alipay and WeChat Pay digital wallets. The partnership allows visitors to make payments with tens of millions of QR code merchants across China. I just returned from China, where I saw firsthand how this is helping international travelers shop and pay in more places in a simple way.", "It's like paying like a local, and this will be valuable as inbound cross-border travel to China improves from approximately 50% of 2019 levels in the second quarter. In the online environment, we are scaling our Click to Pay capability to enhance the guest checkout experience. Click to Pay transactions grew over 70% year over year in the second quarter, and the technology is now live in 30 markets. In the quarter, we added Chile, Bahrain, and Slovakia.", "And NatWest Group became the first bank in the U.K. to go live with Click to Pay Push Provisioning for cardholders. Shifting to new payment flows. We are making tangible progress in this area.", "In commercial point of sale, we've extended our partnership with Brex to support the international expansion of their commercial portfolios. We expanded our relationship with myPOS continuing to drive new merchant acceptance across more than 30 European markets while also migrating their small business debit portfolio to Mastercard. And we've established an exclusive partnership with Australian lender, Grow Finance, to introduce credit cards to their small business customers later this year. In B2B accounts payable, we remain the market leaders in virtual card.", "We continue to drive growth by tapping into new use cases. For example, we established an exclusive partnership with Easy Transfer in Greater China. This competitive flip leverages our virtual card capabilities to support cross-border tuition payments for international students. We're also making it easy for buyers and suppliers to integrate virtual cards into the technology platforms they already use.", "Building on our prior announcements with SAP and Coupa, we've recently partnered with GEP to integrate our virtual card technology into their payables platform. And on the supplier side, we launched Mastercard Receivables Manager with Bill Trust. The solution streamlines the processing of virtual card transactions for suppliers and automates the integration of reconciliation data into accounts receivable systems. This is a great solution, and it builds on partnerships with companies like Boost Payment Solutions, who have been working closely with Mastercard to expand and optimize commercial acceptance.", "And finally, in new flows, we continue to deploy our disbursement and remittances capabilities in new ways and across new geographies. In the U.S., we partner with top sports gaming processor, Interchecks, who will make Mastercard Send available to gaming operators for payouts. Karempe, one of the largest digital wallets in UAE, will use Send to top up their wallets using Mastercard. And on the cross-border front, we've partnered with Alfardan Exchange in Qatar to facilitate remittance services and support cross-border travel.", "Our work in real-time ACH continues to support these new flows. Our historical approach has been to expand our infrastructure reach into new markets. Going forward, we will be focusing on delivering and scaling in the markets we already are serving while building applications and services in these key locations, in line with our overall strategic and financial objectives. And in blockchain, we're introducing the MasterCard Multi-Token Network, MTN.", "MTN is a set of foundational capabilities designed to make transactions within digital asset and blockchain ecosystems more secure, scalable, and interoperable. We believe in the potential of blockchain technologies. However, regulated money, such as bank deposits and CBDCs, need to be part of the solution, and they should interoperate with traditional systems. We can help with that.", "MTN is the natural evolution of the work we have already done in this space. The initial sandbox will kick off in the U.K. this summer. Now turning to services.", "Our services inform decision-making of our customers. They help them create stronger connections and greater loyalty. Payments and services reinforce each other, multiplying our impact and the value we deliver to all our partners. Our services help many -- drive many of the wins I mentioned earlier.", "So here are a few additional examples. We recently launched our consumer fraud risk solution, which leverages our latest AI capabilities and the unique network view of real-time payments I just mentioned to help banks predict and prevent payment scams. AI is a foundational technology used across our business and has been a game changer in helping identify such fraud patterns. We've partnered with nine U.K.", "banks, including Barclays, Lloyds Bank, Halifax, Bank of Scotland, Networth, Monzo, and TSB, to stop scam payments before funds leave a victim's account. TSB, one of the first banks to adopt the solution, indicated that it has already dramatically increased its fraud detection since deploying the capability. We're combining our loyalty, consulting, analytics, and identity services in different ways to help our customers capitalize on the travel recovery. This quarter, we extended our broad-based partnership with Expedia Group.", "Together, we will combine Mastercard's loyalty solution with Expedia's extensive travel supply to enable Mastercard cardholders to book travel using loyalty points. We also partnered with Thomas Cook in India to issue prepaid cards for international travel. The proposition includes cardholder access to over 450 cross-border travel offers through Mastercard Travel Rewards. And earlier this month, I met with our partners at Deutsche Bank and Lufthansa in Frankfurt.", "We resigned our long-standing partnerships with Lufthansa Group for its Masimo loyalty program and welcomed Deutsche Bank as the new issuing partner. In this enhanced relationship, you will see a combination of our loyalty solutions, personalization capabilities, and digital user experiences help the partnership take off to the next level using airlines peak. We're also leveraging our personalization and Test & Learn capabilities to help our partners across the ecosystem enhance the customer experience and improve acquisition and conversion rates. For example, the combined Dynamic Yields personalization capabilities with our marketing services to drive digital customer acquisition for Ecobank in Nigeria.", "In addition, HP Inc. has partnered with us to deploy personalized bank content for their consumers across Canada and Europe. And on the merchant side, we are working with 7-Eleven in Australia using our Test & Learn capabilities to support their rollout of new store concepts involve its food and beverage offerings. Our third strategic priority area is embracing new networks with a focus on open banking and digital identity.", "We continue to make progress in open banking and establish a series of new and expanded collaborations this quarter, including ones with Freddie Mac, Algoan based out of France; and Dapi in the UAE. These entities will leverage our smart and consumer permission data to drive increased financial inclusion and make digital interaction simpler and safer. Turning to digital identity. We're driving adoption across several new verticals, including travel, ticketing, retail, and financial institutions.", "Travel provider, FlightHub, is using our identity solutions to help travelers book their new next adventure. Sports teams across the U.S., including the New Jersey Devils, use these solutions to enable fans to buy tickets while reducing fraud in ticketing platforms. Major League Baseball used our NuDetect technology to ensure that all-star votes were authentic for this year's all-star game. In retail, we partner with IKEA, who is using Ekata to help reduce friction and fraud.", "And financial institutions like Greenwood, a digital banking platform for Black and Latinx communities, are using our capabilities to authenticate consumers in real time, making financial empowerment a reality for more people. So in summary, we delivered another strong quarter of revenue and earnings growth, supported by resilient consumer spending, particularly in travel and experiences. Our strong deal momentum continues with new wins and expanded relationships powered by our services across a range of partners, including UniCredit, Fiserv, Tim Hortons, Brex, and many more. Our differentiated capabilities, diversified business model, and focused strategy positions us well to capitalize on the significant opportunity ahead.", "Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. So turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis, excluding special items and the impact of gains and losses on our equity investments. Net revenue was up 15%, reflecting resilient consumer spending and the continued recovery of cross-border travel, as well as the continued growth in our value-added services and solutions. Operating expenses increased 13%, including a minimal impact from acquisitions.", "And operating income was up 16%, including a minimal impact from acquisitions. Net income and EPS increased 11% and 14%, respectively, both reflecting a sizable discrete tax expense this quarter related to foreign tax legislation enacted in Brazil. EPS of $2.89 includes a $0.22 reduction due to the discrete tax expense I just mentioned and an $0.08 contribution from share repurchases. During the quarter, we repurchased $2.4 billion worth of stock and an additional $497 million through July 24, 2023.", "So let's turn to Page 4, where you can see the operational metrics for the second quarter. Worldwide gross dollar volume, or GDV, increased by 12% year over year on a local currency basis. In the U.S., GDV increased by 6% with credit growth of 8% and debit growth of 3%. Outside of the U.S., volume increased 16% with credit growth of 14% and debit growth of 17%.", "Of note, we have now completed the NatWest debit migration in the U.K. Overall, cross-border volume increased 24% globally for the quarter on a local currency basis, reflecting continued improvement in travel-related cross-border spending. While this is sequentially lower versus Q1, this is due to tougher comps as we opened up post Omicron last year. When you look at the trend versus 2019, you see continued strength.", "For example, cross-border travel is at 154% of 2019 levels in Q2, which is up 6 ppt from the prior quarter. On the same basis, cross-border card-not-present, excluding travel, continues to hold up well in relation to 2019 levels, up 2 ppt from the prior quarter to 210%. Turning to Page 5. Switched transactions grew 17% year over year in Q2.", "Both card-present and card-not-present growth rates remain strong. Card-present growth was aided, in part, by increases in contactless penetration as contactless now represents over 60% of all in-person switched purchase transactions. In addition, card growth was 8%. Globally, there are 3.2 billion Mastercard- and Maestro-branded cards issued.", "Turning to Slide 6 for a look into our net revenues for the second quarter, which came in above our expectations. As a reminder, earlier this year, we revised our disaggregated revenue disclosure. Net revenues are now broken down into two new categories: payment network and value-added services and solutions. Now getting into the numbers described on a currency-neutral basis.", "Payment network net revenue increased 14%, primarily driven by domestic and cross-border transaction and volume growth and also includes growth in rebates and incentives. Payment network net revenue was higher than anticipated, primarily due to higher revenues related to FX volatility and the timing of planned deal activity. Value-added services and solutions net revenue increased 16%, primarily due to the continued healthy growth of our Cyber & Intelligence Solutions, driven by our underlying driver growth and the demand for our fraud and security solutions, and strong demand for consulting and marketing services, which was partially offset by other solutions. Now let's turn to Page 7 to discuss key metrics related to the payment network, again, described on a currency-neutral basis, unless otherwise noted.", "Looking quickly at each key metric, domestic assessments were up 11%, while worldwide GDV grew 12%. The difference is primarily driven by mix. Cross-border assessments increased 29%, while cross-border volumes increased 24%. The 5-ppt difference is primarily due to favorable mix as higher-yielding, ex intra-Europe, cross-border volumes grew faster than intra-Europe cross-border volumes this quarter.", "Transaction processing assessments were up 16%, while switched transactions grew 17%. The 1-ppt difference is primarily due to lower revenues related to FX volatility versus the prior year. Other network assessments related to licensing, implementation, and other franchise fees were $270 million this quarter. As a reminder, these other network assessments may fluctuate from period to period.", "Moving on to Page 8. You can see that on a non-GAAP currency-neutral basis, excluding special items, total adjusted operating expenses increased 13%, primarily due to increased spending on personnel to support the continued execution of our strategic initiatives. Now turning to Page 9. Let me first comment on the operating metrics trends in the second quarter.", "Versus 2019, overall spending has remained resilient. When viewed year over year on a sequential basis, we are seeing some moderation in both inflation and spend in select international markets, as well as more difficult comps. As it relates to the first three weeks of July, our metrics are holding up well, generally in line with Q2 when indexed to 2019. Just for your information, we have included all the data points from this schedule, excluding activity from Russian-issued cards, from current and prior periods in the appendix.", "Turning to Page 10. I want to reshare our thoughts on the remainder of the year. Let me start by saying that our business fundamentals continue to remain strong as overall consumer spending remains healthy, and we continue to deepen our relationships with partners across the globe. Domestic spending patterns have broadly normalized post pandemic.", "Cross-border travel continues to grow at a healthy pace, now above 150% of 2019 levels. While the travel recovery has progressed well in most regions, there remain pockets of opportunity, notably into and out of China. We remain well-positioned to capitalize on this continued growth with our travel-oriented portfolios and related service offerings. Cross-border card-not-present, ex travel, continues to hold up well.", "While we are monitoring a number of macro and geopolitical factors, our base case scenario for the year continues to assume consumer spending remains resilient, buoyed by strong labor market, and reflects current spending dynamics and the ongoing recovery of cross-border travel. For the year, our outlook is broadly unchanged. We expect net revenue growth for the full-year 2023 to remain in the low teens range on a currency-neutral basis, excluding acquisitions and special items. As a reminder, this growth rate would have been approximately 1.5 ppt higher if you exclude Russia-related revenues from 2022.", "Foreign exchange is expected to be a tailwind of 1 ppt for the year, and we expect a minimal impact from acquisitions. Our expectations for operating expense for the year are also unchanged with growth expected to be at the high end of a high single-digit rate on a currency-neutral basis, excluding acquisitions and special items. Acquisitions are forecasted to add about 1 ppt to this growth, and foreign exchange is expected to be a headwind of approximately 0 to 1 ppt for the year. As Michael mentioned, we are prepared to proactively adjust our operating expenses if we see meaningful changes to top-line growth.", "With respect to the third quarter, year-over-year net revenue is expected to grow at a low double-digit rate, again on a currency-neutral basis, excluding acquisitions and special items. Coming off a strong Q2, this sequentially reflects a lower anticipated contribution to growth from revenues related to FX volatility. Foreign exchange is expected to be a tailwind of approximately 3 ppt, and acquisitions are not expected to have much of an impact for the quarter. From an operating expense standpoint, we expect Q3 growth to be at the high end of a high single-digit rate versus a year ago on a currency-neutral basis, excluding acquisitions and special items.", "Acquisitions are forecast to add approximately 0 to 1 ppt to this growth, and foreign exchange is expected to be a headwind of approximately 1 to 2 ppt. Other items to keep in mind. First, on the other income and expense line, we forecast an expense of approximately $90 million for Q3. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics.", "Second, we expect a non-GAAP tax rate of between 18% and 19% for Q3 and Q4 based on the current geographic mix of our business and the recent U.S. tax guidance that allows for more tax credits to be claimed related to 2022 and 2023. And with that, I will turn the call back over to Devin." ] }, { "name": "Devin Corr", "speech": [ "Thank you, Sachin. Audra, we are now ready to begin the question-and-answer session." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] We'll take our first question from Tien-Tsin Huang at J.P. Morgan." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hi. Good morning. Good to talk to you, guys. Just want to ask on the UniCredit win there.", "That was a nice one, just outside of the top 10, it looks like, in Europe. So you mentioned a multimarket strategy is what they're going after, and I heard sustainability also as a reason for the win. I'm just curious, thinking about this as a case study, is this a new trend? Why are they employing the strategy now in the wake of the macro uncertainty, open banking, and there was a lot of talk about pan-European schemes and whatnot? So I'm -- just wanted to study this a little bit and if there's any comments on timing pricing as well. Thanks." ] }, { "name": "Michael Miebach", "speech": [ "Hi. Tien-Tsin, thanks for the question. So this is a fantastic win. We're excited about that.", "As I laid out, it's very unique. This is a pan-European bank, so cutting across 13 banks in 12 markets. It's a wide strategy. Therefore, it's single card, multimarket, and it cuts across a lot of our digital capabilities.", "So I think the breadth of our offering on the digital-first side, as well as our services, are a key aspect of us winning this particular portfolio. The sustainability part, we see this across a whole range of customers who are all looking at climate as the question of the century to solve, what can be done, the consumption question in the context of payments. There's so many angles to it. Our price is pan as position on [Inaudible] planting itself plays into that.", "So that is particularly important to UniCredit. So here again, we had a meeting of the minds. In the end, it comes down to as part of the migration. And you alluded to this in your question, do we stand ready to serve their needs from day one as the migration starts? We have proven this with Deutsche Bank.", "We've proven it with NatWest and so forth. So this is something that is not new to us, so we're excited to see this unfold over the near future." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Great. Thank you, Mike." ] }, { "name": "Operator", "speech": [ "We'll go next to Harshita Rawat at Bernstein." ] }, { "name": "Harshita Rawat", "speech": [ "Thank you for taking my question. Michael, I want to ask about FedNow, which is now finally launched. I know you've commented on this before, and it's very early days and far from any sort of ubiquity or potential retail payment use cases. But you've had also a lot of experience working alongside real-time payments creating -- owning some TAM.", "So how are you thinking about FedNow and the risk that it creates in the market? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Thanks, Harshita. Yeah, we're all monitoring what FedNow is doing. They are now going live. So this is clearly a milestone, a good opportunity to look at this topic again.", "Our view on this really hasn't changed. So in the end, it comes down to what problem are you trying to solve. What are merchants looking for? Merchants are looking for reach to consumers, so scale matters. What are consumers looking for? Consumers are looking for safe ways to pay in a predictable fashion, ubiquity available.", "So those are all factors that haven't changed with this launch. We built that acceptance. We have a brand, the two interlocking circles that represent trust so that addresses a lot of what merchants and consumers are looking for. And we strengthened the position -- the proposition over years, contactless, Tap on Phone; buy now, pay later, i.e.", "Mastercard Installments; Click to Pay; and so forth. So that's good. The Mastercard debit proposition is strong, and we keep evolving that. So it's well understood now FedNow is launching.", "So as we look at that, we will obviously continue to compete and offer our services to our banking and issuing partners. At the same time, in our experience, to your question, we have stayed close to these systems in various other countries in the end, ending up partnering with most of them. So here, we'll have to see where it goes. Live -- going live doesn't mean that it is broadly available yet.", "It is early days, as you said. It doesn't have features. It doesn't have a consumer platform as such. You can't access it through your mobile banking app.", "All of that is what our solution today provides. So we have to see where it goes. Head-on competition but the mindset of partnership and where it makes sense for us and where this goes. It is important to say that we do have solutions for these systems.", "If you look at the Chase Pay by Bank solution that we put into the market, so that's exactly leveraging these kind of flows that would run across these systems, generally P2P-focused. Some noncard penetration verticals run across these particular systems, so we see that as an opportunity. And Chase Pay by Bank app will be one of those ways to go in after that. We've done similar kind of solutions in the U.K., in Europe, and so forth.", "So more to come. We'll stay very close. At this point in time, I think we have a better solution in the market." ] }, { "name": "Harshita Rawat", "speech": [ "Very helpful. Thanks." ] }, { "name": "Operator", "speech": [ "We'll go next to Sanjay Sakhrani at KBW." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. I had a question on the fed routing rules on debit. I guess the card-not-present transactions went through in July.", "I'm just curious sort of how you see the opportunity there. It would seem like you're in a good position to take some share." ] }, { "name": "Michael Miebach", "speech": [ "Right. So the clarification came to networks available as of 1st of July, so we put that in place. And we said we would, and we're ready to do that. It's still early days.", "We have to see where that goes. But as you rightly said, Sanjay, we stand ready to compete. And that is certainly -- we will look for the opportunity, and I'm sure we will find it." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Great. Thanks." ] }, { "name": "Operator", "speech": [ "Next, we'll go to Lisa Ellis at MoffettNathason." ] }, { "name": "Lisa Ellis", "speech": [ "Hi. Good morning. Thanks for taking my question. Michael, in the prepared remarks, you highlighted that with Mastercard's real-time ACH strategy, you're sort of in the phase of transitioning from building out infrastructure to focusing more on building applications and services.", "Just kind of taking a step back, it's always been a big differentiator for Mastercard that you own infrastructure and fast ACH with Vocalink and Nets' Corporate Services. Can you just kind of comment a bit on the movie over the last six or seven years? Like how has that helped differentiate Mastercard in the -- in terms of being able to capture account-to-account network payments, new flows, etc.? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Thanks, Lisa. So real-time payments -- when the rise of real-time payments started 2016, '17, and so forth and we invested into Vocalink, it was clear at the time that we wanted to be in the infrastructure application services. That was a bit of the logic. At the time, we needed the street cred, and we needed the talent so we can participate in this trend from day one.", "That was the first season of the movie, so to say, to stick with your analogy. Where we are today, we build out an enviable and unique position in real-time payments, having a footprint in 13 of the top 50 GDP countries where we run and partially operate real-time payment infrastructure. Our strategy was we will be in the markets that matter, and we don't win to be in the markets that don't matter. So we feel we've reached that point, and now it's really to drive up scale and use that infrastructure position.", "The business in itself of running these systems in these markets is attractive enough. As we pointed out, we're going to focus on building out a set of applications and services on top of that. If you recall from the prepared remarks where I talked about the scam -- the anti-scam solution in the U.K. with these non-U.K.", "banks, it's a fantastic example of how our expertise in these markets has positioned us to rally nine banks around the table to come up with a marketwide solution. Now not everything that we will do will be marketwide solutions. There will be individual customer solutions, but we feel we have muscle in the space. It's not going to go away.", "All these government payment systems out there, more and more real-time payment solutions will come up, and I think we will be in demand. And because we've done it for a long time, we'll have a seat at the table." ] }, { "name": "Lisa Ellis", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll move next to Darrin Peller at Wolfe Research." ] }, { "name": "Darrin Peller", "speech": [ "Hey, thanks, guys. Could we touch on value-added services for a moment? I mean, it's been a good tailwind for some time. I think it grew just about 1 point below transactions this time around. And you mentioned strength in cyber and some other categories, offset by -- that were offsetting others.", "So I'd be curious to get a little more detail as to what were the strengths and weaknesses of value-added services now, including the other. And then more importantly, just how much room do you think you have across those different categories to keep that growth alive and cross-sell well into your meaningful payments business?" ] }, { "name": "Michael Miebach", "speech": [ "Right. So let me start, and then Sachin can add a bit around the various dynamics around growth rates and so forth. So as I said in prepared remarks, payments and services complement each other. The strategy is the combination of both, and we extend that into new networks.", "So that's the starting point. We remain convinced that that is a key reason that all those wins I just talked about earlier are happening, so central to our strategy. Our services, in aggregate, continue to grow faster than the core. So we continue to diversify our revenue base.", "We like that. We want to continue to do that. There's a whole range of services to choose from. We could do lots of things.", "We have pruned our strategy when it comes to processing because we didn't feel that was such a differentiator. But we felt that cybersecurity in a world that is rapidly digitizing is just going to drive the biggest demand, and we're seeing that coming through in the numbers when I look into our C&I business, which grow at a very healthy clip. If you think about our D&S and data analytics business, here, we keep on building out the value chain. It's a vertically integrated value chain we have -- where we have Test & Learn, we have loyalty, and you go all the way into personalization.", "That is before, after, during the transaction, helping our customers run a better business. I don't see an end to the demand. In fact, that is key to our segment diversification strategy, so running at a healthy clip. I don't see any moderation here.", "This is -- will continue to grow, and you should see us continue to build out across the key aspects of services in cybersecurity and data analytics insight. So we love this business, and we'll continue to nourish it." ] }, { "name": "Sachin Mehra", "speech": [ "Hey, Darren, it's Sachin. Good morning. A couple of additional thoughts. So Michael kind of covered off the strength we continue to see in our value-added services and solutions, and that's indeed the case.", "But you got to remember that growth rates move around quarter to quarter on this area, and so we should all focus on the longer-term trends out here. As it relates specifically to Q2, when you look at growth rates for value-added services and solutions in Q2 of 16%, I assume you're looking at the sequential trend out there. One point to keep in mind is that there was a 1-ppt drop in Q2 on account of acquisitions. So Q1 had the impact of acquisitions.", "Q2 doesn't have it because it kind of lapped that acquisition period. So that's one piece. And then specifically in my comments, I talked about that the strength in Cyber & Intelligence, as well as in some of our Data & Services capabilities, was offset by other solutions. And it's really all about what the growth rate trends are for Cyber & Intelligence and Data & Services relative to growth rates and things like real-time ACH, especially on the infrastructure level.", "So when we talk about other solutions, think about it in the context of things like real-time ACH, which tend to grow at a lower pace there. So historically, what we had spoken about was just services. Now we are talking about value-added services and solutions. When we think about services in the historical context, in Q2, that services growth rate was more like 18%.", "So just for a reference point beyond that." ] }, { "name": "Darrin Peller", "speech": [ "Understood. Very helpful. Thanks." ] }, { "name": "Operator", "speech": [ "We'll move next to Timothy Chiodo at Credit Suisse." ] }, { "name": "Timothy Chiodo", "speech": [ "Great. Thank you for taking the question. I want to dig in a little bit on another business that is important to your -- both your volume and your revenue growth algorithm over the medium term, which would be Mastercard Send. You touched a little bit on some of the cross-border use cases.", "I believe many of the initial use cases were much more domestic, but it's evolving over time. Maybe you could just dig in a little bit more to some of the cross-border use cases that are really gaining traction." ] }, { "name": "Michael Miebach", "speech": [ "Right. So, Timothy, let me start off with that. So our Send business, domestic and cross-border together, that's how we look at it, there's a big chunk in there, which is cross-border disbursement remittances, as you rightly said. The way that we go after that is by adding new geographies.", "I gave you three markets that we've added this year, Chile, Bahrain, and Slovakia. So there is tremendous reach -- unparalleled reach in what we have in our cross-border proposition, 100 countries around the world. Then there's new ways to go after it, and that is the use cases. So earlier when I was talking about gaming payout, some of that is domestic, some of that is international.", "The whole workers' remittances piece, Alfardan in Qatar, those are important corridors. We very specifically go after these corridors, Middle East into South Asia, and so forth. So it's pretty methodological. But there's another way that -- which I haven't talked about on how to accelerate this business, and this is how we make it easier for our customers to onboard with us.", "So cross-border service express, which is kind of prepackaged solution around cross-border payments, is another way for us to accelerate this business. So new geographies, new use cases, corridor-specific, great methodology. I think we have the right kind of assets here across our HomeSend integration, across our Transfast acquisition, the MasterCard proprietary system, and our card reach. So all in, this is growing at a very healthy pace, and we like that business a lot.", "We are experts in cross-border, as you know, on the card side, and we're building that out here -- over here in cross-remittances and disbursements." ] }, { "name": "Timothy Chiodo", "speech": [ "Excellent. Thank you for taking the question." ] }, { "name": "Operator", "speech": [ "We'll go to our next question from Rayna Kumar at UBS." ] }, { "name": "Rayna Kumar", "speech": [ "Both of you in the past have discussed how B2B remains a large opportunity for Mastercard. Can you talk about what trends you're seeing in B2B payments in this macro environment, how you're progressing against capturing the TAM, and if you're seeing any slowdown in corporate spending as companies potentially tighten their budgets?" ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Rayna. I'm noticing a lot of questions coming from me means that there isn't a lot of questions in the numbers, which is fantastic. And I love to talk about B2B. Let me take the lens, Rayna, that's a little bit broader here on commercial overall.", "So I feel like I'm repeating myself here, but we're choosing priorities because they are growing at a healthy clip, so is the story for commercial growing at a healthy clip. So this is -- we're seeing a quarter-over-quarter two-year growth above the consumer side. There's particular strength in our international markets business. And we've sustained elevated levels of growth when we compare this back to 2019, all the noise of COVID out of it.", "We have two main focuses in this area. One is commercial point of sale, and the other one is our B2B accounts payable business. Commercial point of sale, now this is a tremendous total market opportunity, massive TAM out there, and it's likely penetrated by cards today. The way we look at this is this isn't really about building new systems.", "This is about penetrating with the tools that we have today, targeting SMEs and corporate T&E, purchasing fleet, all of that with our existing capabilities that we have, plus our complementary solutions like smart data and easy savings, and so forth. So a lot of cash and checks out there, a lot of opportunity with cards that we have today. So we leverage that. We build out a separate vertical in the company.", "We're focusing hard, and we're seeing the growth rewarding us for that. On the B2B side, this is accounts payable, trusted relationships, this is invoice payments, and so forth. This is an even larger TAM with a lot of clear pain points. Companies are looking to automate these processes, digitize these processes, get rid of the paper.", "And virtual cards is a solution that works tremendously well. We -- as I called it out earlier, we are the leaders in virtual cards. But the solution isn't perfect. So we invest a lot of energy through our product teams to make it better and better.", "What I was saying earlier on Receivable Manager, this is a way to automate the acceptance of virtual card payments, build it into the accounts receivable system, automate it to get the benefits of virtual cards without some of the manual processes that we have to go through over the past year. So this is a real breakthrough. This business is going to be hugely important for us going forward. We called it out in November 2021 at our strategy day.", "It's one of our biggest growth opportunities. We feel we're ahead in the market, and we're seeing the healthy growth. And that will be remaining focus for us." ] }, { "name": "Operator", "speech": [ "We'll go next to Ashwin Shirvaikar at Citi." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Hey. Good quarter, guys. Michael, since you said Sachin's not getting enough questions, maybe I'll ask a numbers question." ] }, { "name": "Michael Miebach", "speech": [ "Yes, please." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "So I wanted to figure out sort of the cadence of operating expense. 3Q versus 4Q, it sort of looks like -- it looks like you're kind of exiting the year a little bit higher than the 3Q levels in terms of growth. So what's causing that, as well as -- I know your cadence of spending tends to be longer term in nature, but are there product or service callouts in terms of the types of investments that you're making that's most pertinent now?" ] }, { "name": "Sachin Mehra", "speech": [ "Hey, Ashwin, good morning. So, look, what we shared with you is our thoughts around what we think operating expenses look like in the third quarter. And I've given you what the full-year numbers -- or what our expectations for the full-year numbers are, so I think you can kind of back into what our operating expense growth rate is going to be or is expected to be in the fourth quarter. There's nothing unusual going on from an opex standpoint in Q4.", "Honestly, I would tell you, if you look at it on a year-over-year basis growth rates, when you back into those numbers, you'll see there's nothing really unusual going on there. Broadly speaking, on opex, here's what I would say: we continue to remain focused on driving our operating expenses in what matters. It's the strategic priorities. It's making sure we're channeling our capital in the appropriate manner to drive growth, both in the short, medium, and long term.", "And that's what we'll continue to do. As you know, we are a people business, to a large extent, because a lot of what we do from a tech development standpoint is around people. A lot of what we do from a sales standpoint is around people. So that's what we invest in.", "So when you see growth rates in terms of operating expenses, I tend to call out personnel as one of the line items essentially for that reason alone, which is the growth comes from people, and people are the ones who actually bring the assets that are there for -- which allow us to deliver that revenue. But really, nothing unusual going on from an opex standpoint as we exit the year." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "OK, great. Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. So we keep top- and bottom-line growth in mind. But there is a tremendous opportunity ahead of us right now, so we are using this tailwind that we're currently seeing to continue to invest. You see the list of wins, the growth momentum in B2B, the growth momentum in services.", "So this is the time to continue to nourish that business and invest, and you will see us do that in a very prudent and disciplined fashion." ] }, { "name": "Ashwin Shirvaikar", "speech": [ "Understood. Thanks." ] }, { "name": "Operator", "speech": [ "We'll go next to Dan Dolev at Mizuho." ] }, { "name": "Dan Dolev", "speech": [ "Hey, guys. Thank you so much for taking my question. I appreciate it. Just a quick question on the guidance.", "Like obviously, results are very strong. You exceeded your second quarter guidance on revenue. Like what was the thought process of not boosting the guidance for the year? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "So, Dan, a couple of thoughts here. One, again, remember, we shared guidance in terms of ranges, and that's what we've shared out here as well, right? And when you think about ranges, it -- that's what they are in essence. Point No. 2 is some of the beat which we had in Q2, as I mentioned in my prepared remarks, was driven by what we call timing of deal activity.", "We still expect to be active in the markets. We still expect to vigorously compete in these markets. And so I kind of intentionally mentioned that as timing only because we do expect that as the year progresses, we will continue to be active in the market. So I think you should take that into consideration as well.", "And then my only other comment I'd make is, in Q1, we had modestly increased our thoughts relative to what we had shared right at the start of the year. So when you bring all of that together, right, that's kind of our thinking behind what we shared from a full-year guidance standpoint." ] }, { "name": "Dan Dolev", "speech": [ "Got it. Thank you so much." ] }, { "name": "Sachin Mehra", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "We'll go next to Bob Napoli at William Blair." ] }, { "name": "Bob Napoli", "speech": [ "Thank you, and good morning. On open banking, Mastercard has been pretty aggressive in investing in open banking. But I just like some additional thoughts on maybe on how that's progressing and then how open banking maybe sits into other strategies like embedded finance and banking as a service." ] }, { "name": "Michael Miebach", "speech": [ "All right. So open banking, as you know, we specifically called that out as one of two opportunities in new networks. The trend is here to stay. That's pretty clear.", "This whole notion of people got to use their data footprint to avail better financial services. There's a lot more regulation coming around that. PSD3 in Europe is coming out. So this train is -- has left the station.", "That's good. We're on it. The way we look at it is we have to move beyond connectivity. We had a good start.", "We are well connected here in the U.S. through our Finicity asset and in Europe through our Aiia assets. And we're very busy now building use cases on top of that, and this is where we think the future is going. Initial demand of Finicity was very clearly in lending-oriented use cases and asset verification use cases.", "That feels that is where the demand is today. To Sachin's earlier point, where do we invest, we invest where we see the demand in the near-term event. So that is where we're optimizing. But you're already starting to see as we're going beyond these lending use cases with our solutions like our Chase Pay by Bank solution here in the U.S.", "This is using a payment success indicator, which is using open banking data to tell a biller this is a good time, when there is balance on an account, please now bill. That is what the payment success indicator does. That is powered by Mastercard's open banking technology. So near-term use case is clear.", "That's working. Connectivity, we're well-positioned with our two assets, and we're very busy building out use cases. And obviously, we're excited to see Pay by Bank with Chase launched in the third quarter, as we said to you." ] }, { "name": "Bob Napoli", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll take our next question from David Togut with Evercore ISI." ] }, { "name": "David Togut", "speech": [ "Thank you. Good morning. Cross-border volume growth remains very strong. But on Slide 9, clearly, there's a deceleration from April growth through June, especially in cross-border travel.", "So my question is for the second half, what growth rate in cross-border volume is embedded in your guidance? And then if you could go a little bit under the hood, what do you see in cross-border travel volumes? Maybe a little more texture on what you're seeing by country in Europe. You gave kind of overall data and some thoughts on China." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, David. So a couple of thoughts first. Let's start at the highest level, which is the value prop of cross-border travel still remains incredibly strong. So we've got a strong value prop.", "We have a strong presence in the market. As you'll remember, as we were going through COVID, when everybody had stopped traveling, we used that as an opportunity to continue to bolster our position in cross-border. And that's paying dividends right now. The fact that we were building portfolios and winning portfolios at that point in time is helping us actually drive strong growth in cross-border, broadly speaking, but also in travel.", "Now specifically to your question around trends, I think you're looking at year-over-year growth rates when you are looking at what the cross-border travel trajectory is month over month, the declines you were talking about. I'd encourage you to look at the right-hand side of Slide 9, which talks about the numbers indexed to 2019. And there, you could see actually there's an accelerating trend in cross-border travel. So said differently, you can see that in Q1, our cross-border travel as a percentage of 2019 was 148%.", "In Q2, that was 154%. In the first three weeks of July, that's 157%. The reason that's important is because the year-over-year growth rates are getting impacted by tougher comps from last year. And I think that's important to actually keep in mind.", "In terms of regional color, I would say that regions are performing well. Look, I mean, the beauty of what we've got at Mastercard is a diversified business model. It's diversified across multiple dimensions, across payments and services, across products, across channels of sale across regions. And the fact that we've got this presence -- strong presence across various regions helps us in the cross-border side as well.", "And really, what you're seeing is good, sustained growth in cross-border, both on travel, as well as nontravel, across the globe. We're seeing accelerating trends in Asia Pacific, which we had very much expected and spoken about. That's what you're seeing coming through in the nature of the numbers here. We still think there are pockets of opportunity on a going-forward basis, in particular going into China and coming out of China.", "Just as a reference point, Michael talked about how cross-border travel inbound into China stood at approximately 50% of 2019 levels in Q2. That just goes to show what the opportunity remaining there is. Conversely, cross-border travel outbound from China was approximately 70% in Q2. And so that -- both those numbers will give you an indication of where the opportunities lie on a going-forward basis.", "And as we continue to do what we're doing in terms of winning more portfolios, enriching our proposition, leveraging services, such as our loyalty programs, that just helps us position us well on a going-forward basis. So that's the kind of color I'd like to share with you on this. Broadly speaking, I think we're in a very good place as it relates to cross-border." ] }, { "name": "Michael Miebach", "speech": [ "One thing to add here, that is the current imbalance in the market between demand and supply. So there's still an unlock there as in airline capacity, airport capacity, and all of that will unlock. So the combination of the underlying desire to travel, how that trend is coming through our position -- strong position in the travel industry with our portfolios, Expedia and Lufthansa, just to add, too, here, and this unlock of capacity over time will be a very good mix. This is an exciting space.", "People just want to be out there." ] }, { "name": "Operator", "speech": [ "We'll go next to Dan Perlin at RBC." ] }, { "name": "Dan Perlin", "speech": [ "Thanks. Good morning. I just wanted to maybe dig a little deeper on the commentary around this moderation in inflation and spending, Sachin, that you called out. Particularly, what can you tell us about kind of the downdraft in average tickets during the current quarter? And then maybe more specifically, are you seeing any discernible signs or indications of trade-downs from the consumer that would be high corollaries to slightly weaker consumer spending as opposed to this resiliency that it sounds like you guys are continuing to talk about? Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Dan. So a couple of thoughts. I mean, it's no surprise. I think you guys are all seeing that inflation, while still remaining at high levels, has started to moderate, right? So you're seeing that come through in terms of the nature of spend, right? We're a nominal value business.", "And at the end of the day, right, inflation -- declining inflation quarter over quarter will have an impact. So that was important to actually call out. And then I also talked about how there's a moderation in select markets, international markets. The reality is when you look at markets -- and this is not broad-based, right? There are select markets where -- let's take a market like the U.K.", "At the end of the day, rising interest rates and high inflation levels, ultimately, will put a squeeze on people's ability to spend. That doesn't mean that the consumer isn't necessarily resilient. The consumer remains resilient on a more holistic basis. But at the margin, right, what you start to see is as, say, for example, mortgages get reset.", "When mortgages get reset, they're getting reset of high interest rates. What it's doing is it's squeezing the wallet -- or share of wallet, which would be available for other discretionary categories of spend. So you're going to see a little bit of that trend come through, which is what we were kind of calling out. But all of that is factored into our thinking as we think about the rest of the year and in my full-year guidance.", "So that's really, in essence, what we were kind of thinking about. So again, I'll summarize it by saying there's recent reductions in inflation. There's a little bit of moderation in select international markets. And really, we haven't seen this as being broad-based.", "We haven't seen this as something which is causing concerns for us. It's very much in line with what we've been thinking about from a guidance standpoint. And I'll remind you that at the end of the day, cross-border continues to be strong, back to the question which David just asked. So to kind of bring that all together, right, we feel good about what the strength of the consumer is." ] }, { "name": "Dan Perlin", "speech": [ "Excellent. Thank you." ] }, { "name": "Devin Corr", "speech": [ "Audra, I think we have time for one more question." ] }, { "name": "Operator", "speech": [ "And we'll take that question from Bryan Keane at Deutsche Bank." ] }, { "name": "Bryan Keane", "speech": [ "Hi, guys. Good morning. Thanks for fitting me in. Sachin, just want to ask about FX volatility and how it impacts the model.", "I know cross-border assessment revenue growth was above volume, so it had a positive yield. I think in your peers -- one of your peers' reports, it was actually negative, and they called out the lack of FX volatility. So just trying to understand how it impacts Mastercard's model." ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Bryan. So first, the -- what -- when we talk about FX volatility, you see that in our numbers in transaction processing assessments, not in cross-border assessments. It is tied to the activity of clear and settle, which is why it sits in transaction processing assessments. And what I called out was the higher growth rate in cross-border assessments relative to volume was driven by what we call favorable mix, which is the fact that our inter volumes, which is everything, ex intra-Europe, right, are growing at a faster pace than intra-Europe.", "Inter volumes tend to be high yielding than -- as compared to intra, and that's the reason you had that positive kind of gap between where revenues were on cross-border assessments and where volumes were. And again, the volatility comment I made was tied to transaction processing assessments, which is where it sits." ] }, { "name": "Bryan Keane", "speech": [ "Great." ] }, { "name": "Devin Corr", "speech": [ "Thank you. Michael, any closing comments?" ] }, { "name": "Michael Miebach", "speech": [ "All right. Thanks, Devin. The first thing I want to say, you should all know that Warren sits in the other room and is listening to us. So this is the first time, solo by Devin, and we're delighted to -- with this next chapter now.", "As always, I want to make a comment about all the people at Mastercard who make this happen, the 30,000 of us. I sent them a note earlier today with the results that, this is the value that you guys deliver every day, so I just wanted to share that with you. And with that, thank you for your support, your questions today, and we'll talk to you soon. Take care.", "Bye-bye." ] }, { "name": "Devin Corr", "speech": [ "Thanks, everyone." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2021-01-28	[ { "description": "Head of Investor Relations", "name": "War Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "", "name": "Unknown speaker", "position": "Other" }, { "description": "Autonomous Research -- Analyst", "name": "Craig Maurer", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "Tsin Huang -- J.P Morgan", "name": "Tien", "position": "Other" }, { "description": "Mizuho Securities -- Analyst", "name": "Dan Dolev", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Timothy Chiodo", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Don Fandetti", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to the Mastercard Q4 and full-year 2020 earnings conference call. [Operator instructions] I would now like to hand the conference over to your speaker for today, War Kneeshaw, head of investor relations. Thank you. Please go ahead, sir." ] }, { "name": "War Kneeshaw", "speech": [ "Thank you, Tanya. Good morning, everyone, and thank you for joining us for our fourth-quarter 2020 earnings call. We hope you're all safe and sound. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer.", "Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session. It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the investor relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning.", "Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted. Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements.", "Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days. With that, I'll turn the call over to our chief executive officer, Michael Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren, and good morning from New York. It certainly feels like a privilege to be addressing you today for the first time as Mastercard's CEO. I believe the foundation established under Ajay's leadership positions us extremely well for the future. And I'm looking forward to leading Mastercard from here on and of course, counting on your continued support.", "Now, 2020 presents the world and the economy with unprecedented challenges. Still, the resilience of our business model and the focused execution of our strategy by our dedicated employees allowed us to close out the year on a positive trajectory. Fourth-quarter revenue and EPS growth rates versus a year ago are continuing to show sequential improvement. As we look to the future, we will continue to execute on our strategy.", "With our ability to enable and secure the payments ecosystem through the partnerships, our differentiated services and our role as a true multi-rail provider, we're well positioned to capture additional flows and the significant opportunities ahead. These opportunities include certainly the accelerated secular shift to digital payments and the advancement of real-time payments and open banking. Now, let's take a look at our business from the macro level. Retail spending during the holiday season and fourth quarter overall was relatively steady with very strong e-commerce sales.", "According to our SpendingPulse estimates for Q4, U.S. retail sales were up 4%, ex auto, ex gas, while overall Europe retail sales slowed with a decline of 1.9% for the quarter, in part due to the recent lockdowns. In Asia, we see some bright spots in markets like Australia and then similarly, in Latin America, where retail sales in Brazil rebounded this quarter. Now, we're also heartened to see the availability of effective COVID vaccines.", "But distributing them at scale will dictate when social distancing measures can be relaxed and borders opened, and that will ultimately drive further recovery. We see fiscal stimulus, such as the most recent package in the United States, as an important interim measure in the near term. And we're working closely with governments to get funds into people's hands quickly and safely. Now, turning to our business specifically and the four-phased framework we established for monitoring the COVID environment.", "These markets go through the containment and stabilization phases, and we continue to believe most markets are now in the normalization phase domestically, where spending levels gradually improved with some markets actually approaching growth. Looking at the trends. Volumes continued to modestly improve quarter over quarter. And our switched volume growth rates, excluding travel and entertainment, were similar to what we saw in Q4 2019 pre-pandemic.", "Speaking of travel. Domestic travel, including spending in categories such as lodging and restaurants, declined slightly in the quarter, reversing some of the improvement we saw in the summer months. Cross-border travel remains limited. In October and November, we saw some improvement in cross-border within the EU, although recent restrictions are causing some slowing over there, as mentioned earlier.", "Improvement in the cross-border travel outside the EU remains limited. Now, we continue to believe travel will improve, starting with personal travel as border restrictions ease and as vaccination efforts expand. We believe corporate travel will follow. As we said in the past, progress may not be linear, but we believe there is significant pent-up demand for travel.", "And we continue to expect to see improvements in the second half of the year. In the meantime, we remain focused on building on our already strong position in travel, positioning us well to capitalize on this opportunity when it occurs. So while the pandemic is affecting business drivers in the short term, we have diversified our revenue streams and remain focused on managing our business for the long term. This means focusing on our strategic priorities: One, growing our share of core payments, ensuring the digital experience for our customers, partners and consumers is safe and seamless as we help drive the accelerated secular shift; two, deploying meaningful services that help our partners adapt to the changing environment; and last but not least, providing choice with our multi-rail capabilities.", "Illustrating all of that, we have quite a number of significant strategic wins this quarter, which I will now share with you. Starting in the U.K. and Ireland and building off the success we've had in debit with Santander and first direct, we're really pleased to expand the long-term relationship we have with NatWest Group of credit. The bank will move its entire debit portfolio to Mastercard across all consumer and business product lines and across multiple brands, including NatWest and Royal Bank of Scotland.", "This migration of approximately 16 million debit cards will start later this year and when complete, will contribute to the growing overall debit share in the U.K. from low single digits to approximately a third of the market on all these new wins that migrated to Mastercard. We look forward to innovating together to build an enhanced digital experience for NatWest's customers across multiple payment rails. Now, turning to Germany.", "We expanded our relationship with Deutsche Bank and will become the exclusive international scheme partner, including both Deutsche and Postbank Banks, expanding our market share in debit and credit. As part of the upcoming migration, a total of 10 million consumer and commercial credit and debit cards will be reissued to Mastercard-branded products. Deutsche Bank is already leveraging our services within our existing partnership and will now extend those to the larger customer base and use our advisors' consulting and analytics to assist with the conversion. And we look forward to developing new opportunities together in B2B and other payment flows.", "In the U.S., we will be the network partner for the Citi Plex account on Google Pay, which leverages our tokenization services to provide Citi Plex customers with a seamless and more secure payment experience. The Citi Plex account will include a digital debit Mastercard that's automatically loaded for use in the Google Pay wallet with an option to request a physical contactless card, providing customers the choice to pay when, where and how they want to pay, by debit card, smartphone or online. Building on our fintech momentum, we have secured additional wins around the globe with new partners like Payoneer and Aeldra in the U.S., HYPE and Flow in Italy, Treezor in France and Prex in Peru. Our fintech customers appreciate our tailored approach, addressing their very specific needs, leveraging our expertise, our tech and of course, our global network.", "Now, we're also excited to announce a new strategic partnership with Walgreens. This multifaceted relationship includes a new credit product to be issued by Synchrony Bank and prepaid products that enable contactless shopping experiences, mobile-first money management and rewards via the Walgreens app. This partnership will enable Walgreens to leverage a number of Mastercard services, including insights and analytics, loyalty and point-of-sale financing, including installments. We will also look into future opportunities together, including a digital-first debit card and other tech-driven solutions to innovate the future of healthcare payments.", "Now we remain very active in the U.S. co-brand space, where we extended and expanded our Sam's Club co-brand with enhanced rewards and digital experiences, as announced yesterday, and extended our Walmart consumer credit in co-brands and payroll cards, renewed our GM co-brand, now with Goldman Sachs as the new issuer, and expanded our relationship with Bass Pro Shops and Cabela's to include small business. Let's come back to travel. We continue to prepare for the broader return of travel with several new partnerships in this space.", "First off, building on the travel co-brand momentum we announced last quarter, we will now be the exclusive network for Aeroplan co-brand program in the U.S. with J.P. Morgan Chase Bank and Air Canada, which will launch later this year. In both the U.K.", "and Spain, we're innovating with IAG Loyalty, part of the International Airlines Group, our new co-brand and loyalty partnerships that will provide customers more choices to earn Avios points and reward them with exclusive benefits. And on the wholesale travel program front, one of the largest global online travel agencies, Booking.com, has chosen Mastercard to be their preferred partner for virtual card payments to their suppliers. Let's talk about the change in consumer. As spending patterns change, it is critical to offer online and in-person capabilities, and we have solutions for both.", "As e-commerce accelerates, with card-not-present transaction accounting for about 45% of our switched volume in 2020, which is up from 40% in 2019, we have several efforts under way to enable safer and more seamless online purchases. Notably, we continue to scale our merchant tokenization services for card-on-file, a critical use case, with a sixfold increase in the number of unique merchants transacting in quarter 4 versus a year ago. Now, recent surveys tell us that seven in 10 e-commerce consumers have a payment card information saved with at least one merchant type. Card-on-file tokenization is particularly helpful for subscription services like Netflix, marketplaces like Etsy and ride hailing services like Didi who have just signed on this quarter.", "But we do believe that when restrictions ease, people will return to shopping in person, and hence, we're driving a secular shift in store as well. For example, we saw a strong acceleration of contactless in 2020 as more than 80 markets grew contactless penetration as a percentage of in-person transactions by at least 10%, which is driven by consumer demand for increased speed and safety, but of course, friendliness at the point of checkout. This paves the way for new solutions that leverage contactless, such as our recently launched Cloud Tap on Phone, which will allow merchants of any size to quickly and easily accept contactless payments on a range of devices, including mobile phones, further expanding our acceptance reach. This will be particularly important for all those hard-hit small businesses trying to operate more digitally coming out of the pandemic.", "Now with respect to services. Services continue to be in strong demand as we help our customers adapt and succeed in this evolving omnichannel environment we just talked about. In aggregate, our services line represented about a third of our revenues in 2020 and grew at 18% during that period on a currency-neutral basis, providing a critical source of growth and diversification. We will continue to invest in these capabilities across all payment flows to keep the ecosystem secure and to provide key insights to our customers, including publishing monthly trends, leveraging assets such as SpendingPulse.", "Our recent acquisitions in the services space providing a key source of differentiation are continuing to gain scale. For instance, Bank of America recently expanded its use of Ethoca's dispute management tools. Fintechs in the U.S. and abroad, including American e-commerce company Rappi, are using the behavioral biometric technology of new data, enhance the authentication process, signing new customers, for RiskRecon to ensure cyber health across their system.", "And brands like Chico's are leveraging our end-to-end loyalty platform through SessionM. So let's turn our focus on the initiatives that are designed to address a broader set with payment flows with our multi-rail capabilities. They offer the choice and flexibility that consumers, businesses and governments need and increasingly expect. First, we are pleased to report that we closed the acquisition of Finicity in November, extending our network to provide data transmission capabilities essentially to fully capitalize on the future of open banking.", "Finicity continues its leadership in signing direct data access agreements with financial institutions and fintechs, building off existing direct relationships with major banks like Chase, Citi, Bank of America, Capital One and Wells Fargo. We recently added Chime, Brex, BMO Harris, Charles Schwab and TD Bank, and we're moving quickly to secure more direct access relationships. Finicity continues to build out its digital assets and credit decisioning solutions, including those launched with four leading mortgage companies, and have seen rapid adoption of its lending and payment solutions. In parallel, we continue to expand our open banking capabilities in Europe and intend to leverage Finicity there as well.", "In the real-time space, we're excited that Payments Canada has selected Mastercard to build and run its new real-time payment systems, clearing and settlement infrastructure. Our technology and expertise will power our best-in-class real-time payment infrastructure that provides a platform for innovation to enhance Canada's economy. With this win, we are now providing real-time payments infrastructure for 12 of the top 50 GDP countries, extending our global footprint. Relating to these new infrastructure wins, we continue to build out applications that leverage real-time payment rails like with Mastercard Track Business Payment Service, which is now live with real-time payments and batch ACH in the U.S.", "alongside our card functionalities. We've also extended Track's card payment capabilities worldwide and now continuing to build out our network with a number of bank and nonbank partners that considerably extend our reach on both the buyer and supplier side. This year, we plan to continue expanding the platform into new geographies and add our cross-border payment capabilities. We're also delivering on our multi-rail promise with Mastercard Send, which continues to grow across the globe.", "For example, we expanded our reseller network by deepening our long-standing relationship with Citi to enable them to offer business-to-consumer disbursements in the U.S. This is one of several new partnerships leveraging Mastercard Send to enable B2C and person-to-person money transfers domestically and internationally. We also partnered with TransferGo, enabling customers across 20 European countries to make international money transfers from any card or bank account directly to a Mastercard debit or credit card. Now, let's take a look into the future.", "As you've surely heard, there's a lot going on in the digital currency space, with many governments around the world evaluating central bank digital currencies. When a country chooses to issue its own CBDC like the pilots we've seen in countries like Sweden or China or instead, it provides a regulatory framework for private stable points or otherwise pursues both public and private options in parallel, we are engaged to central banks through our policy and the solution perspective. We've continued to invest in this space to be ready to co-invest with governments, banks and fintech partners. For example, the virtual test platform that we launched a short time ago is being received well.", "And our cryptocard programs, including Wirex in the U.K. and Uphold in the U.S., enable consumers to spend their crypto balances within our acceptance network. This year, we plan on adding digital currency directly on our network, enabling our partners to take advantage of our acceptance reach and settlement capabilities. This will give choice and flexibility for consumers and merchants for what currency they want to use or receive.", "Our level of support will vary based on regulations in a given market. It will continue to be guided by our published principles on security, compliance and consumer protections and the value to our stakeholders in determining our involvement in a specific initiative. So there's certainly a lot going on and significant opportunity ahead. With that, let me turn the call over to Sachin." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. Turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis and excluding special items related to certain litigation and tax matters and the impact of gains and losses on the company's equity investments. Net revenue was down 7%, reflecting the impact of the pandemic and includes a 1 ppt benefit from acquisitions. Operating expenses were flat year over year or down 3% if you exclude the 3 ppt impact of acquisitions.", "Operating income was down 12% and net income was down 17%, both of which include a 2 ppt decrease related to acquisitions. EPS was down 16% year over year to $1.64, which includes $0.04 of dilution related to our recent acquisitions, partially offset by a $0.03 contribution from share repurchases. During the quarter, we repurchased about $1 billion worth of stock and an additional $356 million through January 26, 2021. So let's turn to Page 4, where you can see the operational metrics for the fourth quarter.", "Worldwide gross dollar volume or GDV increased by 1% year over year on a local currency basis, reflecting the effects of the pandemic. U.S. GDV increased by 4%, with debt growth of 15%, partially offset by a credit decline of 7%. Outside of the U.S., volumes were flat.", "Cross-border volume was down 29% globally for the quarter. Similar to last quarter, intra-Europe volumes were less impacted than other cross-border volumes. Specifically, intra-Europe volume was down 15% for the quarter, whereas other cross-border volume was down 41%. Turning to Page 5.", "Switched transactions grew 4% in the fourth quarter globally. We saw positive growth in switched transactions across most regions, aided in part by the continued adoption of contactless. In addition, card growth was 6%. Globally, there are 2.8 billion Mastercard- and Maestro-branded cards issued.", "Now, let's turn to Page 6 for highlights on a few of the revenue line items, again described on a currency-neutral basis unless otherwise noted. The decrease in net revenue of 7% was primarily driven by a decline in cross-border volumes due to the effects of border restrictions and social distancing measures, partially offset by growth in GDV, switched transactions and continued growth in our services. As previously mentioned, acquisitions contributed approximately 1 ppt to net revenue growth. Looking quickly at the individual revenue line items.", "Domestic assessments were up 1%, while worldwide GDV grew 1%. Cross-border volume fees decreased 41%, while cross-border volumes decreased 29%. The 12 ppt difference is primarily due to an adverse cross-border mix mainly driven by lower-yielding intra-Europe cross-border volumes being less impacted than higher-yielding other cross-border volumes. Transaction processing fees were up 4%, while switched transactions were up 4%, with the unfavorable cross-border mix I just mentioned being offset by strong services growth.", "Other revenues were up 17%, including a 1 ppt contribution from acquisitions. The remaining growth was primarily driven by our data analytics, consulting and cyber and intelligence solutions. Finally, rebates and incentives were up 1%. Moving on to Page 7.", "You can see that on a currency-neutral basis and excluding a special charge related to litigation, total operating expenses remained flat. This includes a 3 ppt increase related to acquisitions. Excluding acquisitions, we delivered an expense decrease of 3 ppt. Turning to Page 8, let's discuss the specific metrics for the first three weeks of January.", "Starting with switched volumes, we continue to believe that most markets are in the normalization phase domestically with some approaching growth. Overall, switched volume growth remains generally consistent with the trends we saw in December. While we are seeing stronger growth in the U.S., this is being more than offset by slower growth in markets outside the U.S., primarily Europe. Switched volumes in the United States have been strong in recent weeks, supported in part due to the recent fiscal stimulus.", "Outside of the U.S., switched volumes in Europe have slowed considerably due to the increased lockdowns in countries like the U.K., Germany and Italy. When you look at how people are spending, we have recently seen a decrease in card-present growth rate due primarily to the effects of the increased lockdowns that began to be put in place in December, while our card-not-present growth rates remain healthy. Trends in switched transactions remain steady and are tracking the trends we are seeing at switched volumes. In terms of cross-border, we have seen a reversal in intra-Europe cross-border in recent weeks relative to the improvement we saw in November and December.", "Higher-yielding other cross-border remains more adversely impacted than intra-Europe cross-border. Turning now to Page 9. I'd like to provide some additional color on the cross-border trends across card-present and card-not-present. You can see the trends that we shared through the course of the quarter continue.", "Week-to-week fluctuations in November and December reflect holiday timing differences year over year. In total, if you look at the gray line, total cross-border, which showed some improvement in November and December, is now continuing in a relatively similar band to what we saw in October due to the reimplementation of border restrictions. If you look at the orange line, card-present spend reflects continued limited travel, in part due to the border restrictions I just mentioned. Card-not-present growth, which is the yellow line on the chart, continues to be resilient and has held up well.", "The green line represents card-not-present spend, excluding online travel-related spend, and remains positive as we effectively received strong growth across discretionary and nondiscretionary retail categories. Turning now to Page 10. I wanted to share our thoughts for the upcoming year. First and foremost, we feel like we are very well positioned to grow with the strategic deals we have laid out over the last several quarters, including those with Bank of America, NatWest, Deutsche Bank and Santander, to name a few.", "Further, we have positioned ourselves with the return of travel with travel-oriented portfolios. We have built a strong set of services capabilities, which continue to grow at a faster rate than before, and we will deepen penetration of these services across our customer base while expanding this portfolio. And our multi-rail strategy positions us well to address new flows and adapt to the changing payments landscape. In terms of the macro environment, we're enthusiastic about the availability of effective vaccines.", "However, the rate at which vaccinations will take place is still uncertain. As a result, we will not be providing a forward view on net revenue for 2021 at this time as we believe visibility is dependent upon border opening, the further relaxation of social distancing measures and improvement in consumer confidence. As we have said, we expect to see progress in these areas in the second half of 2021. Turning to the first quarter.", "We anticipate that some of the more restrictive measures that have recently been put in place because of rising infections will persist in the near term. If this were to be the case, we would not expect spending levels to improve from what we have seen so far in January. By the way, we do plan on providing periodic updates to the operating metrics during this quarter. In addition, I will offer a few additional points to help you with your modeling.", "First, we will continue to experience lower cross-border related deals until broader scale interregional travel recovers. Second, from a growth rate perspective, we expect to start lapping the effects of the pandemic primarily in March. Also, as a reminder, last year was a leap year and so Q1 2020 had an extra day of volumes and revenues. And finally, we expect rebates and incentives as a percentage of gross revenues to be flat or up slightly sequentially due to new deal activity, including some of the recent wins Michael has just discussed.", "Now, let's turn to operating expenses. We continue to carefully manage our properties in order to preserve our ability to invest in our key long-term growth drivers, namely digital, cybersecurity, data analytics, B2B and multi-rail solutions. For Q1, we expect operating expense growth to be up mid-single digits versus a year ago on a currency-neutral basis, excluding acquisitions. Of note, this increase reflects the lapping of spending actions taken a year ago as a result of the pandemic as well as a 3 ppt increase due to the lapping of a favorable hedging gain from a year ago.", "With respect to acquisitions made in 2020 or later, Finicity closed near the end of last November, and we continue to expect the transaction with Nets to close in Q1. Based on this timing, we expect the acquisitions to contribute about a 0.5 ppt to revenue in Q1 and 1 to 2 ppt for the year. Similarly, acquisitions will contribute approximately 4 to 5 ppt to operating expenses growth in the first quarter and 7 to 8 ppt for the year. As a reminder, we discreetly disclosed the impact of acquisitions for the year in which they closed and the subsequent year.", "After which, we do not split them up. Other items to keep in mind. Foreign exchange is expected to be about a 2 ppt tailwind to net revenues and a 2 ppt headwind to operating expenses in Q1. On the other income and expense line, we had an expense run rate of approximately $110 million per quarter given the prevailing interest rates.", "This excludes gains and losses in our equity investments, which are excluded from our non-GAAP metrics. And finally, we expect the tax rate of approximately 18% to 19% for the year based on our current geographic mix of the business. And with that, I will turn the call back over to Warren." ] }, { "name": "War Kneeshaw", "speech": [ "Thanks, Sachin. Tanya, we're ready to take questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions]" ] }, { "name": "War Kneeshaw", "speech": [ "Tanya, it's coming through very rough at this end. So if you can try to correct that. First question, please." ] }, { "name": "Operator", "speech": [ "Your first question [Inaudible] with J.P. Morgan." ] }, { "name": "Unknown speaker", "speech": [ "[Inaudible]" ] }, { "name": "War Kneeshaw", "speech": [ "There's a lot of static on the line. If we move to the next caller." ] }, { "name": "Operator", "speech": [ "Your next question is from Craig Maurer from Autonomous Research." ] }, { "name": "War Kneeshaw", "speech": [ "Can you turn the line on mute, please." ] }, { "name": "Operator", "speech": [ "Yes, sir." ] }, { "name": "Craig Maurer", "speech": [ "It's Craig Maurer. Can you hear me?" ] }, { "name": "War Kneeshaw", "speech": [ "Yes. Barely, Craig. Please go ahead." ] }, { "name": "Craig Maurer", "speech": [ "OK. I can barely hear you. I wanted to ask about some of the announcements you made earlier. Any improvements in terms of [Inaudible] transaction or any other [Inaudible]" ] }, { "name": "War Kneeshaw", "speech": [ "Craig, you just dropped off. We -- can you still hear us? I'll just rephrase the question in the hopes that you're still on. Did the [Inaudible]" ] }, { "name": "Michael Miebach", "speech": [ "So Craig, I can take that question. I just want to make sure you're still around. Craig, can you hear us?" ] }, { "name": "Craig Maurer", "speech": [ "I'm still here. There's a lot of static." ] }, { "name": "Michael Miebach", "speech": [ "OK. We're working on got it. Yeah, we're just working on it. Let me try and take that so I can -- Sachin can hear it.", "You asked a question on what the impact of the [Inaudible]. A couple of things we said any changes that we made in Europe that I think the answer is the whole definition, your volume remains the same. There is no change in our pricing either. Specifically on your question on interchange, once the transaction ended on the 31st of December of last year, the U.K.", "effectively became subject to the same interchange tax as any other non-EU countries as agreed with the European Commission. And recognizing the prevailing pandemic, what we did is we set the timing of the change we commenced in October of 2021. We are very aware of the challenges which are being faced by retailers, businesses and people because of this pandemic. And we continue to view the timing of the implementation of this position as we go forward -- look forward for this year." ] }, { "name": "War Kneeshaw", "speech": [ "Next question please." ] }, { "name": "Operator", "speech": [ "We'll take the next question with [Inaudible] with Crédit Suisse." ] }, { "name": "Unknown speaker", "speech": [ "Can you hear me?" ] }, { "name": "Michael Miebach", "speech": [ "Yeah, I can hear you." ] }, { "name": "Unknown speaker", "speech": [ "[Inaudible]" ] }, { "name": "War Kneeshaw", "speech": [ "Yeah, I'm sorry. We couldn't get that. Just hold on a sec. We're just trying to switch over the lines.", "This is Warren. There's a problem with the operator's line. AT&T is working it. We're just going to pause for a moment.", "So please just bear with us. We're just waiting for the operator's line to be fixed. I just wanted to say, one more time, we're working with technical difficulties. Please stick with us." ] }, { "name": "Operator", "speech": [ "Excuse me. This is the operator. We are currently having technical difficulties. Please, the call will resume momentarily.", "Hello, everyone. OK." ] }, { "name": "War Kneeshaw", "speech": [ "This is Warren. Can you put us back in the main?" ] }, { "name": "Operator", "speech": [ "You are in the main conference, sir." ] }, { "name": "War Kneeshaw", "speech": [ "I apologize for the technical difficulties. Hopefully, you can hear us well now. We're ready to take your questions. And in light of the technical difficulties, we'd be happy to extend the call for -- to take your questions.", "Next question please, Tanya." ] }, { "name": "Operator", "speech": [ "Your next question is from Ramsey El-Assal with Barclays." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi. Glad you're back and thanks for taking my question here. I wanted to ask about the impact of stimulus on your volumes. Is the U.S.", "switched volume improvement in January versus December, is this -- do you attribute this largely to the impact of stimulus? And then secondarily, I was interested, Michael, on what you were saying about Mastercard's participation with the central bank digital coins and how you're going to enable them to flow on your network. How do you help governments with that product? What can Mastercard do there to be of utility?" ] }, { "name": "Sachin Mehra", "speech": [ "Hi, Ramsey. It's Sachin. I'll take the first question. So to your question, what we are seeing in the first three weeks of January is better performance in the U.S., and we are attributing that primarily to the impact of stimulus.", "Obviously, there's several factors which go into overall spending trends, but that soon is definitely does play a part. And we are seeing that come through. In terms of spend levels in the U.S. in the first three weeks as well as from a mixed standpoint, what we're seeing as being more weighted to a debit in terms of what we're seeing in the U.S." ] }, { "name": "Michael Miebach", "speech": [ "Good. And on the central bank digital currency front, Ramsey, so here's multiple ways that Mastercard can be helpful. As I was saying earlier, first of all, we are engaging with governments all around the world, really, first on a basis to find out what is the path forward when it comes to modernizing the payment stack on a given country. So is it the right tool for the job? And the conclusion is, it is the right tool for the job and then we will certainly partner, but I would also say that you will find situations where real-time payment is a better answer because it just happens to exist already, and it lives in the existing financial infrastructure.", "But let's come back to CBDCs. We have a few principles that we put out into the market and which I'm happy to see is shared by most leading central banks around the world, and that is that you start off with recognizing there's different roles between a central bank and a private sector bank. You don't -- you want your lender of last resort. You want, so to say, the mining of the currency in any one of the private sector to bring utility to the currency for consumers or for businesses and so forth, so a two tier approach.", "And our partnership is with both sectors in this case. Private sector to say what utility could be brought? What's the functionality that makes a difference, let's say, when you want to pay with a cryptocurrency in a store. And here, that is where we bring to bear our acceptance network, for example. So the IP that we have that links the cryptocurrency that's trading on our network is a very tangible example of what we could do.", "Then you think about other aspects here is that it's generally the last-mile question. It is also consumer protection. It is transparency. It is business models around that.", "And it is using fundamentally the nature of the distributed ledger technology that is put to use here. And if you could imagine a world where there's a bunch of smart contracts riding on a government-issued CBDC, and that is very similar to what we do in terms of applications in the real-time space, all what we do with debit and credit in the card space, underlying set of rails which we participate in and then we help bring utility across governments and private sector. That's the play. Early stages, but we will support.", "And we, today, only carry currency in our network. And when this makes its way, then we'll carry CBDCs in our network." ] }, { "name": "Ramsey El-Assal", "speech": [ "Got it. Thank you so much." ] }, { "name": "Operator", "speech": [ "Your next question is a follow-up from Tien-Tsin with J.P. Morgan." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey, thanks. Hope you guys can hear me OK now." ] }, { "name": "Michael Miebach", "speech": [ "Yes." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey, guys. I just want to ask on the NatWest win on the debit side. That's a nice one. Anything interesting to share on how this win came together? And I'm also just curious, bigger picture of the pipeline for new deals, if it's changed at all, if it's different in terms of size and quality now versus, say, this time last year, pre-COVID." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. So let me take the first part of the question and then Sachin can talk a little bit more about the pipeline and so forth. Now this big win, NatWest, but then looking at the other strategic relationship with Walgreens, Deutsche Bank, if I look at some of the aspects that recently driven or wins, these ones specifically but broader -- the broader portfolio, it is our capabilities across one set of rails. You heard me talk earlier about it.", "We're going to want to co-innovate with NatWest on multiple payment rails. So certainly a differentiated capability matters, particularly in Europe, where the rival of real-time payment is absolutely real. Then you think about aspects in these markets, there is -- open banking is a little more pronounced than in other markets. So again, it's an additional capability that's a differentiator that we have with open banking connect in Europe.", "You look into digital-first capabilities. So again, something that played out over the last two years in Europe. So I would summarize it, Tien-Tsin, as innovation. Certainly, pricing and all that matters.", "But the fact that there is something else that we can bring to the party and our solution selling approach brings it all together across services, multi-rail and what we do in our core business. So I think that's generally the story. And how that's changing to, let's say, two years ago? Well, multi-rail, with the Canada venue just saw it, we're growing our reach if something that is matters in so many more markets today. So we're just advancing the strategy, and then we can bring it all to bear in a case like this." ] }, { "name": "Sachin Mehra", "speech": [ "Yes. And Tien-Tsin, I'll just add. Michael touched upon the point around the power of the services capabilities that we bring. And you've heard this over the last, I don't know how many quarters.", "The wins we're having are very much supported by the strength of our services capabilities. It makes a real difference when we can walk in and talk with customers about how we can help them grow their top line and manage their expense base as it relates to fraud and things like that, which become more of a partnership discussion than a vendor relationship. And that's been a key enabler as to helping us win. And that carries on, whether it's NatWest, Deutsche Bank, the whole kind of spectrum of deals.", "And what do I expect on a going-forward basis? The pipeline remains robust. I mean things are going to keep happening. We're going to renew existing customers. We're going to keep working on new customers.", "We're going to look to expand portfolios with existing customers. So that's very much upfront and center in the bucket of what I call controllables. So there's stuff which is happening in the macro environment, which we don't necessarily control. But there are things we do, which is engagement with our customers and we're driving hard on that." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Great detail. Thanks a lot guys. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Thank you." ] }, { "name": "War Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Your next question is from Dan Dolev with Mizuho." ] }, { "name": "Dan Dolev", "speech": [ "Hey, guys. Thanks for taking my question. A quick question on debit. You mentioned debit is driving most of the growth.", "And if I look at Q4 versus Q3 debit growth in the U.S., it did decelerate by about 200 basis points. I just want to know what's behind it. I see the comps are a little easier. So it would be great to get a bit of an explanation of what drove that in the fourth quarter and how is it looking in the first quarter." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. So again, you should think about the mix between debit and credit are based on a couple of things. One, what's going on globally in the nature of the release of stimulus payments? What the timing of that is and what's the timing of associated spend on that stimulus payment. That's kind of bucket number one.", "Bucket number two is, what are the categories of spend and -- which have a higher propensity for debit versus which have a higher propensity of credit. So when I think about Q3 versus Q4, and while debit grew at a very healthy pace in Q4, it was a little bit at a slower rate than what we saw in Q3, back to your point. It's largely been driven by the fact that the impact of the stimulus we've referred in Q3 started to weigh in Q4. On the flip side, credit performed really, really well.", "And when I say really well, it was still in negative, but a market improvement in credit because there was a great amount of spend taking place in discretionary categories, which are credit heavy. So we follow this and we track this pretty closely. And I think that would be the reasons why you should explain what changes are taking place in terms of the mix between debit and credit." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. And just one point to add, Dan. What we've seen in previous challenged periods in terms of economic outlook, there is -- in a downturn, debit is all generally preferred. And the main reason for that is people really want to spend the money that they have and avoid taking on extra burden in terms of additional debt.", "So this is a normal pattern that we have seen and it plays out in a way that Sachin just talked about." ] }, { "name": "War Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Dan Dolev", "speech": [ "Thank you and congrats on your fiscal." ] }, { "name": "Michael Miebach", "speech": [ "Well, thank you." ] }, { "name": "War Kneeshaw", "speech": [ "Tanya?" ] }, { "name": "Operator", "speech": [ "Your next question is from Jason Kupferberg with Bank of America." ] }, { "name": "Jason Kupferberg", "speech": [ "Thanks, guys. Good mornin.g I just wanted to ask a two-part question on cross-border. The first part is -- the highest yielding part of the cross-border business, the non-intra-Europe piece recently seems like the year-over-year declined or moderating a little bit. I don't want to make too much out of a couple of weeks of data.", "But can you just touch on what has maybe driven the incremental improvement in that metric and the sustainability of the improvement as the comps presumably get progressively easier from here, more or less on a weekly basis? And then just the second part is more of a conceptual question. I mean in your base case of macro recovery and travel recovery, is it feasible that cross-border revenues next year in 2022 could get back to 2019 level? Not obviously asking for guidance but conceptually based on how you think the macro could theoretically unfold. Thank you." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah, Jason. On the first part of your question, here's what I'd tell you. I would tell you, we're closely watching what these trends are. In the first three weeks, we have exactly what you're saying, which is the non-intra-Europe cross-border had started to see a little bit of a recovery come through.", "There are lots of puts and takes which take place there. And let me try and give you a little bit of color as to what could be driving some of that, right? First, at the end of the day, when you think about this component of non-intra cross-border, there are still several borders which are open. There are people traveling, if you think about U.S.-Mexico, if you think about borders within the Middle East and Africa. I could think about certain travel which is taking place in Asia Pacific.", "So you might be seeing -- you're seeing a little bit of that come through. The other component which is driving this is, at the end of the day, when we think about other cross-border, we think about it generically speaking in the context of people getting on planes and traveling. But other cross-border is also influenced by expats, people who are settling in far locations, who have cars, which are -- from their home countries. And the spend patterns on that could be influencing a little bit of what were going on -- what we're seeing here.", "I wouldn't make too much of the trend we are seeing in the first three weeks. We have to watch it for a little bit of a longer period of time. And that's the kind of color I could share with you on that. On your longer-term question on cross-border, look, I got to tell you, we as a company are very encouraged by what we're seeing from an overall availability of a vaccine standpoint.", "The rollout is something which is still kind of uncertain, and we'll watch how the rollout goes. We believe -- with the availability of vaccines at scale, we believe of the availability of more efficient testing therapeutics. People -- the consumer -- the governments or consumers will come back. Borders will start to be relaxed.", "And social distancing measures would start to relax. Now we expect that to happen more in the latter half of this year. So longer term, I would tell you, I'm quite optimistic about the fact that we're seeing vaccines, which are proving to be as effective as what the test results would suggest. And we'll see where it all kind of shakes out.", "I'm really not in a position to give you guidance as it relates to what I think cross-border will look like through the course of 2021. But I feel like if you just stand back and you thought about it, the near term and in the longer term, the nearer term will continue to be linear until the vaccine stuff is rolled out at scale. The longer term, we feel very encouraged about." ] }, { "name": "Michael Miebach", "speech": [ "Just an aspect to add here. And that is that there's distinction between personal travel and corporate travel. We've seen it in the summer, this past summer 2020. The reaction, once consumer confidence increases, turned right up into travel increasing because people want to get on with their lives.", "They want to see their friends, their families and whatever. So the reaction of personal travel, too, driven by consumer confidence, which will in turn be driven by the vaccine rollout Sachin just talked about, I think, was going to be relatively near term. Corporate travel, that will take longer. Video tools, we should have actually used the video tool today maybe.", "You just see that, that is an additional way of getting together. Yes, people want to see their customers. How that will play out, we don't exactly know. But back to personal travel, that is a significant majority of our travel portfolio.", "And all the wins that we had recently, they're going to kick at this time. So medium term, we're encouraged." ] }, { "name": "Jason Kupferberg", "speech": [ "Great. All right. Thank you." ] }, { "name": "War Kneeshaw", "speech": [ "Next question." ] }, { "name": "Operator", "speech": [ "Yes. Your next question is from Darrin Peller with Wolfe Research." ] }, { "name": "Darrin Peller", "speech": [ "Thanks, guys. Just a very quick follow-up on cross-border and then a structural question. But on cross-border, we remember, in February and March, it really started in Europe and the slowdown and then in March, obviously, the U.S. And so I'm just curious if that's where the comps you expect to start seeing it ease up.", "But Michael, more from a structural standpoint, I just want to understand, I mean, what do you -- now that it's almost been a year, when we look at services and the opportunity there, when you look at some of the other opportunities around contactless and e-comm, can you just touch on what you expect to be more permanent or more sustainable in terms of the business improvements due to the electronic nature of what we've seen in the pandemic? Thanks." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. So Darrin, it's Sachin. On your question around the lapping effect of cross-border, you're right. We saw some cross-border decline start in the later part of February is what I would tell you.", "But the vast majority of the lapping effect, like I said in my prepared remarks, we expect to see across all our drivers in the month of March. That's the way I kind of think about what we're seeing here." ] }, { "name": "Michael Miebach", "speech": [ "All right. And Darrin, on the questions on the trends, what makes the trends? That's like -- that's the key question here. Certainly, we started a digitization trend that's been around for years, accelerate dramatically. I think it's fair to say that years have been compressed into months.", "So what part of that will stick? When I look at what we're going to see as structural changes, as sticking trends, I fundamentally believe that e-commerce is not going to revert back to what it was. So no back to quarter 4 2019. I think the general attitude toward cash is going to remain more negative than before. The surveys that we've done every single month since April of last year is telling us that consumers -- broadly speaking, 60% of consumers have a somewhat more negative attitude toward cash now, and we don't think that will change.", "70% of consumers, they're going to do more digital banking, more online purchasing and more contactless. So I think that will just remain. As I said earlier in my prepared remarks, once you can venture out there and social distancing measures are relaxed, people will want to go and shop in their stores, in their local community, support the local restaurant, whatever it is. But the good experience, as people started to appreciate and learn online, that will not go away.", "So the good thing is we'll have two legs to stand on with our business. We'll benefit from both of them. Other structural trends that I see is more digital transactions, more data, more desire to understand the data. Data Insights, our service portfolio is on point for that.", "The same as more digital transactions, larger cyber footprint, potentially more risks. And a bunch of new businesses coming online that have been brick-and-mortar only, that's an opportunity for us from a cybersecurity perspective. And then there's a whole cross-border thing digitizing supply chains, B2B. I would say that's the other structural change that people take away from the pandemic." ] }, { "name": "Darrin Peller", "speech": [ "That make sense. Thank you." ] }, { "name": "War Kneeshaw", "speech": [ "Next question, please." ] }, { "name": "Operator", "speech": [ "Our next question is from Lisa Ellis with MoffettNathanson." ] }, { "name": "Lisa Ellis", "speech": [ "Good morning. And Michael, congrats again. In the prepared remarks, you highlighted the addition of Finicity to Mastercard's open banking portfolio. Can you elaborate a bit on how you're thinking about open banking where a payment or funds transfer could be made with debit, with Mastercard Send, with Fast ACH or RTP? Can you just comment a bit on how Mastercard's role differs, value-added differs, economics differ across all of these different methods of payment? And are you agnostic or not? Why? Why not? Thank you." ] }, { "name": "Michael Miebach", "speech": [ "Yeah. That's a pretty broad question, Lisa. So let me tick the first part of it, and then Sachin can talk around the economics and the business all behind that. Broadly speaking, the way we look at open banking is, it's adding data transmission capabilities as well as an additional set of transaction rails.", "We can initiate payments through open banking, permission API connections. We can do that. But we also can just verify assets or help in credit decisioning. So it's a wide range of use cases, and we're pretty agnostic what they are.", "We're quite happy to initiate payments directly through reassigned payment rails but also the combination of a market where there is real-time payment infrastructure. There is an open banking regulation as in Europe. The fact that we have a strong position in both allows us to leverage the combination of that quite effectively. That is one of the things that Tesco does with us.", "The proposition that Tesco is offering is you pay your credit card very simply through an open banking connection, leveraging the real-time payment rails. That's check, check, check, and it's a good combination for us. Overall, where is this going to go? I see it as an additional leg in our multi-rail strategy. So one link into Mastercard.", "You want to pay through an open banking trend link, you want to pay through real-time payments, you want to pay through cards, whatever it is, one thing is through Mastercard. That's the overall strategy. Finicity helps us clearly in the United States. But as I said before, these use cases that they have on asset verification and on credit decisioning, they are so in demand at this point in time.", "Taking them to Europe as quickly as possible will matter. Now Sachin, can help you unravel some of these business models behind that." ] }, { "name": "Sachin Mehra", "speech": [ "Yeah. So -- hey, Lisa. Just a couple of thoughts around that. I think you're quite familiar with the way we think about what constitutes our yield as a business, right? It's across infrastructure, applications and services.", "And I would tell you whether it's our card rails or it's our real-time ACH rails or it's open banking. The reality is there's an opportunity to realize revenue across all of these three layers: infrastructure, apps and services. And so as we get more in the flow of transactions and/or data, there is the opportunity to realize on all of those levels. If your specific question is around what the interaction of economics will be if payments were to take place over open banking rails or for card rails, well, the reality is we're in the business of providing choice to consumers.", "And what we're going to do is provide choice, we're getting price for the value we deliver across all of these three layers. I think it's a little early to tell you exactly what the actual economics of a transaction over -- for example, open bank rails maybe, but it's a payment transaction. What I can tell you, though, is take something like Pay by Account, which we've launched in the U.K. The economics for us on Pay by Account in the consumer use case in the U.K.", "are quite similar to our economics out there." ] }, { "name": "Michael Miebach", "speech": [ "Yes. But broadly speaking, I think fair to say we are agnostic. It's about choice. If the market want to go the one way, then the market will go one way and we'll partner it.", "And otherwise, it goes a different way, we'll partner it." ] }, { "name": "Lisa Ellis", "speech": [ "Wonderful. Thank you." ] }, { "name": "War Kneeshaw", "speech": [ "Thanks. We're going to go to about 10 after 10:00, if you can stick with us just to take a few more questions. So Tanya, next question, please." ] }, { "name": "Operator", "speech": [ "Your next question is from Timothy Chiodo with Credit Suisse." ] }, { "name": "Timothy Chiodo", "speech": [ "Thanks a lot for taking the question. So one area of focus for investors has been what the makeup of cross-border volumes will start to look like over the next three to five years. So clearly, in 2020, retail e-commerce became a much larger piece of the mix. Travel became a smaller piece of the mix.", "But longer term, once we assume a travel recovery -- but there will also be the mix in Mastercard Send, Transfast, Mastercard Track expanding into B2B, more account-to-account remittances, etc., across the board mixing into the cross-border volumes. Maybe you can talk about that evolution over the next few years and what that mix might look like." ] }, { "name": "Sachin Mehra", "speech": [ "Sure. Hey, Tim, it's Sachin. So a couple of thoughts. One, we do expect, with the return of travel, the mix will start to come back to a certain level similar to what we saw pre-COVID.", "It might take a little of time as it relates to the business travel component. But I want to remind you that the vast majority of our travel from a cross-border perspective happens to be personal travel, which we expect to come back and come back based on the comment which Michael made around the pent-up demand. So we'll see that come through. But you're exactly right about other elements of cross-border, whether it's leveraging our real-time rails and the applications in our cross-border manner, real opportunity we feel that as well because today, what we're tapping into is the consumer flows, what we call the person-to-merchant flows, leveraging our card rails in a cross-border environment.", "The opportunity from a B2B standpoint still remains largely untapped. And this is where our suite of assets from a multi-rail standpoint really will play an important part, whether it's our Send capabilities or the acquisition of Transfast which we did. All of those are key contributing factors. And we're rolling those out pretty nicely.", "We're building scale, we're building capabilities as we go down that path. So all in all, I tell you, cross-border remains a selling -- decent sized opportunity on a going-forward basis." ] }, { "name": "Michael Miebach", "speech": [ "And Tim, back to my earlier comments around structural changes, B2B and supply chain. A big part of the supply chain insight that people have just gained over the last nine months is that there's dependency on parts of the supply chain cross-border that they want to digitize and this -- so they can be more flexible to change suppliers in future scenarios. Now here, we come in with Transfast. We come in with our announced acquisition of HomeSend, the combination of all of that.", "And then you take this multi-rail capabilities, picture this in the context of Track, where there's a data switch, all the data that you want alongside with your B2B transaction is coming along and you choose whichever way you want to send it. Use case of like remittances by our supplier payments, which make up about $110 trillion of global flows. Significant opportunities for us, we got the assets in place." ] }, { "name": "Timothy Chiodo", "speech": [ "Thanks for taking the question." ] }, { "name": "Operator", "speech": [ "Your next question is from Don Fandetti with Wells Fargo." ] }, { "name": "Don Fandetti", "speech": [ "Hi, good morning. So Michael, congratulations as well. I did get your updated thoughts on like big tech. Clearly, fintech proliferation is a big positive for the networks in our view.", "But how are the discussions with the big tech players going today versus a year or two ago? And do you think your interests are still aligned commercially and also in Washington from a regulatory perspective?" ] }, { "name": "Michael Miebach", "speech": [ "Yeah. Don, that's a good question to round this call off, I think a very, very wide-ranging question. You have a lot of elements that you put in there. So let me go at this from a couple of perspectives.", "The first is our office, just want to run you, these are partners, these are customers, and we have strong relationships with all of them. Amazon, Facebook, Apple, you name it. And just think about the Apple Card as an example there. When you then look forward, you look at where is the world going in terms of different rails, in terms of emerging technologies, in terms of 5G.", "So there's a lot of change from a technology side in our ecosystem and here's big tech players. But what I'm finding is that our specialist role here and our focus specific on payment technology makes us a very relevant partner. Most of these companies are oriented and focused on delivering a particularly good consumer experience, digital user experience to their customer base, trying to keep customers in their ecosystem, whatever they might be doing, if they're a social network or something like that. And we stand the role of being the payments partner.", "That is a model of interaction that I think will continue to evolve. Some of these players do have payment aspirations. And Don, that's where your question is going. But then you look at our services portfolio.", "You look at our capabilities like card-on-file tokenization and so forth. We help them with our services portfolio while they create quite a nice consumer front-end experience. The xPays is a good example for that. And as long as there's choice and underlying payment tools, we're quite happy to partner because it drives the overall digital, the acceleration of the digital trend.", "In terms of change in political regime and the incoming administration and the view on big tech, that is for them to comment on. Basically, we're guided by our partnership. We're going to lean in and continue to drive our business. Overall, otherwise, it's early days.", "We have a great dialogue with the incoming administration. They're interested in payments which we generally like. This is, by the way, the trend around the world. Governments interested in payments is critical national infrastructure, and we engage in that dialogue, topics of cybersecurity and data principles where we're all a leading voice and that's how we engage." ] }, { "name": "Don Fandetti", "speech": [ "Thank you." ] }, { "name": "War Kneeshaw", "speech": [ "Thanks, Michael. I think it's time to wrap up. I just wanted to thank you for bearing with us as we went through this process. And I'm sure Michael will always remember his first call as CEO, but unfortunately.", "Michael, any final thoughts?" ] }, { "name": "Michael Miebach", "speech": [ "Yes. My blood pressure is slowly coming down again after this little hump earlier. No, thank you for the questions. Really appreciate the interest and the dialogue.", "Don't want to repeat anything. Just -- I have to go back one more time to 2020. That was a challenging year for the industry. That was certainly something that made us -- needed us to be as agile as we could possibly be.", "And I just want to comment again that our employees really stepped up and allowed us to close out the year on this positive trajectory. Now, we said on a number of occasions throughout this call here, we're optimistic about COVID recovery, really in the light of the vaccine being deployed. We're optimistic about cross-border coming back driven by the exact same point. So in the near term, there's optimism.", "In the very, very long term, there is optimism. I want to make one more point. All of this is great from an economic perspective and a performance perspective. What is equally important is that we do the right thing for communities and for our planet.", "And this week, I'm really proud and so many people at Mastercard are as we put out our net zero commitment. And that is just the last thought I want to leave you with that. With that, looking forward to speaking to you with less technical issues in a quarter from now. Thank you very much." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2022-04-28	[ { "description": "Head of Investor Relations", "name": "Warren Kneeshaw", "position": "Other" }, { "description": "Chief Executive Officer", "name": "Michael Miebach", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Sachin Mehra", "position": "Executive" }, { "description": "KBW -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "AllianceBernstein -- Analyst", "name": "Harshita Rawat", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Rayna Kumar", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Darrin Peller", "position": "Analyst" }, { "description": "MoffettNathanson -- Analyst", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Tsin Huang -- JPMorgan Chase and Company", "name": "Tien", "position": "Other" }, { "description": "Evercore ISI -- Analyst", "name": "David Togut", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Bryan Keane", "position": "Analyst" }, { "description": "Assal -- Barclays -- Analyst", "name": "Ramsey El", "position": "Analyst" }, { "description": "Mizuho Securities -- Analyst", "name": "Dan Dolev", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Andrew Jeffrey", "position": "Analyst" }, { "description": "Cowen and Company -- Analyst", "name": "George Mihalos", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Jason Kupferberg", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good day, and thank you for standing by. Welcome to the first quarter 2022 Mastercard earnings conference call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions] I would now like to hand the conference over to your speaker today, Mr.", "Warren Kneeshaw, head of investor relations. Please go ahead." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Jemiria. Good morning, everyone, and thank you for joining us for our first quarter 2022 earnings call. With me today are Michael Miebach, our chief executive officer; and Sachin Mehra, our chief financial officer. Following comments from Michael and Sachin, the operator will announce your opportunity to get into the queue for the Q&A session.", "It is only then that the queue will open for questions. You can access our earnings release, supplemental performance data and the slide deck that accompany this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a non-GAAP currency-neutral basis unless otherwise noted.", "Both the release and the slide deck include reconciliations of non-GAAP measures to GAAP reported amounts. Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of the earnings release and in our recent SEC filings.", "A replay of this call will be posted on our website for 30 days. With that, I will now turn the call over to our chief executive officer, Michael Miebach." ] }, { "name": "Michael Miebach", "speech": [ "Thank you, Warren. Good morning, everyone. Russia's invasion of Ukraine marked a somber start to 2022 as war returned to Europe for the first time in decades. Given these extraordinary circumstances, we decided to suspend our business operations in Russia.", "We did not take this decision lightly given that Mastercard has operated in Russia for more than 25 years. We are now focused on the orderly suspension of business operations in Russia and supporting the well-being of our employees and their families across the whole region. Even in the context of this challenging geopolitical environment, we're off to a strong start in 2022. We delivered robust revenue and earnings growth with further improvement in our underlying operating metrics, notably in cross-border travel.", "Quarter 1 adjusted net revenues were up 27% and adjusted operating income up 40% versus a year ago on a non-GAAP currency-neutral basis. On the macroeconomic front, consumer spending remains strong, particularly as economies across the globe continue to reopen and pandemic-related restrictions are lifted. Labor markets are firm with low unemployment rates and rising wages. Weighing against this healthy backdrop are a number of factors that they are monitoring, including inflationary pressures, supply chain constraints, geopolitical uncertainties and COVID with infection rates.", "We're monitoring these developments, including the Cisco, monetary, public healthcare and other policy responses. Let's look at this from a geographic standpoint. U.S. retail spending remains healthy, aided in part by the buildup of excess savings during the pandemic.", "According to our Quarter 1 spending pulse report, which is based on all payment types, including cash and check, U.S. retail sales ex auto, ex gas, were up 4.7% versus a year ago. In Europe, spending trends are positive, although the invasion of Ukraine has introduced risks to economic growth looking ahead. Growth in Latin America continues to moderate following a strong rebound in 2021.", "Asia has generally lagged the recovery of other regions. We're seeing several countries relaxing COVID-related restrictions, while others are facing stronger measures. Asia continues to have significant upside potential. Looking at Mastercard spending trends.", "We continue to see strong growth. Domestic switched volumes or strength across a broad range of sectors, including retail, utilities and professional spend. We also saw strong growth in travel and entertainment, including spending with airlines, travel agencies, lodging and restaurants. In terms of cross-border, where the growth was particularly strong, the recovery continued this quarter led by travel.", "Cross-border travel reached 2019 levels as of March for the first time since the pandemic began. Geographically, the cross-border recovery has been broad-based with improvement across all regions. Cross-border card-not-present ex travel continues to be strong. Our strategy is designed to enable and capitalize on these trends and we're executing against our three key strategic priorities: one, expanding in payments; two, extending our services; and three, embracing new networks.", "Here is an update on how we're progressing against each of those. First, we're expanding in payments by continuing to grow card payments and leaning into innovation and new payment technologies to catch up other prioritized payment flows. We're driving growth in comp payments through new consumer, small business, co-brand and fintech wins. On the consumer and small business front, I'm excited to announce an enhanced partnership with Wells Fargo, which includes several new elements.", "Wells Fargo will now issue Mastercard small business credit cards and for the first time in almost a decade, consumer proprietary and co-brand credit products. We're also excited to announce that we have deepened our relationship with our long-standing partner, Capital One. In addition to renewing our existing business, we will also be their issuing network for a larger number of new originations across both their consumer and small business products. Further on the small business front, we are expanding our small business portfolio with First National Bank of Omaha.", "We're also partnering with the bank and Verizon to launch a new Verizon business Mastercard targeting Verizon's small business customers. In total, these partnerships will help us continue growing our U.S. small business market share. Outside the U.S., we're driving commercial card growth through new partnerships with leading B2B tech companies like Clara.", "We will be flipping Clara's business portfolio in Mexico to MasterCard and are working for them to launch new programs in five additional markets across Latin America. Turning to co-brands. We've made substantial progress to ensure we are well-positioned to capitalize on the return of travel. We have renewed and expanded our exclusive partnership with American Airlines, one of the largest co-brand programs in the United States.", "American will continue to leverage our capabilities, including SessionM and will participate in our star-powered program to identify new tech partners who can help drive innovation across the airline. And in the U.K., we have launched two new Mastercard Avios cards with Barclays and International Airlines Group, Loyalty. Outside of travel, we've expanded our relationships with leading retailers, including a new co-brand program with Victoria's Secret and a renewal of our Ulta Beauty co-brand offering, both in partnership with Red Financial. We're also continuing to advance our leadership in the digital and fintech space through new product launches and new partnerships.", "We're partnering with BCA Digital, the digital banking arm of the largest private bank in Indonesia, to launch a digital-first Mastercard debit product catering to millennials. And in Latin America, we signed a regional partnership with global payment processing platform, Galileo. The partnership establishes Mastercard as Galileo's preferred partner across several markets in Latin America, and they will work to integrate and distribute several of our products and services to help their fintech customers. In addition to driving new wins, we are leveraging our services capabilities to execute against many of the large portfolio migrations that are in flight.", "In Europe, our consulting teams are engaging with our partners at Santander, NatWest and Deutsche Bank to ensure a smooth and timely transition and to identify opportunities to optimize those portfolios. Santander is the bulk of the way through a 9 million card migration and we expect it to be complete by early next year, while NatWest commenced the issuance of Mastercard at the end of last year and plans to migrate their entire 16 million card portfolio by the middle of 2023. Deutsche Bank's $10 million consumer and commercial credit and debit cards will be reissued as Mastercard-branded cards with a credit migration starting in Quarter 4 of this year and a debit migration commencing early next year. Similarly, our team in the U.S.", "is supporting key migrations, including Gap Inc., Merrick Bank and First Interstate Bank. All the migrations are on track with Gap Inc.'s scheduled to be completed this summer. We're also expanding in payments by leaning into payments innovation in areas like installments and cryptocurrencies. Here are a few examples.", "Our open-LEAF Mastercard installments program has been very well received and is progressing according to plan. Remember, Mastercard installment is built into our network, making by Buy Now Pay Later available to millions of consumers and merchants worldwide. We continue to add a wide array of new lender and fintech partners, including Amount, Deserve, i2c, Lithic and Sutton Bank. In this quarter, we announced several merchant partners who are excited to support Mastercard installments, including Bass Pro Shops and Cabela's, H&R Block, Saks Fifth Avenue and Walgreens.", "U.S. customers will begin offering Mastercard installments to consumers this quarter, and international expansion is planned for later this year. And we continue to build solutions to support the crypto economy with a principled approach focused on three key areas. First, helping consumers easily and safely purchase cryptocurrencies and NFTs.", "In addition, we are enabling consumers to spend their crypto holdings on card and cashing out their crypto wallets via Mastercard Send. Second, providing identity, cyber and consulting services for market participants, including engaging with central banks as they design and develop central bank digital currencies. Third, preparing our core network to directly support digital currencies. Making substantial progress in each of these areas.", "This quarter, the Gemini Mastercard, which offers crypto rewards went live across the U.S. We're also fond of its Nexo to launch a new crypto card in Europe, one that uses consumers' digital assets as collateral to back their credit line. And we established several other international Crypto Card partnerships, including banks in Europe, and Abra, Invesco and Belo in Latin America. On the crypto services front, MercadoLibre will be leveraging CipherTrace's AI and cyber capabilities to bring security and trust to their digital wallet in Brazil.", "Now turning to our second strategic priority, services. As I've noted before, our services support can differentiate our core products and have played a critical role, enabling many of the wins I mentioned. We also continue to extend our services across multiple growth vectors through new payment platform capabilities, new verticals and new use cases. Here are a few examples.", "First, earlier this month, we completed our acquisition of Dynamic Yield. Now that the transaction is closed, we will combine Dynamic Yield personalization platform and decision engine within our SessionM loyalty platform and our test-and-learn experimentation software. The result will be a truly differentiated consumer engagement and loyalty hub for our customers. Second, we announced that we're expanding our consulting services into three new practices dedicated to Open Banking and Open Data, crypto and digital currencies and ESG.", "We've seen increased customer demand and a growing portfolio of successful engagements in these areas. For example, we are supporting Handelsbanken and Intesa Sanpaolo design programs that advance their ESG priorities. We're helping Wirex explore innovations in crypto. And finally, we're expanding the breadth of our customer base and deploying our capabilities to solve for a wider range of use cases.", "For example, we deployed our test and learn capabilities to help tailored brands optimize retail operations and improve marketing efficiency for the leading menswear brands. And we deployed our fintech capabilities with Santander in Spain to help streamline dispute resolutions and improve the customer experience. Beyond expanding in payments and extending in services, our third key priority area is embracing new networks. Our current focus is on two areas: Open Banking and Digital Identity.", "Our Open Banking and multi-rail strategies are converging, enabling us to leverage our unique set of assets to address new flows in verticals like rent payments. For rent payments, the risk of ACH returns due to insufficient funds is a significant pain point in both renters and landlords. To address this challenge. We're launching a new suite of smart payment decisioning tools.", "These solutions use Finicity's open banking capabilities to recommend the optimal payment day and payment rail for each transaction based on cost, speed and risk. The Bill Payment Alliance, a collection of more than 2 million rental homes will be one of the first fintech partners to launch these capabilities. And we plan to expand these solutions across a broad range of bill payment verticals. In addition, we continue to extend our open banking reach with Finicity and Aiia by penetrating new verticals and establishing new partnerships.", "We continue to enhance our capabilities at the mortgage vertical and are now expanding into the auto lending vertical. We're leading the way in terms of provisioning permission-based income, employment and asset verification information, and we've partnered with Stripe, who will be using our open banking capabilities for a variety of use cases. We're also extending our open banking reach through data access agreements with partners like Fiserv, which will enable direct API connectivity to thousands of FIs in the United States. In the Digital Identity space, in contrast, continued its strong performance in Quarter 1, securing deals with financial services companies, including Moneyline and several leading Buy Now Pay Later providers.", "In addition, we recently joined forces with Microsoft on a collaboration to improve digital transaction approval rates and reduce fraud. The solution enables issuers to optimize authorization decisions using network and merchant-specific authentication data. Combined, open banking and digital identity extend our value before and after the payment transaction and into new digital transactions. These are attractive and growing opportunities, and we are uniquely positioned to be successful in both.", "In summary, our business fundamentals remain strong, and we delivered robust revenue and earnings growth again this quarter, which also reflects our disciplined approach to expense management. We're executing against our strategic priorities, notably expanding our share with key issuers. In addition, we've worked hard to expand our travel-oriented portfolios which positions us well to capitalize on a strong recovery in cross-border travel. And last but not least, we want to reflect on what is most important.", "The safety and well-being of our employees and their families who have been impacted by the war. Our thoughts are with them and the people of Ukraine. Sachin, over to you." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Michael. Turning to Page 3, which shows our financial performance for the quarter on a currency-neutral basis, excluding special items and the impact of gains and losses on our equity investments. Net revenue was up 27%, reflecting the continued execution of our strategy and the ongoing recovery in spending. Acquisitions contributed 2 ppt to this group.", "These revenues were above expectation, primarily due to stronger-than-expected cross-border and domestic volumes, favorable cross-border mix and FX-related revenues. Operating expenses increased 13%, including a 6 ppt increase from acquisitions. Operating income was up 40%, which includes a 1 ppt decrease related to acquisitions. Net income was up 61%, which includes a 20 ppt benefit due to the recognition of a one-time discrete tax benefit related to a U.S.", "tax regulation published in the current period and a 1 ppt decrease from acquisitions. EPS was up 65% year over year to $2.76, which includes a $0.36 contribution from the one-time discrete tax benefit and a $0.05 contribution from share repurchases. During the quarter, we repurchased $2.4 billion worth of stock and an additional $599 million through April 25, 2022. So let's turn to Page 4, where you can see the operational metrics for the first quarter.", "Worldwide gross dollar volume or GDV increased by 17% year over year on a local currency basis. Of note, data related to sanctioned Russian banks was not reported to us and hence, such amounts are not included in Q1 2022. In the U.S., GDV increased by 14% with credit growth of 31% and debit growth of 1%, reflecting the recovery of credit spending on travel and the lapping of stimulus. Outside of the U.S.", "volume increased 19% with credit growth of 20% and debit growth of 18%. Cross-border volume was up 53% globally for the quarter with intra-Europe cross-border volumes up 50% and other cross-border volumes up 56%, reflecting continued improvement in travel-related cross-border. For the first time since the onset of the pandemic, cross-border volume was above 2019 levels for all regions and cross-border travel was above 2019 levels for the first time in March. Turning now to Page 5.", "Switched transactions grew 22% year over year in Q1 and were at 150% of 2019 levels. Card-present and card-not-present growth rates remain strong. Card-present growth was aided in part by increases in contactless penetration in several regions. With respect to card counts, as a result of the suspension of our business operations in Russia, cards issued by Russian banks are no longer active on our network and are therefore excluded from our card counts this quarter.", "Accordingly, card growth was lower at 4% this quarter. If you exclude Russian-issued cards from current and prior years, card growth would have been 9%. Globally, there are 2.9 billion Mastercard and Maestro-branded cards issued. Now let's look to Page 6 with our highlights on the revenue line items, again described on a currency-neutral basis, excluding special items, unless otherwise noted.", "The increase in net revenue of 27% was primarily driven by domestic and cross-border transaction and volume growth as well as growth in services, partially offset by growth in rebates and incentives. Acquisitions contributed approximately 2 ppt to this growth. I'd also like to point out that in the first quarter, the suspension of business operations in Russia had a minimal impact to the overall growth rate of the company as the loss of volume was offset by a one-time benefit of lower rebates and incentives due to the absence of a customer incentive agreement renewal in Russia. Looking quickly at the individual revenue line items.", "Domestic assessments were up 21%, while worldwide GDV grew 17%. The 4 ppt difference is primarily due to unreported volumes from Russian-related sanction customers and a favorable mix. Cross-border volume fees increased 57%, while cross-border volumes increased 53%, both ahead of expectations. The full ppt difference is primarily due to favorable mix as higher-yielding ex intra-Europe cross-border volumes grew faster than intra-Europe cross-border volumes this quarter.", "Transaction processing fees were up 27%, while switched transactions grew 22%. The 5 ppt difference is primarily due to favorable cross-border mix and FX-related revenues. Other revenues were up 20%, including a 7 ppt contribution from acquisitions. The remaining growth was driven by our Cyber & Intelligence and Data & Services solutions.", "Finally, rebates and incentives were up 30%, reflecting the strong growth in volumes and transactions and new and renewed deal activity. As a percentage of gross revenues, rebates and incentives were lower than expected primarily due to the absence of a planned customer incentive agreement renewal in Russia, a higher mix of cross-border revenues and the timing of new internode deals. Moving to Page 7. You can see that on a currency-neutral basis, total operating expenses increased 13%, including a 6 ppt impact from acquisitions.", "Excluding acquisitions, operating expenses grew 7%, primarily due to increased spending on advertising and marketing, higher personnel costs to support the continued investment in our strategic initiatives and increased data processing costs. Turning to Page 8. Let's discuss the operating metrics for the first three weeks of April. For your reference to help you understand the trends in the business ex Russia, we have included an appendix later in this deck to show all the data points from the schedule if you excluded activity from Russian-issued cards from current and prior periods.", "Going through the metrics in turn. Starting with switched volumes. For the first three weeks of April, we grew 23% year over year, down 4 ppt versus Q1, primarily due to the cessation of activities in Russia. If you exclude Russia-related volumes from the current and prior periods, switched volumes grew 27%, down 1 ppt versus Q1.", "Switched transactions grew 14% year-over-year through the first three weeks of April, down 8 ppt from Q1, again, driven primarily by the absence of Russia-related transactions. Of note, Russia has a relatively low average ticket size, which results in a larger relative impact to this metric. If you exclude Russia-related transactions from the current and prior periods, switched transactions grew by 25% year over year, up 1 ppt versus Q1. Overall, cross-border volumes through the first 3 weeks of April grew 60% year over year, up 7 ppt versus Q1.", "Excluding Russia from the current and prior periods, cross-border volumes through the same period grew 65% year over year, up 13 ppt versus Q1. Since the end of January, cross-border travel has rebounded quickly as border restrictions continue to be lifted and we distance ourselves from Omicron. In the first three weeks of April, cross-border travel was up 179% year over year, up 38 ppt versus Q1. Cross-border card-not-present, excluding travel, was up 5% year over year in April, a decrease of 8 ppt compared to Q1, reflecting in part the lapping of a strong comparable period a year ago.", "One point to emphasize is cross-border travel is now above pre-pandemic levels at 110% of 2019 levels. Turning to Page 9. I want to share our thoughts on the remainder of 2022. Let me start by saying that our business fundamentals remain strong as we continue to grow our customer relationships and expand our product and service offerings.", "As Michael mentioned, consumer spending remains robust, particularly as economies open further and pandemic-related restrictions are lifted. Having said this, we are monitoring a number of factors, including inflationary pressures, supply chain constraints, geopolitical uncertainties and COVID infection rates. At this stage, we have not seen any significant impact of these in consumer spending. Cross-border travel is recovering rapidly as border restrictions ease.", "This is occurring faster than our earlier expectations. We are well-positioned to capitalize on this growth with our travel-oriented portfolios. Weighing against these positive trends are the impacts of the war in Ukraine and the suspension of our business operations in Russia. So now taking all of this into account, we continue to expect net revenues for full year 2022 to grow at the high end of a high teens rate on a currency-neutral basis, excluding acquisitions and special items.", "So essentially, we are maintaining our growth expectations in the same range as the strong cross-border travel recovery and strength in consumer spending helped mitigate the loss of sizable revenues in Russia and Ukraine. Acquisitions are forecasted to add about 1 ppt to this growth, while foreign exchange is expected to be a headwind of 3 to 4 ppt for the year, primarily due to the strengthening of the U.S. dollar relative to the euro. In terms of operating expenses, we are reducing our forecast for the year to reflect cost savings related to Russia.", "All year, we expect operating expenses to grow at a high single-digit rate on a currency-neutral basis, excluding acquisitions and special items. Acquisitions are forecast to add about 4 to 5 ppt to this growth, while foreign exchange is expected to be a tailwind of approximately 2 to 3 ppt for the year. With respect to the second quarter, year-over-year net revenue is expected to grow at the high end of a high teens rate, again, on a currency-neutral basis, excluding acquisitions. This reflects closely strong consumer spending, including continued improvement in cross-border travel spending relative to 2019; secondly, the discontinuation of revenues from Russia and a sequential reduction in revenues related to Ukraine; and finally, the lapping of a strong year and a good quarter that was aided by fiscal stimulus and the easing of pandemic-related restrictions as vaccination programs rolled out.", "Acquisitions are forecast to add about 1 ppt to this growth, while foreign exchange is expected to be a headwind of approximately 5 to 6 ppt for the quarter. From an operating expense standpoint, we expect Q2 operating expenses to grow at a high single-digit rate versus a year ago on a currency-neutral basis, excluding acquisitions and special items. Acquisitions are forecast to add about 4 to 5 ppt to this growth, including the acquisition of Dynamic Yield, which we are pleased to have just closed. Foreign exchange is expected to be a tailwind of approximately 3 to 4 ppt for the quarter.", "Other items to keep in mind, on the other income and expense line, we are at an expense run rate of approximately $115 million per quarter, given the prevailing interest rates and our recent debt issuance. This excludes gains and losses on our equity investments, which are excluded from our non-GAAP metrics. And finally, we expect a tax rate of approximately 18% to 19% for each of the remaining quarters of the fiscal year based on the current geographic mix of our business. Before closing out, I want to briefly comment on our three-year performance objectives for 2022 to 2024.", "Clearly, the elimination of Russia-related revenues and the reduction of those from Ukraine create a headwind to achieving these objectives. If this would continue, it would result in a headwind of approximately 2 ppt to our net revenue CAGR. Having said this, we are off to a strong start in 2022 with the recovery of cross-border travel ahead of expectations, as I previously mentioned. We remain focused on building long-term sustainable growth for the company.", "And net-net, it is really too early to adjust our three-year performance objectives as we work to offset some or all of these headwinds. And with that, I will turn the call back over to Warren." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Sachin. Jemiria, we are now ready for the question-and-answer session." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Your first question will come from the line of Sanjay Sakhrani with KBW. Please proceed with your questions." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Good morning. I've got a question on inflation. I know the data suggests the consumer remains in good shape as we look across trends in the vertical as such.", "Are you seeing anything that sort of is seeing some kind of negative impact on consumer spending patterns as a result of inflation? I know we heard some comments on e-commerce. Maybe you could talk about that." ] }, { "name": "Michael Miebach", "speech": [ "Sanjay, thanks for your question. So on the inflation side, as Sachin mentioned earlier, we have not seen anything yet in terms of changing consumer spending behaviors. But what we are seeing is in terms of the impact on vertical mix and so forth, there has been a 1% increase in our switched volume that's related to gas price increases. We're seeing some shifts in the airline.", "That is again under an inflationary pressure there from ticket prices perspective. So we have to see where it goes going forward. I mean fundamentally, where I stand on this is the push by consumers into the digital space. They learn these habits, they're online.", "All that will continue. And we'll see where the underlying prices go. In the end, it comes back to what we've been saying all along. There's macro considerations in each country.", "That has to be considered here. One's monetary fiscal policy and then there is the micro aspects of the different verticals, which ones of those are carded, which ones we would see, which ones we wouldn't see. Could there be a crowding-out effect of rents or gas prices, particularly in Europe? Yes, there might be, but that's not something we can tell yet." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Harshita Rawat with Bernstein. Please proceed with your question." ] }, { "name": "Harshita Rawat", "speech": [ "Hi. Good morning. Michael, Sachin, I want to ask about cross-border travel, very strong recovery here. Is there a scenario where even if, let's say, China or other parts of Asia don't come back meaningfully, you can still kind of get back to this, like, normalized 30% to 40% kind of levels, above 2019, which is the kind of its run rate pre-pandemic because there's so much pent-up demand? Or does Asia and China need to come back for the next leveling of the cross-border recovery? And, Sachin, just a follow-up for you.", "Can you just talk about the sensitivity of your revenue guidance should macro consumer spend, like, to degenerate from here?" ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Harshita. So first, on your question on cross-border, you're absolutely right. Cross-border travel has actually come back stronger than our expectations, and there continues to be pent-up demand. And we -- in terms of how we're thinking about our guidance, we've kind of built in that improving recovery in cross-border travel on a going-forward basis as well.", "So I just want to kind of get that out there. But to give you a little bit more color, right, on cross-border. So cross-border volumes are above 2019 levels across all regions for the first time. I would tell you that the top 20 destinations, which represented approximately 70% of our total cross-border travel pre-pandemic, and we're at 70% of 2019 levels when we discussed this at our Investor Community Meeting, are now at 85% in Q1 of 2022.", "Specifically, on your question around Asia Pacific, I think it's important to note that Asia Pacific has been slower to recover. The Asia Pacific opportunity as I see is as follows: Asia Pacific represented approximately 15% of total inbound cross-border travel volumes pre-pandemic, and we're at 40% of our 2019 levels in Q1. So as you can see from this number, right, that there is a fair amount of recovery still remaining to come from Asia Pacific. Obviously, it does matter in terms of how restrictions are lifted in that market.", "Again, the point is at the end of the day, cross-border fundamentally is still very sound. This is something we've been talking about right through the pandemic where we felt like when restrictions are eased, volumes in cross-border will come back. We've seen that happen, and we continue to believe fundamentally that, that remains very much in place. On EV, in particular.", "A couple of thoughts in China. One, the -- both China -- both from an inbound and an outbound standpoint were not a very significant portion of our cross-border volumes prepandemic. In fact, I would argue that the outbound China was slightly higher than the inbound China. So when you think about recovery, you've also got to think about what restrictions are there in terms of people going into countries versus people coming out of countries.", "And I would tell you, outbound China has shown better improvement than inbound China for obvious reasons, as we all know, that there have been lockdowns in China and things of that sort. So net-net, as I said back, and I think about this, I think about the fundamentals of cross-border being strong. I think about the potential for pent-up demand continue to contribute to improvements in cross-border travel spend. And again, the volume in the Pacific region still remains a fairly large opportunity on a going-forward basis." ] }, { "name": "Michael Miebach", "speech": [ "Yes. If I can just build on that, we love cross-border. But while we love the trends, it's a lot of hard work. And over the last two years, I mean, the travel industry was hard hit from the outset of the pandemic.", "We have leaned in. And As I recall, over the last two years, JetBlue, Cathay Pacific, British Airways, LATAM, Aeroplan, Air Canada, you name it, it's a long list of where we have either expanded, renewed one additional volume. So we're participating in the trend in a very significant way. And we've always said it's going to happen this year, and we're ready for that." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Rayna Kumar with UBS. Please proceed with your question." ] }, { "name": "Rayna Kumar", "speech": [ "Good morning. Thanks for taking my question. It was really good to see the strong operating margin expansion in the quarter, 460 basis points. Can you discuss some of the underlying drivers outside of the return of cross-border and how sustainable you believe in upper 50% operating margin as going forward?" ] }, { "name": "Sachin Mehra", "speech": [ "Yes, Rayna. I'm happy to take that question. So look, I mean, at the end of the day, you know that the business, as we have, is a high operating leverage business, right? At the end of the day, incremental dollars of revenue typically flow to the bottom line, just given the nature of how we operate. So certainly, cross-border recovery is playing into the recovery in operating margins, but it's not just about cross-border.", "It's about, overall, strong consumer spending and cross-border travel recovery, all of which is contributing to the delivery of improved operating margins. Helping that even further is the renewed strength in our services and everything we're doing along those parts. So it's everything which we are doing in terms of driving the fundamentals of our business back to the strategic priorities Michael was talking about, which is growing our payments, keeping on leaning in on services and then continuing to invest in the new network space, which is really, really important. So all of those factors are contributing factors to the expanding operating margins that you're seeing come through.", "The message I'd like to leave you with on this is the following: We continue to run the business for long-term sustainable growth, which means, effectively, that we're going to continue to invest in a disciplined manner to ensure that we are creating the right opportunities for ourselves to deliver this long-term top-line growth. And while we do that, you should see the impact of that come through in terms of operating margins." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Darrin Peller with Wolfe Research. Please proceed with your question." ] }, { "name": "Darrin Peller", "speech": [ "Hey. Thanks, guys. When we look at the types of opportunities on cross-border that you're seeing right now, you clearly are positioned, as you said before, to take advantage of this upswing in travel. And historically, it's been very high pass-through without rebates and incentives having a cyber correlation.", "So first of all, just to be clear, I mean, should we still expect that to be the case? Or is there anything around the new business -- the relationships that Michael, you mentioned earlier, that would cause that growth yield, I guess, we can say, or net yield to be a little bit different going forward on this type of big pickup in resumption and spending on travel. And then, Michael, just more strategically, when we think about that, that industry in terms of cross-border payments. There's been so much change. And even you guys are trying to work through opportunities for more A-to-A and open banking opportunities across globally.", "And so does that change the ecosystem at all? Or is card-based really how you expect to see cross-border players stay really dominant for payments cross-border over time?" ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Darrin. I'll take the first part and then Michael will kind of address your second question. I guess the headline is the following, which is we're not seeing anything fundamentally changed in terms of the profile of our cross-border revenues. I mean net-net, things are going to move around depending on how much cross-border comes from intra-Europe versus volumes from outside of that intra-Europe corridor because as you know, intra-Europe is lower yielding and then other cross-border volumes are higher yielding.", "But fundamentally, I would tell you not much has changed. I will make one point. You talked about rebates and incentives not being there with cross-border. I would say that there's a lower indexation of rebates and incentives to cross-border.", "There's always been some level of rebates and incentives, which have been associated with cross-border, and not nearly as high as what's there in the domestic volume environment. But we're not seeing fundamentally much change in that regard." ] }, { "name": "Michael Miebach", "speech": [ "Right. And strategically, so Darrin, here's what I'd say is similar lens that we took at Investor Day where we looked at different universes and different use cases. You got it at the P2M world where a card is well established domestically, but also certainly cross-border. The industry, and we, very specifically with our services propositions, have found a way to ensure that the risks associated with these cross-border transactions for merchants and for consumers are addressed.", "So the conversion rates and the approval rates have continuously increased. And there's a lot of value brought. So there isn't much of a problem to be resolved to payment for -- payments for goods on a cross-border basis. Now where we're actively looking at -- it tends to participate in all relevant payment flows.", "We're saying what other payment volumes happening cross-border that we can contribute, too, with our technology, through our franchise and so forth. And here, the whole space of import-export, cross-border and accounts payable. That's a space where account-to-account solutions make sense for us, the whole -- we have specifically called out for you at the Investor Day, the focus on remittances. Again, that's a significant opportunity for us.", "That's all additive and expensive from a target market perspective, from an opportunity perspective. Attractive growing opportunities. We have the technology on the cross-border remittances side, our Transfast acquisition, our buyout on the HomeSend side, all of that is coming together. It's a 100 country reach.", "So I think what we're bringing here is the multilateral network idea into this space that has been historically inefficient. So I look at it as a growth opportunity, while we're going to continue to power the cost side of the house." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Lisa Ellis with MoffettNathanson. Please proceed with your question." ] }, { "name": "Lisa Ellis", "speech": [ "Terrific. Thank you. I was hoping to shine a spotlight on LatAm, specifically Brazil. Just taking a peak of the supplementals, Mastercard's volumes are up 40% to 50% in that region.", "But Brazil's also a market where you've got a local network like PIX gaining a lot of traction. Can you just use that as an example to talk a bit about how Mastercard coexist in a market like that with one of these domestic networks and is a player like PIX actually a customer or a potential customer of some of your open banking or fraud or identity services?" ] }, { "name": "Michael Miebach", "speech": [ "All right. So let me take that. So first of all, Brazil has been a market in focus, strategically important market for us for years. We're very well established on with the large banks out there, Itau and others to mention.", "So I'm actually seeing the Brazilian country manager right after this call. So it's very much in focus. We're very happy with what's going on there. Overall, it's a market that drives a lot of innovation.", "Buy Now Pay Later has been a thing in Brazil forever. Open banking is on the rise. Real-time payments is on the rise. So a lot of movement there.", "And the P2P network that's been introduced by the Central Bank in the Brazil market is another push to further digitization in that market. So the whole digitization in Brazil is really seeing great momentum, and we're leaning right into that. Now the kind of flow that PIX is going after, you see a lot of P2P flows and some B2B flows so that's not necessarily anything that we're particularly worried about, but it's also the kind of flows, as part of our multi-rail strategy, that we like to support ourselves and we have a whole set of technologies for that. WhatsApp page, just to point one out, which is a -- been first live in Brazil itself is set a market with innovation and a lot of momentum there.", "So here's our technology powering a social network as an alternative, which is an easy user experience, great adoption, 4.7 million users already on that platform. So I look at it as a market that's a lot to learn from, a market that we invest in. And where we chart past for the new additional flows beyond card flows very -- with specific local solutions considering the size of the market." ] }, { "name": "Sachin Mehra", "speech": [ "And I'll just add, Michael, a couple of thoughts on Brazil. One, you asked the question about the strong growth. Clearly, the -- it's a combination of the macro environment, but it's also the fact that we've been leaning in pretty heavily with our traditional issuers as well as our fintech partners in that space, which has been part of the reason why we've been seeing some of that growth come through in a decent manner, Lisa. The second point I'd make, tying back to Michael's comments around PIX.", "The market has to be bifurcated in the context of both debit and credit. And on the credit side, we continue to see tremendous growth. PIX, which Michael said, is primarily catering to P2P and B2B flows, even if it were to actually proliferate a little bit into, call it, the smaller merchants from a P2M standpoint. We'll primarily be focused around the debit side of the equation.", "And so credit still remains the mainstay for us in Brazil as it stands." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Tien-Tsin Huang with JPMorgan. Please proceed with your question." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Thank you very much. Good morning. I wanted to check in on the, call it, balance of trade and this whole card volume coming in and out from wins and losses migrating. Given the update, I know you mentioned Wells and of course, Santander, NatWest and Deutsche Bank, are you gaining share when all is said and done? I'm just trying to get a better sense, especially in the short term with all the migrations in and out, where you stand in the share gain." ] }, { "name": "Sachin Mehra", "speech": [ "Thanks, Tien-Tsin. So everything we kind of talked about and Michael talked about earlier on in this conversation was about our expanding relationships with these issuers. And so with these issuers, we are gaining share. That's kind of the reality of the situation.", "Again, there are puts and takes in the market, right? So as I think about the new relationship, well, I should say new relationship, the expanded relationship we have with Wells, right, that's an increasing share position with Wells which is taking place, for example, there. So the bottom line is the following, which is whether it's Wells, Capital One, what we're doing with Santander, NatWest, Deutsche, you name it, The Gap portfolio, all of these incrementally are helping us drive our volumes. From a holistic market standpoint, again, like I said, there are puts and takes, right? But we're very, very optimistic about how we are seeing business translate for us. And as we mentioned at the Investor Community Day, we are growing market share across all regions and the market share growth, which we've seen in 16 of our top 20 markets, which is something we shared with you at the Investor Community Day is really the data points we put out so far." ] }, { "name": "Michael Miebach", "speech": [ "And Tien-Tsin, I should add, I'm very happy to ask the question. I thought these news was just going to pass by with none of you asking about it, so it's much appreciated." ] }, { "name": "Operator", "speech": [ "Next question will come from the line of David Togut with Evercore ISI. Please proceed with your question." ] }, { "name": "David Togut", "speech": [ "Thank you very much. Cross-border card-not-present ex travel growth was solid in Q1, but did slow throughout the quarter and into April against known very difficult comparisons. Can you unpack cross-border card-not-present ex travel growth by geography, especially in Europe and U.S. and how you see this playing out throughout this year, especially with the return of the consumer, the physical point of sale as vaccination rates go up? In other words, do you see a reacceleration of e-com later this year? Or do you think the consumer is going to be more active at kind of physical bricks-and-mortar locations?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure, David. So I think you're touching upon a couple of things which are there on that card-not-present ex travel. The reality is, as cross-border travel comes back, you do see some give-back in terms of cross-border card not travel -- card-not-present ex travel. That's a mouthful.", "So the point is, at the end of the day, right, there are a few factors you got to take into consideration when you're thinking about future growth rates for cross-border card-not-present ex travel. Number one, what's the pace of recovery on cross-border travel is going to be? Number two, what the prior year comps were on cross-border card-not-present ex travel? Because remember, these growth rates are all influenced by prior comps as well. And what was happening in the fluid environment last year, which might have caused what elevated levels of cross-border card-not-present ex travel. And number three, you do see fluctuations come in that number through as a result of crypto and crypto volumes, right? And so these three factors are kind of things you've got to take into consideration.", "The point as an up level is the following, which is the consumer continues to spend in an omnichannel manner. When they can get out and spend in a physical environment, they do that. When they can spend in a card-not-present environment, they do that. We are ready to support them in both manners, whether it's through our omnichannel capabilities that we're offering our merchants.", "And the strength which we're seeing in card-not-present ex travel, from a cross-border standpoint, is something we expect that strength to actually stay going forward as well. There might be puts and takes for all the reasons I just mentioned, but largely, I think consumer behavior has changed in a manner where they've gone more digital, and you're going to see some strength come throughout there." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Bryan Keane with Deutsche Bank. Please proceed with your question." ] }, { "name": "Bryan Keane", "speech": [ "Hi. Good morning. Just a couple of quick clarifications. On the Russia, Ukraine, I heard the 2 points to net revenue targets to the performance objectives, '22 to '24.", "Could you help us clarify the revenue and expense impact for the going forward quarters like the second quarter, third and fourth this year? Just trying to quantify that. And then the second question is just what level of cross-border recovery are you assuming in the guidance for '22?" ] }, { "name": "Sachin Mehra", "speech": [ "Sure, Bryan. So first, I'll take your question on Russia and what we're assuming. So we have suspended operations in Russia. As a result of which, we're not earning any revenues related to Russian-issued cards.", "So as it relates to revenue for the rest of the year, we had mentioned that we put out an AP about how Russia represented roughly 4% of our revenues in 2021. And so we've assumed that, that 4% doesn't exist in any of the quarters going forward from a net revenue standpoint, right? Point number two. And again, like I said in my prepared remarks, there's some level of headwind which we're assuming in Ukraine as well. But the reality is that's a little bit of an uncertainty just because we're not entirely sure as to how the -- this -- the war in Ukraine evolves and what the implications of that are.", "So we built in some assumptions and that's what we've kind of given you in our overall thoughts. From an expense standpoint, the Russia-related expenses represented roughly 2% of our operating expenses. And again, from an opex growth standpoint, kind of that's the way we think about it. As I mentioned, we have taken down, when we've shared with you our thoughts for full year 2022, we have taken down our opex growth rate on the next acquisition, currency-neutral basis, to reflect that very impact from a Russia standpoint." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Ramsey El-Assal with Barclays. Please proceed with your question." ] }, { "name": "Ramsey El-Assal", "speech": [ "Hi. Thank you for taking my question this morning. I was wondering if you could give us your latest view on what the kind of longer-term post-pandemic payment mix looks like for Mastercard. This is related to a prior question about how consumers might have changed their behaviors during the pandemic.", "Do you see a different longer-term mix of debit versus credit or any associated impacts to P&Ls or yields or anything that we should consider as we model out in the long term." ] }, { "name": "Michael Miebach", "speech": [ "Right. Ramsey, let me start off on that. So the structural changes that we are seeing, that we've been observing with our regular consumer engagement surveys over the last two years and that have transpired with our customers as well is less cash and checks, number one; anything digital more of, number two. The whole -- this whole notion though has changed in the consumers' mind.", "A couple of things going on. First is consumers are really ready to move on with the pandemic. They want to go out there. They knock off their bucket list.", "They want -- pent-up demand. So there's a lot increased spending back into services. So it's not a structural feature of the years to come that it's all in goods. It's going to go back to services, and it's going to balance out.", "It's also not going to be only online as Sachin just said, it's going to balance out across multichannel: buy in-store, pickup, have delivered, do it the other way around, whatever works. I think consumers will go for more choices and that comes right down through our multi-rail strategy to enable basically all relevant choices that are out there. I think that's the right positioning. That's what we're going to see going forward.", "In terms of debit and credit, if you kind of get a little more granular over here. There was a period in the early parts of the crisis, people will not want to spend on credit if they can avoid it, more control around their finances. That was a big, big tailwind for debit. We see travel coming back, that's more credit-oriented, particularly because of the rewards around it.", "You start to see, in the crypto space, there's a whole new set of credit propositions. We just talked about the Gemini roll outs and crypto rewards on that, the Nexo card. So there's a whole thing going on. I think in the end, it's going to be multiplicity around these different tools." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Dan Dolev for Mizuho. Please proceed with your question." ] }, { "name": "Dan Dolev", "speech": [ "Hi. Thank you for taking my question. My question is more specific. If I look at U.S.", "trends, debit versus your competitor, I mean, over the last few quarters, I'm seeing a downward trend in your share of the mix in debit and this picture in credit, is there anything to call out there? Is there an opportunity to improve in debit? Or am I just missing something very fundamental here. Again, just U.S. versus your large competitors." ] }, { "name": "Sachin Mehra", "speech": [ "Yes. So Dan, there's nothing fundamentally which is really changing as it relates to our debit business. I'll put that out there in the first place. Growth rates obviously are impacted by comps.", "I think you get that piece. I think you've got to take into consideration that there is a one portfolio, which is a debit portfolio, which is rolling off in the U.S., which was previously announced, which is probably impacting that comparative analysis that you're seeing. Because obviously, we're seeing the detriment of that comes through in our debit metrics, and that primarily started in the recent past and will go on through the course of this year. And the competitor is likely actually getting the benefit of that.", "So that's probably the reason you're seeing some of the divergence." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of Andrew Jeffrey with Truist Securities. Please proceed with your question." ] }, { "name": "Andrew Jeffrey", "speech": [ "Hi. Good morning, and I appreciate you taking the question. Michael, I actually have a question on other revenues, value-added services, in particular. Ex acquisition seems that it's decelling a little bit.", "I would have perhaps expect to see that growing faster and certainly approaching the growth in the card business. Can you just comment on kind of puts and takes there and what the long-term trajectory is for value-added services?" ] }, { "name": "Michael Miebach", "speech": [ "Andrew, excellent questions. As you know, we love our services business. It drives growth for us. It's a differentiator.", "It's a margin increaser. It's all of that. And the key focus is on cyber solutions on one hand and data analytics and inside solutions. This comes back to the structural trend, by the way.", "More data, more digital world, more digital work to be kept safe. More insights for all these new people that are having businesses online on the data analytics side. So fundamentally, there are sound trends here. If you just pick up this quarter and you do the -- unpacking the numbers that you have just laid out, that is simply timing.", "We are expecting our -- there's nothing to be said that there's anything changing on the growth rates of our business. So that will continue. Our teams are fully engaged and as we looked ahead in the guidance that Sachin gave, we assume a strong services growth." ] }, { "name": "Sachin Mehra", "speech": [ "And I'll just add some -- a little bit more color on that just because I think it's important for you as you're thinking about your models going forward that, in fact, let us in -- When we talk about Russia revenues, there are a few things from a Russia revenue standpoint, which you might want to take into consideration. One of which relates to the fact that Services was well penetrated in the Russia and Ukraine markets and had strong growth. And so as you think about the model and the impacts across the different line items, you're going to see impact related to lost services revenue come through in other revenues in the ensuing quarters. That's kind of point number one.", "Few other salient pieces on Russia-related revenues as you think about the different line items. Yes, we will lose the volumes and transactions. Russia was a fast-growing market. It has no average ticket size, which I kind of mentioned earlier.", "There's a high degree of contactless penetration. Again, I think these are important things where you want to kind of keep in mind as you think about comps on a going-forward basis. And the cross-border issuing out of Russia was mostly higher-yielding into regional cross-border issuing. So also the strong remittances and disbursements market.", "Why am I sharing all of this with you? Because as you think about the various metrics we've shared across all of these aspects, those will get impacted as Russia starts coming into play in future quarters." ] }, { "name": "Operator", "speech": [ "Your next question will come from the line of George Mihalos with Cowen. Please proceed with your question." ] }, { "name": "George Mihalos", "speech": [ "Great. Good morning, and thank you for taking my question, guys. Sachin, I wanted to ask, you called out currency volatility is obviously being a benefit to your first quarter results. Can you isolate what that benefit was in 1Q? Just -- I know it's still a volatile time, which is sort of three weeks into the next quarter.", "But how are you thinking about that looking into 2Q?" ] }, { "name": "Sachin Mehra", "speech": [ "Yes. So look, George, I called it out because Q1 had unusually high foreign exchange volatility. I mean, the reality is we don't typically talk about this because these numbers kind of go back and forth from a volatility standpoint, but there was unusually high FX volatility in Q1. The outcome, from a going forward standpoint, is really hard to say.", "I mean, this is one of those things where, I guess, as Michael jokes with me, \"Sachin, you wouldn't be doing the job, if you knew where volatility was going on a forward basis for foreign exchange.\" So the point is, at the end of the day, we've taken our best assumptions on a holistic basis for our business share with you what our thoughts are from a full year and a Q2 basis on net revenue. Very hard to predict what the outlook going forward is going to be. Unusually high volatility does help us. The other thing to keep in mind is since it's related to cross-border volumes, as cross-border volumes come back, that combined with unusually high volatility has that much more of an impact." ] }, { "name": "Warren Kneeshaw", "speech": [ "Jemiria, I think we have time for one more question." ] }, { "name": "Operator", "speech": [ "OK. Our final question will come from the line of Jason Kupferberg with Bank of America. Please proceed with your question." ] }, { "name": "Jason Kupferberg", "speech": [ "Thanks, guys. It's a quick one. So just in terms of your expectation for cross-border travel relative to 2019 levels, last quarter, you were expecting to be at 100% by the end of this year. You're already at 110% in April.", "So what's your updated assumption on that?" ] }, { "name": "Sachin Mehra", "speech": [ "Jason, as I mentioned, we're assuming improving trends vis-a-vis compared to 2019 as we go forward. We're not sharing a specific number for what that looks like in the second quarter or the end of the year. We've built in our expectations in terms of the revenue guidance. I've shared with you our thoughts around how that trend takes place.", "The combination of that was consumer spending and what the improving trajectory in consumer spending is. It's all factored into the numbers." ] }, { "name": "Jason Kupferberg", "speech": [ "Can we get a directional sense on rebates and incentives just for the rest of the year?" ] }, { "name": "Sachin Mehra", "speech": [ "So think I mentioned to you, on rebates and incentives, is the following, which is we have a rich pipeline of deals. We continue to execute on that, as you heard from Michael, in terms of some of the wins which we had recently. Obviously, you get the benefit of improving cross-border trends to play through in terms of lower amounts of business incentives impacting that. And the last point I'll make on rebates and incentives is, in Q1, we had this one-time benefit relating to the nonrenewal of our Russian customer agreement, which you should not expect the benefit of that to come through on a going-forward basis.", "So net-net, I would tell you that a lot of this is going to be dependent on what the timing of deals are, how we put those new and old deals into play and what the recovery of cross-border is going to be." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thanks, Sachin. Michael?" ] }, { "name": "Michael Miebach", "speech": [ "All right. So thanks for your questions. Insightful questions, as always. Thank you for your support for the company.", "Just a thought from me. Here we are. We're thinking that we're going to get out of Omicron and then a few days later, we have an invasion in Europe. So for our teams, it's -- around the world, it continues to be a never-ending marathon and I just want to extend the thanks to everybody in the Mastercard team.", "And with that, we'll see you next quarter. Thank you so much. Bye-bye." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
MA	2018-10-30	[ { "description": "Executive Vice President, Investor Relations", "name": "Warren Kneeshaw", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Ajaypal S. Banga", "position": "Executive" }, { "description": " -- Chief Financial Officer", "name": "Martina Hund-Mejean", "position": "Executive" }, { "description": "Bank of America Merrill Lynch -- Managing Director", "name": "Jason Kupferberg", "position": "Executive" }, { "description": "Goldman Sachs -- Analyst", "name": "James Schneider", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Managing Director", "name": "Donald Fandetti", "position": "Executive" }, { "description": "Tsin Huang -- J.P. Morgan Chase -- Analyst", "name": "Tien", "position": "Analyst" }, { "description": "Wolfe Research -- Managing Director", "name": "Darrin Peller", "position": "Executive" }, { "description": "Keefe, Bruyette, and Woods -- Analyst", "name": "Sanjay Sakhrani", "position": "Analyst" }, { "description": "Deutsche Bank -- Managing Director", "name": "Bryan Keane", "position": "Executive" }, { "description": "MoffettNathanson -- Partner", "name": "Lisa Ellis", "position": "Analyst" }, { "description": "Autonomous Research -- Partner", "name": "Craig Maurer", "position": "Analyst" }, { "description": "William Blair and Company -- Partner", "name": "Robert Napoli", "position": "Analyst" }, { "description": "SunTrust Robinson Humphrey -- Analyst", "name": "Andrew Jeffrey", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Mastercard Q3 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press *1 on your telephone keypad. If you'd like to withdraw your question, press #. Thank you. Warren Kneeshaw, Head of Investor Relations, you may begin your conference." ] }, { "name": "Warren Kneeshaw", "speech": [ "Thank you, Denise. Good morning, everyone, and thank you for joining us for our Third Quarter 2018 Earnings Call. With me today are Ajay Banga, our President and Chief Executive Officer, and Martina Hund-Mejean, our Chief Financial Officer. Following comments from Ajay and Martina, the operator will announce your opportunity to get into the queue for the Q&A session. It is only then that the queue will open for questions.", "You can access our earnings release and supplemental performance data and the slide deck that accompanies this call in the Investor Relations section of our website, mastercard.com. Additionally, the release was furnished with the SEC earlier this morning. Our comments today regarding our financial results will be on a currency-neutral basis and exclude special items unless otherwise noted, but the release and the slide deck include reconciliations of non-GAAP measures to their GAAP equivalents.", "Please note that due to our decision to deconsolidate our Venezuelan entity starting this year, we are providing additional information regarding our switched transaction and card growth rates. The adjusted growth rates eliminate Venezuelan switched transactions and card counts from prior periods so that you can better understand the underlying growth rates of our business. Our comments on the call today will be on the basis of these adjusted growth rates. These are the only supplemental operational metrics which are significantly impacted by the deconsolidation.", "Finally, as set forth in more detail in our earnings release, I would like to remind everyone that today's call will include forward-looking statements regarding Mastercard's future performance. Actual performance could differ materially from these forward-looking statements. Information about the factors that could affect future performance are summarized at the end of our earnings release and in our recent SEC filings. A replay of this call will be posted on our website for 30 days. With that, I will now turn the call over to our President and Chief Executive Officer, Ajay Banga." ] }, { "name": "Ajaypal S. Banga", "speech": [ "Thanks, Warren, and good morning, everybody. So, our strong performance continued this quarter. We had revenue growth of 17% and an EPS growth of 36% versus a year ago on a currency-neutral basis that excludes special items. Now, as you further exclude the impact of the accounting changes that affect year-over-year comparisons, our underlying net revenue growth was 14% and our operating income increased by 19%. I think these results reflect our operational focus, our market share growth, and strong underlying business fundamentals while we continue to invest in the business for the longer term.", "Let's start with the macroeconomic environment. We continue to see solid overall growth, although just like others, we're keeping an eye out for potential impacts related to fiscal stimulus reductions, rising interest rates, and possibly increased trade barriers, which could slow global economic growth. In addition, we are monitoring the impact of a stronger U.S. dollar on cross-border flows and the economic weakness in some emerging-market countries.", "In the U.S., economic growth remains positive. Low unemployment and healthy consumer confidence helped. Our spending pulse estimates for Q3 show retail sales remain strong, and we're actually up 5.2% ex auto, ex gas versus a year ago. Businesses are investing, and the provisional agreement on a new trade deal in North America is good news, both in terms of the stability it'll provide to companies as they plan their supply chains and due to some of the specific terms that it includes, which we believe will be beneficial to our industry.", "Overall, conditions in Europe remain stable. Unemployment continues to decline. Consumer confidence remains strong in areas such as the Nordics while political concerns weigh on some countries, including the U.K., Italy, and Turkey. In Latin America, the elections in Brazil and Mexico are now behind us, and the real and peso have recovered somewhat, although yesterday was not a great day for the peso. At this stage, we are beginning to see how the economic and fiscal policy agendas develop as these new administrations take office. We're also monitoring a few potential headwinds in Asia. While the consumer sentiment remains relatively positive, trade tensions are weighing on business sentiment, most notably in China, Japan, and Korea.", "Against that backdrop, we are driving healthy double-digit volume and transaction growth for Mastercard across most of our markets, with momentum across our co-products and services. As usual, let me give you a few examples. First, we have expanded our existing relationship with HSBC, including winning new business in the U.K., Hong Kong, and Mexico. And, like many of our customers, HSBC will now also leverage Mastercard Labs' rapid prototyping capabilities along with Mastercard advisors and our data and analytics services to help optimize their portfolios.", "In North America, we continue to build momentum in the co-brand states, and this quarter, we announced we will be the exclusive network for the new Air France-KLM portfolio with Bank of America, which includes a suite of enhanced travel benefits. We also expanded our partnership with Kroger, which includes joint efforts to improve the customer experience to create a safer, more efficient checkout experience. Kroger will leverage a broad array of Mastercard's products and solutions, including data and analytics, fraud tools, and digital services. We're also going to migrate the commercial card business to Mastercard, and this partnership basically builds on the co-brand portfolio Flip that we won last year.", "In Europe, we expanded our relationship with Bankia, one of the larger banks in Spain, to flip the vast majority of their debit and credit portfolios to Mastercard. Bankia will also leverage our advisors and lab services as we partner to build their business going forward. In Belgium, Mastercard was selected as Ikea's credit co-brand partner. And, we've also extended our relationship with PayPal. Now, as you know, we are PayPal's partner for almost all their credit and debit co-branded programs around the world. Now, we have also been selected as PayPal's partner as they embark on direct card issuance in Germany and in the U.K. In Germany, for example, we will work with PayPal to support digital cards issued in Google Pay wallets, which will enable German PayPal users to have access to contactless payments at the point of sale.", "In Asia/Pacific, we continue to benefit from strong deal momentum and we are prioritizing two key areas: First, partnering with digital players to harness new payment roles, and secondly, increasing our participation in domestic transactions. So, let's start with the digital players and harnessing new payment roles. Last week, we announced a deal with Grab, which is a leading fintech platform, digital wallet provider, and ridesharing service in Southeast Asia. The Grab app has been downloaded onto more than 10 million mobile devices in the region.", "And, through this relationship, Grab will offer its customers both a prepaid Mastercard within the Grab Pay wallet as well as a physical prepaid Mastercard to enable online and offline payments across a wide range of spend categories. The partnership also opens up the Grab Pay wallet for acceptance across the Mastercard merchant base using existing point-of-sale systems or QR codes. This Grab effort will initially launch in Singapore and the Philippines in 2019, and the plan is to quickly expand across six additional countries in Southeast Asia.", "In China, we have strengthened our cross-border and mobile presence through an exclusive cross-border credit co-brand program with the Ctrip Group and the Bank of East Asia. Ctrip is the largest online travel agency in China. Seventy percent of their bookings, for example, are executed via mobile phones.", "The second part of the conversation in Asia was around increasing our participation in domestic efforts and domestic transactions, so let me give you a couple of examples. In Thailand, in response to on-soil regulatory changes, we built a co-badged partnership with NITMX, which is the leading domestic switch in the Thai market. That partnership enables us to deploy a range of safety and security and gateway services. It will also allow us to significantly grow our co-badged debit share via flips and new issuance with four additional issuers in Thailand.", "Another example is Indonesia, where we recently launched on-soil debit switching, enabling us to comply with local regs, but also work with domestic networks to integrate a set of value-added services. These local capabilities and the global acceptance footprint gave us the entry point to flip the closed-loop debit business of BCA, which is one of Indonesia's largest banks, to debit Mastercard.", "Those are some of the regional updates, and I'm going to highlight progress in addressing new payment flaws. On the B2B front, we are really excited about the launch of Mastercard Track, which is a global trade platform which we have developed in collaboration with Microsoft. Track basically solves key challenge in the procure-to-pay process, including managing supply chain risk and creating more transparency in the B2B payments process. We're going to deploy the platform through a phased rollout. The first phase is focused on helping corporations with the cumbersome process of compliance screening of new and existing suppliers.", "Now, how we address that challenge is we provide a comprehensive trade directory, which is currently at more than 150 million businesses in over 75 countries. The trade directory includes corporate industry details, business credit scores, and compliance data, including sanction notifications and other regulatory information. The directory will be regularly updated to support a business's Know Your Customer and Know Your Supplier processes, and includes automated change notifications to ensure that corporations understand the evolving risk across their supplier base.", "We're also going to build out additional capabilities on that platform, including the integration of our account-based payment rails, and eventually, we envision that Track will enable B2B networks, banks, insurance companies, and technology providers to extend value-added services to business customers, including data analytics and supply chain finance. In Singapore, Track has already been integrated with the Networked Trade Platform, which is a trade and logistics platform developed by the Singaporean government, and it got card payment facilities incorporated inside to facilitate secure and efficient electronic payments between buyers and suppliers.", "And, in the faster payment space, we've talked about the opportunity to leverage our assets to provide a combination of infrastructure, applications, and services to help solve customer needs across an entirely different set of rails, and a recent example of this is the announcement of the Mastercard Bill Pay Exchange. That's a digital application that will enable U.S. consumers to view, manage, and pay their bills instantly from their bank accounts.", "The solution basically attempts to address consumer pain points, like managing multiple billing sites and passwords, and most importantly, remembering when bills are due. Consumers will be able to use their mobile banking app to set up a broad set of their billers, receive notifications when a bill is due, see the bill details, and specify when and how much they want to pay from their bank accounts.", "The Bill Pay Exchange will support payments over the clearinghouse's real-time payments infrastructure, which, as you probably recall, is based on technology from Vocalink. It'll also support traditional ACH payments, and card integration is planned for the future. The Exchange includes a large community of over 100,000 U.S. billers, which is built on our existing bill pay network, and similar to how we distribute most products, this solution is designed to be offered through banks and credit unions, and the idea is to enable the bank or the credit union to become a one-stop shop for bill payments for their consumers.", "On the services layer of our faster payment strategy, we've now launched AML Insights, which is our network-level anti-money-laundering solution, currently in the U.K. AML Insights runs advanced analytics to identify potential money laundering across the faster payments network there, and it helps our bank customers comply with their obligations. The solution has already been adopted by 10 banks, representing over 90% of the U.K. market. We're in active discussions with prospective customers in several markets around the world.", "Finally, a quick update on our efforts to improve the online checkout experience for consumers, merchants, and issuers. Last week, we announced a retargeting to have token services on all cards by 2020, allowing consumers to store credentials with merchants without exposing their actual card details. That's the first part. The second part is we're improving the consumer authentication experience to move quickly and accurately and allow them to verify that a consumer is who they say they actually are.", "Our solution is called Mastercard Identity Check, which uses the data-rich EMV 3D Secure Authentication Standard, and applies our AI and behavioral biometric capabilities to verify the consumer with a single touch or click. We've worked with issuers and merchants in the U.S. and Europe to enable this technology. It begins to roll out globally in early 2019.", "Finally, you've heard us talk about the importance of a safe, streamlined, and standardized online checkout experience for all key stakeholders. The Secure Remote Commerce framework, or SRC, will create a standard for a simplified and secure digital point-of-sale process. EMV calls draft technical specs for SRC have now been finalized. We're working to complete the branding guidelines and other go-to-market considerations. We expect to begin the rollout of SRC in the second half of 2019. So, with that, let me turn the call over to Martina for an update on our financial results and operational metrics. Martina?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Thanks, Ajay, and good morning, everyone. Turning to Page 3, despite the expected foreign exchange headwinds, we delivered another very strong quarter. Here are a few highlights on a currency-neutral basis excluding special items related to litigation provisions and the adjusted tax effect of previously recorded special items.", "Net revenue grew 17%, driven by strong underlying performance, and includes a 3ppt benefit from the new revenue recognition rules. Excluding this, underlying revenue growth was 14%. Operating income grew by 22%, or 19% if you exclude the revenue recognition rules' impact. Net income was up 33%, reflecting strong operating results and the impact of the U.S. tax reform, which contributed approximately 9ppt to net income growth. EPS was at $1.78, up by 36% year over year, with share repurchases contributing $0.04 per share. During the quarter, we repurchased about $1.2 billion worth of stock and an additional $385 million through October 25.", "Let's turn to Page 4, and here, you can see the operational metrics for the third quarter. Worldwide gross dollar volume, or GDV, growth was 13% on a local currency basis, down 1ppt from last quarter. We saw solid double-digit growth across most regions. U.S. GDV grew 9%, similar to last quarter, with credit and debit growth of 8% and 10% respectively. And, outside of the U.S., volume growth was 15%, down 1ppt from last quarter.", "Cross-border volume grew at 17% on a local currency basis, in line with expectations and driven by double-digit growth in all regions. This was down 2ppt from the second quarter, primarily due to one less switching day in Q3 versus a year ago.", "Turning to Page 5, switching transactions continued to show strong growth at 16% globally, normalized to exclude Venezuelan transactions, as we no longer consolidate that entity. Again, there was one less switching day versus a year ago, which impacted growth by 1ppt. We saw healthy growth in switched transactions across all regions, led by Europe and the U.S. In addition, global card growth was 6%, again, normalized for Venezuela. Globally, there are 2.5 billion Mastercards and Maestro-branded cards issued.", "Now, let's turn to Page 6 for highlights on a few of the revenue line items, again, described on a currency-neutral basis unless otherwise noted. The 17% net revenue increase was in line with expectations and was primarily driven by strong volume and transaction growth as well as growth in our services offerings. As I mentioned already, the new revenue recognition rules contributed 3ppt to the growth rate. Excluding these impacts, underlying net revenue growth was 14%.", "Looking quickly at the individual revenue line items, domestic assessments grew 24% while worldwide GDV grew 13%. The difference is mainly due to pricing and the impact of the new revenue recognition rules. Cross-border volume fees grew 18% while cross-border volume grew 17%. Transaction processing fees grew 17%, primarily driven by the 16% normalized growth in switched transactions as well as revenues from our various service offerings. Finally, other revenues grew 11%, driven by increases in our advisors and safety and security services.", "Moving to Page 7, you can see that total operating expenses increased 10%, excluding special items, on a currency-neutral basis. Within our expense growth, we had a 2ppt increase related to the new revenue recognition rules, offset by a 2ppt benefit associated with foreign-exchange-hedging losses in the year-ago period.", "I'm going to now turn to Slide 8, and let's discuss what we have seen through the first three weeks of October. Our drivers are generally similar to or slightly better than what we saw in the third quarter on a normalized basis. Just remember, Q3 had one less switching day, which reduced each of the switched metrics by approximately 1ppt. So, the numbers through October 21st are as follows: Starting with switched volume, we saw global growth of 16%, an increase of 2ppt compared to the third quarter. In the U.S., our switched volume grew 13%, a sequential increase of 3ppt aided in part by the timing of certain Social Security payments this quarter. Switched volume outside the U.S. grew 19%, up 1ppt from the third quarter. Globally, switched transaction growth was 17%, up 1ppt from the third quarter, with healthy growth in each region.", "With respect to cross-border, our volumes grew 18% globally, up 1ppt sequentially. As a reminder, we will face a more difficult comp as this quarter progresses due to the timing of cryptocurrency-related activity last year.", "Turning to our thoughts for the full year 2018, which I will describe on a currency-neutral basis excluding special items, overall, not much has changed. The economic environment remains healthy and we continue to expect year-over-year revenue growth to be in the high teens and operating expense growth to be in the mid-teens. As a reminder, these growth rates include the impact of the new revenue recognition rules that we adopted in 2018 and the full-year effect of acquisitions.", "A few other items of note: FX is now expected to have no real impact to revenue for the full year, and we expect Q4 to have a higher foreign exchange headwind to revenue than in Q3. We expect a sequential increase of operating expenses in Q4, due primarily to the timing of some of our marketing programs, and we estimate the tax rate will be approximately 19% for the year. With that, let me turn the call back to Warren to begin the Q&A session." ] } ]	[ { "name": "Warren Kneeshaw", "speech": [ "Thanks, Martina. Denise, we're now ready for the question and answer session." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, to ask a question, please press *1 on your telephone keypad. To withdraw your question, press #. Your first question comes from Jason Kupferberg from Bank of America Merrill Lynch. Your line is open." ] }, { "name": "Jason Kupferberg", "speech": [ "Good morning, guys. Just two quick ones here. First, one for you, Ajay. I just wanted to take your temperature macro-wise. I'm not sure if your tone is softening a little bit -- some caution points out there, obviously, U.S. equity markets dropping a lot this month. Not sure what your historical data would show in terms of potential impacts on consumer spending going forward. And then, Martina, any comments on rebates? We were expecting the number to be a little higher in Q3. I know timing is always an issue here. Any changes in how you're thinking about full-year rebates? Is this just a timing issue between Q3 and Q4? Thanks, guys." ] }, { "name": "Ajaypal S. Banga", "speech": [ "On the macro, Jason, honestly, in our numbers, nothing is showing up that should give me reason to be cautious. Look at even our three weeks of data that we've shown you until October 21st, and you will find that consumer spending remains kind of robust or even a little better in some cases. So, nothing is showing up directly. It's just that at the end of the day, any and all time you spend in industry and business, you do feel that if you've got trade barriers, you've got discussions going on with rising interest rates and removal of liquidity in the system, at some point in time, that should have an impact overall on the economy, if nothing else to slow down the growth rate a little to keep the heat down.", "And so, that point of view that you are hearing me speak about -- I don't have any indicator in the system that I could point to that should give you either exuberance or caution where we are today. We're going along the way we see our data, which is good spending, even in the three weeks of October that we've shared with you." ] }, { "name": "Martina Hund-Mejean", "speech": [ "And, on rebates and incentives, as you know, Jason, our first quarter was actually the low quarter from a rebates and incentive growth point of view. Second and third quarter are very similar, and we continue to expect strong deal activity into the fourth quarter." ] }, { "name": "Operator", "speech": [ "Your next question comes from James Schneider with Goldman Sachs. Your line is open." ] }, { "name": "James Schneider", "speech": [ "Good morning. Thanks for taking my question. I wanted to ask a question on cross-border. Obviously, that was still strong, and it looks like it improved a little bit in October. Can you give us a little bit of color on some of the regional composition of that, and anything in that have implications in terms of you taking a more cautious view on spreads of cross-border pricing, and then, in the general macro sense in any particular region?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Cross-border has continued to be very strong, and in fact, when you look at the Q3 numbers, they're very similar to the Q2 numbers when you adjust for the switching day, and you can see that when we look at the October 21 stats, it continues to be very strong, so we put out a bit of a cautionary note on that because when you remember the fourth quarter of last year, in particular at the end of November into December, we saw all that cryptocurrency-related activity that we don't expect to repeat. In fact, that activity has gone down in a very significant way.", "The areas that we're looking at very carefully are, of course, 1). What is happening from a strengthening U.S. dollar point of view? So, we can already see that cross-border inbound into the U.S. has been -- the growth rate has been declining versus what we saw in Q2. In addition to that, we're looking at some of the emerging market phenomena in terms of people being able to travel, so our watch-outs are countries like Brazil, Indonesia, and a number of other countries on this, but also, we watch very carefully on Canada as well as Australia because how these currencies behave versus the U.S. dollar very much impact what our cross-border volume growth does." ] }, { "name": "James Schneider", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Don Fandetti with Wells Fargo. Your line is open." ] }, { "name": "Donald Fandetti", "speech": [ "Good morning. Ajay, as you look out, the market seems to be convinced that there's potential risk action coming into the U.S., and if you look back at your company, you have very good revenue growth through the downturn. Can you talk a little bit about what the playbook would be in this scenario? Do you still feel like pricing could be a buffer and take cost out, or do you feel like you have a similar type of buffer?" ] }, { "name": "Ajaypal S. Banga", "speech": [ "I don't know about the conclusion that the market is pricing in a recession or that the market is pricing in a correction caused by the reality of increasing Fed rates and reducing liquidity. I don't know that yet, and I think I'd be cautious on including that as of now. But, having said that, I guess the question really is what's our flex in our P&L to manage our rate through cycles of different types? Our revenue is built out of multiple legs of the stool, first of all. One part of it is clearly impacted by personal consumption expenditure. It tends to be the quickest impact on our revenue. So, if PCE in the U.S. tomorrow slows in its growth rate from the 5.2% that I referred to for Q3 and the spending pulse ex auto, ex gas to, say, 4.5%, that impacts our revenue immediately.", "What's happened in past cycles with that has been that when some countries slow down, others pick up, and over a period of two to three years, you tend to find that global PCE, supported in addition by the secular shift from cash to electronic, gives us a reasonable multiple legs of the stool to keep some form of revenue growth growing through that period. Pricing is a function of what you think the market can bear, both on acquiring pricing and issuing pricing, but remember, we now have another leg of the stool, which is our services, and there's pricing there as well.", "It's safety and security tools, it's data analytics and consulting, all of which tend to get used a great deal more when people feel the pressure to grow their own company's revenue, or manage their own expenses, or be more efficient. So, I think on multiple legs of the revenue stool, if anything, it will help us through the next challenging set of circumstances in an even better way than it was 10 years ago.", "On the expense side, we've got two forms of expenses that can be dialed up or dialed down. Remember, we're putting a lot of money consciously into strategic growth initiatives. Some of that is people, and that's a cost that you incur to get the right quality or skills and talent, but some of it is technology and the rollout of new products and new platforms. Clearly, if there's a pullback, you will find lower appetite for rolling out some of the new products and platforms.", "We can show some of that to show up in our expenses. A&M is an obvious one. Marketing can be another one that can be played with and dialed with during times of crisis. But, as we've shown from years back, we know how to manage our expenses tightly and down when there's a crisis as well. So, I'd say you're going to get more of this from Martina, but on the revenue side of the stool, more legs, and therefore some degree of balance, and on the expense side, a couple of good levers to play with. Martina?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Just to add, every time that we put a budget together or yearly budget together, we obviously put a base plan together based on our base assumptions of what we think revenues will be and what we can afford from an investment point of view, both in the core as well as additional investments that we are making into our strategic initiatives. But, at the same time, we actually always put a couple of downside scenarios together so that the entire organization actually premeditates if a downturn were to come down the road, what we actually have to do so that we don't have to scramble at that point in time.", "We have a road map, the road map is very defined, obviously, when anything happens, you refresh your road map, but the company is able to course-correct if it needs to be course-corrected. Let me just add a couple of things to that. First of all, if it's a mild downturn, we generally would not be cutting out strategic initiatives. We would try to find our way through it because from a long-term perspective, we are obviously looking at long-term growth and garnering that.", "If we were to shortchange some of the strategic initiatives, we would not be able to do that and really create the kind of value that you want to have for our shareholders. However, if it's a more severe downturn, then it's some of the things that Ajay said are jumping in, where we would evaluate very carefully which initiatives we would continue and which ones we would maybe mothball for a while." ] }, { "name": "Donald Fandetti", "speech": [ "Okay, thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Tien-Tsin Huang from J.P. Morgan. Your line is open." ] }, { "name": "Tien-Tsin Huang", "speech": [ "Hey, good morning. I just wanted to ask on the pipeline for new deals and renewals, and how you'd characterize that, and your win share so far. It looks like obviously, with KLM, that was a nice one, so just curious what the go-forward looks like." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Tien-Tsin, across the board, we are still continuing to win share, and just remember that it's not just against one competitor. This is obviously against domestic competitors, too. Secondly, from a pipeline point of view, we look pretty strong. You can see that in the rebates and incentives number. I do expect that that will continue to grow, and of the agreements that we have announced, most of them will be rolling out between the first and the fourth quarter of 2019." ] }, { "name": "Operator", "speech": [ "Your next question comes from Darrin Peller with Wolfe Research. Your line is open." ] }, { "name": "Darrin Peller", "speech": [ "Hey, thanks, guys. When looking at the strong trends, even into calendar fourth quarter, how much of that is really market share? I know the switching day helps, obviously, but market share versus macro strength. And then, just as a follow-on to that, can you just touch on the contribution of the potential benefits from the Maestro conversion that you're seeing? How much is that impacting numbers now? It seems like it's got a long road ahead of it, but really good benefits. Thanks." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Darrin, it's tough for us to parse this. The macroeconomic environment is obviously good in many countries around the world, and it is, as Ajay was saying, driving quite a bit of our revenue growth, but every quarter, we're winning from a market share point of view given the kind of announcements that you have. So, that is an added benefit. And then, don't forget, the secular trend is also an added benefit, so we are not seeing any changes in terms of the three drivers of our core business besides what we are actually doing on the services side, which is another growth driver for us.", "From a Maestro conversion point of view, I think you're seeing probably in this data about 9 million cards or so have gone away from the Maestro cards. Pretty much all of them got flipped to debit Mastercard. As we told you before, the Maestro product -- given that it cannot be used in a number of different ways, like on e-commerce, but the debit Mastercard product can be used, we see much more significant volume on it as well as the pricing is different, so it's a nice contribution to what we're seeing on the debit side." ] }, { "name": "Operator", "speech": [ "Your next question comes from Sanjay Sakhrani with KBW. Your line is open." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thanks. Ajay, you talked about the SRC initiative in your prepared remarks. I'm curious how confident you feel the industry players will come together with a strong solution that competes with the other players out there. And, perhaps you could just talk about the value proposition to the various constituencies. Secondly, Martina, you guys have obviously had very strong growth in revenues on the back of all the various things you talked about. Just in terms -- you haven't provided formal guidance yet, but is there any reason outside of a macro situation that you can continue or sustain these trends? Thanks." ] }, { "name": "Ajaypal S. Banga", "speech": [ "So, on SRC, Sanjay, it's always early days, but I'm pretty confident that the issuing and acquiring and merchant community will see a fair amount of value out of SRC. But, I have a very simple logic for the response we get when we talk about SRC to any of those communities. The first one is there is clutter on the checkout page if there's going to be multiple checkout buttons. The second one is it's just harder for a merchant or an issuing bank or an acquiring bank to have to handle multiple checkout options for the purposes of digital and online purchase. And so, both of those are appealing to the entire community, and that appeal is what we're hearing back from them.", "So, getting the standards right, which is why it took us some time, that EMVCo, which is a body that comprises, as you know, the networks, the issuing banks, but also some merchants are now parts of the advisory group there -- they're all involved with this together with us in an effort to create the right standards that not only provide for simplicity of integration at checkout, but also force higher standards of security for the merchant and the consumer and the issuer and acquirer.", "So, I think we're actually building this infrastructure the right way for all the different stakeholders in the system. Obviously, the one group of stakeholders we haven't yet tested it on is the consumer because it hasn't reached them yet, and that one, we'll see, and the proof of the pudding will be in the eating, but at the end of the day, there's no reason why they wouldn't find it the right thing to use.", "So, my general view of this thus far from all the interactions is very, very optimistic. Now, it's going to be a run. It's not going to be something that's going to end in a hundred-yard dash. So, we've got to get the standards frozen, get all the work done to get it launched out there, get the issuing, acquiring, and merchant systems to accept these new standards, work with them, and then allow us to roll that out over three or four years. This is not a one-year or six-month effort. It starts in the second part of next year, and you should see this having a lot of energy and momentum from us at least for the next three or four years, and then you'll see where we get to with it. I'm reasonably optimistic about it, and the value prop is embedded in what I just told you. The reason for my optimism is the value prop." ] }, { "name": "Martina Hund-Mejean", "speech": [ "So, on the longer-term guidance, Sanjay, first of all, we said earlier this year that you have to let us finish out 2018, predominantly because of the adoption of the new revenue recognition standard because there are lots of moving parts, and having said that, on the fourth-quarter call, which is in early 2019, you will hear our thoughts about 2019 as well as you will hear our thoughts from a long-term performance objective.", "The one thing that I usually point people back to is when you look at our Investor Day back in September of 2017, you actually see the one chart that we put out for a five-to-10-year period, where it shows our drivers and what we're doing from a services point of view, and kind of puts it together on what we think from a very long-term point of view for revenues, and it says low to mid-teens. We haven't changed our opinion in all of this, but you're going to have to wait for the 2019 thoughts as well as for a longer-term guidance at the Q4 earnings call. I think that's the end of January or so." ] }, { "name": "Sanjay Sakhrani", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Bryan Keane with Deutsche Bank. Your line is open." ] }, { "name": "Bryan Keane", "speech": [ "Hi, good morning. I just wanted to ask about the adjusted operating margins that came in, I think, significantly above last year and above street estimates. How much of this, Martina, is just leverage in the model versus timing of expenses? I think you called out some increased marketing in 4Q, but just trying to figure out how much of that was a surprise in showing leverage versus just a timing issue." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Look, Bryan, first of all, we're going to continue to stick to our guidance where we said when we look at the business overall, we think the business can produce 50% less operating margins at any point in time. So, we're not going to change that. Every year, when we put our numbers together, we basically decide what we think revenue growth will be and how much we can afford from an operating expense point of view.", "Obviously, you're seeing that we've been doing really well from a revenue growth point of view this year, and so, we have been able to produce more profits, and it doesn't go that quickly that we can just turn on a dime and suddenly invest in some other strategic investment. So, you have to have a long-term view. We're not going to change our long-term view, but from time to time, as we've said in the past, depending on revenue growth, you might have a little bit of an extra contribution to operating margins." ] }, { "name": "Ajaypal S. Banga", "speech": [ "The way we run our system is that we took the idea of a 50% minimum operating margin to explain to our investors that we are committed to running the company with a fair degree of efficiency and profitability, but we also committed in a group industry -- because that's what our industry is -- with the amount of PCE that's still in cash with the amount of B2B payments that are still inefficiently done through check and strange ways of paying, that there's an enormous amount of opportunity to enable our company to grow. In that circumstance, our long-term sights -- I've been here nine years, Martina's been here 10 -- I've been saying this from the day I came on: Long-term sights are set on investing to get at that cash and to get at those inefficient ways of doing B2B payments.", "The second thing we've built out over these years is the investment in services. I'm hoping you guys are beginning to see a lot of those services embedded in our relationships with merchants, issuing banks, governments, and acquiring systems. And, the embedding of those services in those relationships enables us to not only have a better, more holistic relationship with our partner, but it also enables us to be seen as a value-added partner, not just a price play. Price is important -- don't get me wrong, I've said this every time -- but it also allows you to have more than that in addition to the service being a good revenue and good margin generator on its own.", "So, our approach to this whole thing has been to play that game for the longer term, play it in a way that our investments make sense for where we're going, including inorganic investments, and then manage -- if there's a couple of years of a slowdown in growth, manage your way through it, but don't take your eyes off where we're going, and that's kind of what we're trying to do.", "So, your question about operating margin in the quarter -- to be perfectly honest, I don't even look at it until Martina comes and bops me over the head and informs me that this is our operating margin. I actually don't. I don't operate through operating margin. I operate through revenue growth to net revenue growth, I operate through basic franchise-indicating trends, and I operate through investing in the strategic portfolio initiatives that we've laid out for you. Those three things -- make sure we've got great people, good technology, great brand -- is how we run our company. Everything else -- quarter by quarter, it comes and goes, and I'll faithfully report it to you." ] }, { "name": "Bryan Keane", "speech": [ "Okay, thanks for the help." ] }, { "name": "Operator", "speech": [ "Your next question comes from Lisa Ellis with MoffettNathanson. Your line is open." ] }, { "name": "Lisa Ellis", "speech": [ "Hi, good morning, guys. This one is for Ajay. At Money20/20 last week, we got a peek into the future of commerce with things like voice commerce, which is like buying through a personal assistant, and social commerce, which is like buying through a photo on Instagram, or doing things like seamless omnichannel, where you're checking out with your phone while you're in the store. So, on the theme of investing for the future, what are some of the unique technologies and investments you're making at Mastercard against those futuristic trends that are looking more like five or 10 years out?" ] }, { "name": "Ajaypal S. Banga", "speech": [ "In backward order, the last one you talked about was about seamless omnichannel thinking. We've been talking about that for some time -- with you and with others as well -- what we think we're doing in that space because consumers do exactly what you said. They actually research online, buy in-store, they buy online, return in-store, they research while in the store. So, for example, in our labs or our tech hub, you'll find things like these mirrors where you can both test out things but also ask the attendant to bring you stuff from the inventory in a different color and purchase right there and have shipped to you later delivered.", "All of that is part of the idea of the fact that consumers don't think online separate from physical. They just look at their experience. And so, a ton of things are going into that seamless back-and-forth. In fact, your entire approach to managing chargebacks and disputes also has to evolve to the idea of buying in one channel, returning in the other. And so, that entire work has been going on for quite a while.", "Your in-between one -- the one about social commerce -- remember, sometime back, we launched an effort withVoguemagazine where if you were onVoguemagazine, and you were flipping through, and you found a pair of shoes -- which Martina has plenty of -- if she found a pair of shoes that she liked even more than the 2,000 pair of shoes she already has, then she would just click on it and go to -- she's making faces at me -- she would click on it, go right there, and buy that pair seamlessly through one click, and by the way, come right back to the same page inVogueas compared to going out to a website to buy and then have to navigate back to theVoguesite. So, it's not just social commerce, it's the ease of in-and-out that you have to manage in that process.", "And, the oral commerce part of that is just beginning to move, and I think you'll find us over the period of time being very focused on evolving our brand and our signature and our capability in all these channels of oral, social, and omnichannel commerce. So, there's investments going on in technology, there's investments going on in chargebacks and dispute management, there's investments going on in the consumer experience from front to back, there's investments going on in the brand and its evolution -- it's kind of across the whole lot. And, of course, there's investments in data and analytics that help you work into that process and connect through the safety and security of transactions in that space.", "So, one of the things that you will find us using artificial intelligence on -- take a look at new data. New data was all about trying to figure out whether the person using the phone is the person whom the phone belongs to or not, or if somebody's been able to get into their phone. So, using AI, you can send back a risk-weighted score to the merchant or the bank to say, \"This may not be Martina buying that 2,001st pair of shoes that she saw in the magazine, and instead, it might be Ajay, who stole her phone and her password.\"", "And, that gives the bank or merchant a chance to make a conscious decision based on the value of the customer whether to let that decision go through or not. So, we could keep going on this topic, but it's a whole series of efforts across all forms of commerce, across all the legs of our revenue stool that we're working on." ] }, { "name": "Lisa Ellis", "speech": [ "Terrific. Thank you." ] }, { "name": "Ajaypal S. Banga", "speech": [ "Martina is running out to buy a pair of shoes right now." ] }, { "name": "Operator", "speech": [ "Your next question comes from Craig Maurer with Autonomous. Your line is open." ] }, { "name": "Craig Maurer", "speech": [ "Good morning. Thanks. So, two questions. I wanted to follow up on Tien-Tsin's question from much earlier. Visa called out 20% of their volume being renewed in fiscal '19. Is there an increased opportunity to win share over the next 12 months? Secondly, how much of the current OpEx is being spent on complying with data localization rules, if you could just frame that for us? Thanks." ] }, { "name": "Ajaypal S. Banga", "speech": [ "Let me start with both of those, and I'll let Martina get into some of that as well. The data localization rules -- you've to remember, we're managing and meeting the needs of what, for example, India has announced or what it wants on data localization. Essentially, data localization comes in many flavors. It's a bit like white bread to whole wheat bread. Which part of it do you want? If you look at data localization, the way the Indian government has put out its original guidelines, managing that data localization is a question of attempting to put a bunch of servers on the ground that enable that data to be kept locally.", "The fact is if you go further onto on-soil processing and on-soil switching, as we've had to do in some countries, that's a different cost base. What we're referring to when we talk about our lack of support for data localization is not caused so much by expenses, it's caused by the inefficiency of what that does to the ability to provide safety, security, and analytics to India's banks and merchants. Honestly, if we are to be able to look at transactions and recognize them -- the example of new data I just gave -- to recognize patterns and to look at them across systems, it's common sense that more transactions give you better predictability and lower false positives. Less transactions give you lower predictably and more false positives.", "Secondly, if you localize, you're unable to learn from the learnings of one country and apply them to global platforms like ours to every country, and therefore, you leverage the cost of learning by 1/200th, meaning you learn one country and it's available to 200, and I have tons of examples of when this has paid off. What India is doing is actually enabling both those benefits to India to be turned off. So, at the end of the day, it's not a cost issue. That's what I'm trying to tell you. It's more of the manner in which we run the business to be able to benefit those stakeholders on the ground in India that I think we're losing out on, and I'm picking on India only because that's a live issue over the last few months. There are others like that. So, it's not a cost issues as much as it is a manner of operating issue." ] }, { "name": "Martina Hund-Mejean", "speech": [ "On the agreements, Craig, first of all, on average, agreements are between three and seven years -- you can actually say five years -- so it's no surprise that typically, in any given year, 20% plus or minus a few percentage points come up for renewal, and we will continue to do what we did in the past many years. It means we are going to go after every agreement, and hopefully, we can convince clients to continue to do business with us or new clients to come over to do business with us. It's kind of business as usual." ] }, { "name": "Craig Maurer", "speech": [ "Okay, thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from Robert Napoli with William Blair. Your line is open." ] }, { "name": "Robert Napoli", "speech": [ "Thank you, and good morning. I was wondering if you could give a little more color on the growth of your B2B business and the investments that you're making there, and just maybe general thoughts to the percentage of your business that could come from B2B payments over the very long term." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Bob, let me start on this one. First of all, when you just look at B2B payments, we've said in the past that it's about 11% of our total volume at this point in time, and that it's growing kind of in the low/mid/high teens, depending on which quarter you're looking at. If I can just recall for you, we think that the opportunity worldwide is actually $120 trillion. That doesn't mean that we're going to go after every $120 trillion, but we're going after the slices where we can actually bring a lot of good value proposition to bear.", "You saw how we expanded into virtual cards. That is actually in these kinds of numbers, and how we're basically adopting virtual cards for ecosystems such as the travel industry, et cetera, and we took that learning further and expanded basically in the United States, how to figure out for smaller companies and mid-sized companies to be outsourcing their accounts payable process, and that is going beyond virtual cards. This is the Mastercard B2B hub, and it's not just virtual cards, it's any -- the whole suite of payment means via check or ACH how vendors can basically make payments to suppliers. So, that is one expansion which is closer, probably, to our core business.", "This morning, you heard Ajay talk about Mastercard Track. That is really to address pain points between trading partners across the whole world, just like Know Your Supplier, and that solution -- which, as Ajay said, will be rolled out in phases -- at some point in time, we hope that we are also going to integrate a payment solution. So, that is addressing a different pain point. In cross-border, account to account, we have told you before that have been working on a permission-based blockchain solution that we have already connected to our settlement capability, and we're currently in a pilot with several banks. And then, in addition to that, you know that Mastercard Send is actually also enabled for cross-border B2B payments, and then you shouldn't forget Vocalink, which is enabling B2B payments, too. So, there is a number of things that we're doing and innovating on, all of which we're hoping, obviously, to come to fruition over time." ] }, { "name": "Robert Napoli", "speech": [ "Has the growth rate of the B2B business accelerated? We've seen signs that maybe it has in other places, but..." ] }, { "name": "Martina Hund-Mejean", "speech": [ "As we're adding to it, you have to look -- that's why I said depending on which quarter you're looking at, it's anywhere between a low-teens and a high-teens growth rate, which is pretty fantastic." ] }, { "name": "Ajaypal S. Banga", "speech": [ "So, the income the B2B business has -- I was a little speechless at Martina's speech because she obviously has imbibed the B2B business deeply. Here's the thing --" ] }, { "name": "Martina Hund-Mejean", "speech": [ "You are a treasurer." ] }, { "name": "Ajaypal S. Banga", "speech": [ "Formerly, yeah. And now, there's such work for her, who I used to rely commercial -- I think this education process has only ratcheted up. So, here's the deal: There's the card-based original business that we always were in. Small corporates, large corporates, T&E, B2B, SME, fleet cards -- that business continues to grow in a good way, and frankly, you should view that as a steady, stable business that we understand the most about because it's been in our portfolio for a fair amount of time.", "Then, the virtual card business came in after that, and that has continuously improved, not only in the form of the industry that targets, as Martina was explaining, but also the form in which we deliver the product more through open APIs and through simple ways for people to integrate with the virtual card. That business is also beginning to, I would say, come to the point where it's in the first category of something we've known for a lot of years.", "The Hub business, which connects through the ERP systems, and the Track business, which we have just about launched -- these are new, and I think you will see the results of these two over the next two to five years, not the next six months to one year. You've got to look at our B2B business as being laid out as the foundation of the way we built the services business. It took us four or five years to build it to some size, and then we began to really plug it hard. You should watch us doing the same with those parts of the B2B business -- the Hub and the Track part -- and there's more to come on Track and there's more to come on the Hub as we go along.", "Vocalink and the fast ACH capability that Vocalink gave us, along with the incremental amount of data that flows in a Vocalink message back and forth, which gives us better reconciliation capability and better capability for these vendors who are buying and selling from each other -- that is just another plus in the system. And so, we're kind of building a repertoire of assets like we built in safety and security, packaged together and bundled together at the front end for meeting that $120 trillion that Martina is talking about. That is how I view the B2B business, as those two distinct parts: Older, more mature type, and newer, probably more interesting future growth variety. Mastercard kind of transcends both of those." ] }, { "name": "Robert Napoli", "speech": [ "Thank you very much, Martina and Ajay." ] }, { "name": "Warren Kneeshaw", "speech": [ "We have time for one final question." ] }, { "name": "Operator", "speech": [ "Your last question comes from Andrew Jeffrey with SunTrust. Your line is open." ] }, { "name": "Andrew Jeffrey", "speech": [ "Hi, good morning. I appreciate you squeezing me here at the end. Ajay, I heard you mention in your prepared remarks at least one flip from a proprietary or closed network. I wonder if you can expound globally on the share that you think those networks have and how much opportunity Mastercard has to open them up, and in fact, what your win rates might look like as you go after that volume." ] }, { "name": "Ajaypal S. Banga", "speech": [ "Closed-loop networks have evolved over the years. They were very strong, for example, in Europe over the last so many years. And then, when PISP and the first payment system directive came around, it began to open up the opportunity for companies like ours to gain vis a vis the closed-loop network in a number of those countries, and the Netherlands were the first big breakthrough, but you'll find that in every quarter in every country, we begin to see some progress. In fact, if you dial back to the big picture, nine years ago, we saw about 40-42% -- Martina will remember the number correctly. Was it 42% of transactions went through us?" ] }, { "name": "Martina Hund-Mejean", "speech": [ "Less, actually. I think it was in the mid-30s." ] }, { "name": "Ajaypal S. Banga", "speech": [ "Okay, so, mid-30s was what we saw. We're now 50-something." ] }, { "name": "Martina Hund-Mejean", "speech": [ "Fifty-five percent." ] }, { "name": "Ajaypal S. Banga", "speech": [ "Fifty-five percent of our transactions, so we can see a large part of that is because we've been able to take on these closed-loop systems over the years and convert them into open-loop and be able to see them ourselves. Closed-loop has many implications. There are bank-owned ones, there are government-owned ones, and then there are smaller closed loops like transit systems. So, the London transport was a closed-loop system where if you took a subway in London, you paid on an Oyster card, which was their own little closed-loop. That's been converted to an open-loop as well.", "So, the closed-loop/open-loop conversation has many dimensions to it across smaller ones for government-run systems to all-the-way big ones that run nationally in infrastructure. I actually don't want to give you a percentage of what comes from those versus the others, only because it'll start becoming a quarterly question, and this is not a change that happens quarterly. But, I will tell you this: In our secular growth story, while there is a great deal of focus on the 80-odd-percent of transactions that are still in cash, in that other 15-20% that are electronic, there is a chunk of closed-loop, and Europe is a big example of that. Canada has that, Australia has that, Latin America has it -- it's sort of a developed market/emerging market thing. It's across the world.", "So, yeah, we are focused on that and we work with those closed loops very often to show them why they're inefficient. Remember the conversation I was giving about India and not having access to global technology and global data analytics? All closed-loop systems suffer from that problem. They can't even keep pace with innovation and new technology forms. And so, it's those arguments that enable us to go after that volume. It's a regular, steady drumbeat of growth." ] }, { "name": "Andrew Jeffrey", "speech": [ "Thorough as usual. Thank you." ] }, { "name": "Ajaypal S. Banga", "speech": [ "Thanks. You're welcome." ] }, { "name": "Warren Kneeshaw", "speech": [ "Ajay, any final comments?" ] }, { "name": "Ajaypal S. Banga", "speech": [ "Yes. Thank you for all your questions. I just want to wrap up with a few thoughts. We have once again delivered strong financial performance this quarter, record revenue, record earnings growth. We are very focused on executing against our strategy. We're investing in our co-products as well as in differentiated service offerings, and the idea is to embed ourselves, but also to provide choice to our customers.", "We continue to drive solid deal momentum across products, across geographies. We've built that momentum on our solutions-selling approach, and we're focused on delivering the best digital experience possible over the next few years across all channels and all devices for merchants, consumers, and issuers. And so, with that, thank you very much for your continued support of the company. Thank you for joining us today." ] }, { "name": "Operator", "speech": [ "This concludes today's conference call. You may now disconnect." ] }, { "name": "Andrew Jeffrey", "speech": [ "More MA analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
PRU	2018-11-08	[ { "description": "Head of Investor Relations", "name": "Darin Arita", "position": "Other" }, { "description": "-- Chairman and Chief Executive Officer", "name": "John Strangfeld", "position": "Executive" }, { "description": "-- Vice Chairman", "name": "Mark Grier", "position": "Other" }, { "description": "-- Executive Vice President and Chief Financial Officer", "name": "Robert Falzon", "position": "Executive" }, { "description": "-- Executive Vice President and Chief Operating Officer, U.S.", "name": "Stephen Pelletier", "position": "Executive" }, { "description": "-- Executive Vice President and Chief Operating Officer, International", "name": "Charles Lowry", "position": "Executive" }, { "description": "-- Principal Accounting Officer", "name": "Robert Axel", "position": "Executive" }, { "description": "-- Keefe, Bruyette & Woods -- -- Managing Director", "name": "Ryan Krueger", "position": "Executive" }, { "description": "-- J.P. Morgan -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "-- Morgan Stanley -- -- Managing Director", "name": "Nigel Dally", "position": "Executive" }, { "description": "-- UBS -- -- Managing Director", "name": "John Nadel", "position": "Executive" }, { "description": "-- Citigroup -- -- Managing Director", "name": "Suneet Kamath", "position": "Executive" }, { "description": "-- Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "-- Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by. Welcome to the Prudential third quarter 2018 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. If you have a question, press * then 1 on your touchstone telephone. You may remove yourself from the queue by pressing the # key. If you are using a speakerphone, we ask you pick up the headset before pressing the numbers. If you should require assistance during the call, press * then 0. As a reminder, this conference is being recorded.", "I would now like to turn the conference over to our host, Head of Investor Relations, Mr. Darren Arita. Please go ahead." ] }, { "name": "Darin Arita", "speech": [ "Thank you, Tawny. Good morning and thank you for joining our call. Representing Prudential on today's call are John Strangfeld, Chairman and CEO, Mark Grier, Vice Chairman, Charlie Lowry, Head of International Businesses, Steve Pelletier, Head of Domestic Businesses, Rob Falzon, Chief Financial Officer, and Rob Axel, Principal Accounting Officer. We will start with prepared comments by John, Mark, and Rob, and then we will answer your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the section titled Forward-Looking Statements and Non-GAAP Measures of our earnings press release, which can be found on our website at investor.prudential.com.", "Also, as a reminder, we will be hosting our 2019 financial outlook call on December 6th at 11 a.m. Eastern. In the call, we plan to provide our 2019 EPS guidance range. We hope that you will be able to join us. With that, I will hand it over to John." ] }, { "name": "John Strangfeld", "speech": [ "Thank you, Darin. Good morning, everyone and thank you for joining us. We're pleased with the continued momentum of our businesses. During the quarter, we rolled out and expanded initiatives to deliver financial opportunity to more and more people around the world. We produced sustainable returns and strong business growth and maintained a solid capital position while distributing $755 million to our shareholders via share repurchases and dividends.", "In addition, we announced leadership succession plans that reflected a thoughtful, multi-year process by our board and our organization's emphasis on talent and culture. I'm confident that our next generation of leadership, led by Charlie and Rob, alongside our seasoned management team will continue our momentum for many years to come.", "We also welcomed the Financial Stability Oversight Council's decision earlier last month to rescind Prudential's designation as a systemically important financial institution. We believe this outcome reflects Prudential's sustainable business model, capital strength, and comprehensive risk management framework, which have and continue to enable us to fulfill our promises to our customers, to deliver consistent performance, and to meet regulatory obligations.", "Turning to slide three, I will provide some additional financial highlights on the third quarter. We produced an annualized operating return on equity of 13.5%, above our near to intermediate term objective of 12% to 13%. Adjusted earnings per share for the third quarter were $3.15, up 5% from $3.01 last year, driven by business growth, tax reform, and capital management.", "Net income was higher in the year ago period, reflecting gains on derivatives. Our adjusted book value per share of $95.20 is up 12% over the prior year. This reflects the earnings we generated as well as the impact of tax reform and accounting changes implemented at the start of 2018.", "These items were partially offset by the payment of $3.45 per share of common stock dividends, totaling $1.1 billion and about $1.4 billion of share repurchases over the past year. Our performance for the third quarter was driven by momentum across our businesses, which worked together to serve the needs of our individual customers, distribution partners, and institutional clients.", "Here are a few highlights from the quarter. PGIM, which is our global investment management businesses, continued to produce positive net flows, this time of $8.7 billion for the quarter. Our retirement business had record account values of $447 billion, including net flows of $6 billion driven by our pension risk transfer and full-service sales. Our individual annuities business produced sales of $2.2 billion, which were 69% higher than the year ago quarter and up 8% sequentially. And we also continued to generate steady growth across our international businesses.", "Now, turning to slide four, I'd like to provide an update on Prudential's financial wellness initiatives, which are helping us build deeper relationships that address the changing financial needs of our customers. We're using technology to deliver the full breadth and depth of our collective businesses so that we can enter new market segments and address an increasingly diverse range of customer needs and financial challenges.", "One recent example is the launch of LINK by Prudential, an online experience that helps individuals visualize their financial goals. LINK connects individuals with solutions and financial professionals to help them with their unique goals, from investment in retirement to safeguarding the future of loved ones. One can access LINK via our Prudential.com website or through an employer where LINK is enabled through our digital financial wellness platform.", "I'm pleased to note our digital financial wellness platform, available to new and existing workplace clients, is growing rapidly. The platform enables individuals to engage in a wide range of financial topics, access multimedia content personalized for their needs, and utilize tools to better manage their financial lives. In addition, employers can better understand the financial wellbeing of their overall workforce.", "Today, our individual wellness platform is used by approximately 1,300 organizations covering more than 1.7 million employees. Our goal is to deploy this by early next year to more than 2,500 organizations covering more than 4 million individuals. Our customers aren't the only ones taking notice. We were honored to be included in Fortune Magazine's 2018 Change the World list, which highlights companies making a positive social impact through their core business strategies.", "And we continue to build upon our leadership position and commitment to financial wellness through the launch of programs like our State of US brand campaign. This campaign, informed by individual stories and intended to highlight the financial issues faced by every day Americans is currently airing across broadcast, social media, and other channels.", "To summarize, we are very excited about what our businesses can collectively deliver to make a meaningful difference in people's financial lives, helping them achieve their fullest potential as we unlock new opportunities to grow our business.", "With that, I'll turn it over to Mark, who will provide an update on how our businesses are executing on key priorities. Mark?" ] }, { "name": "Mark Grier", "speech": [ "Thanks, John. Good morning, good afternoon, and good evening. Before I touch on strategic and tactical highlights in individual businesses, I want to step up to the higher level of strategy, execution, fundamentals, and financial results.", "I've often commented that as a company overall and in a number of our individual businesses, we're a great story around the way these things have come together to drive successful business initiatives. Sometimes, they come together in individual businesses or business by business focused on specific things, and we've highlighted there, for example, success in Japan, success in pension risk transfer, the strategy, execution, and fundamentals story in PGIM, all of which play out very well for us.", "We're also now emphasizing strategies that leverage and exploit our whole franchise value. This adds to the dimension of cross-business, collaborative, and unique strategies, and unique execution opportunities for us. So, in that context, thinking about strategy, execution, and fundamentals, we're pursuing compelling objectives. I want to highlight four things that run through many of the aspects of the individual businesses that I'll touch on in a minute.", "First of all, we're enhancing how we help customers meet their needs. Remember, bring your challenges. The language of the company is solutions and outcomes. That's how we talk about our products now. We're focused on new distribution, making it easier for us to access clients and for clients to access us. Headlines there include the wellness platform and the digital initiatives. And we're growing in our existing distribution channels.", "Secondly, we're implementing process efficiencies to positively impact clients and their experiences with us. The results reflecting these two aspects of strategy and execution include good growth momentum, as evidenced by sales and flows over time across all of our businesses. But completing the story, profitable growth at attractive returns, reflecting financial and risk discipline, and thoughtful pricing strategies.", "So, as I go through the individual businesses, think about the way they tie back to meeting client needs, to improving processes, and to building growth momentum as we translate strategy into execution. I'll start now with PGIM. This is beginning with slide five in the deck.", "The PGIM strategy is defined by meeting client needs as a strategic partner and across a broad range of asset classes and investment vehicles. Now, engagement in dialogue with clients and partners has never been stronger. It's an interesting time, though. Interest rates are higher, equity markets are more volatile, and there's a positive return on cash. So, we would anticipate this would have an impact on client decisions and the way in which they think about things may result in more variability in the flows we see.", "But with the underpinning of very successful execution in the context of thoughtful strategy, we're maintaining very strong business momentum in PGIM. On slide five, I want to highlight a couple of things. Under key priorities, strong investment performance ultimately in a way drives everything. I want to highlight the five-year performance of AUM versus benchmark and note that 90% of the assets under management have outperformed their benchmarks over five years.", "Shifting to the lower-left picture, that investment performance fundamental translates in a near linear way into the very strong flows that we realized. This is the fundamental that we talk about all the time. We had a very strong quarter for institutional flows. We had record international flows. And we've commented before on 15 consecutive years of positive flows and institutional businesses and 13 consecutive years of positive flows in retail businesses.", "Just to touch on a couple of the other key priorities to grow earnings with respect to expanding our global footprint, as I just mentioned, we had record international flows in the quarter. We also have a record percent of our sales and investment professionals outside the US in PGIM now.", "With respect to products, we now have two active fixed income ETFs, launching the second one just about as I speak. We've established the new alternatives group that will focus on mezzanine finance and direct lending. So, the elements that execute in the context of strategy and strong fundamentals remain very much in place with respect to PGIM.", "Let me turn to retirement now on the next page. I really just want to highlight the two bottom charts. We're emphasizing flows in full service on the right-hand side. Year to date, $26 billion of sales and deposits in full service across a good mix of clients, between large clients and core clients and that's translated into $6 billion of net flows year to date in full service.", "We're also doing very well in PRT on the institutional investment side in the quarter, $5 billion of funded reinsurance PRT transactions and we announced another $1.6 billion transaction shortly after the quarter ended. We have a very strong and good pipeline in pension risk transfer, as we've mentioned often on these calls.", "As I bridge from retirement to group, let me highlight, again, the importance of the wellness opportunity, but specifically as it relates to these two businesses. Wellness amplifies our opportunities. It strengthens our sponsor relationships and it provides a meaningful retail potential for us through our institutional channels.", "So, as we move into a couple of comments on group, the first comment, deepening employer and participant relationships with financial wellness programs remains the centerpiece of a lot of what's going on group and we've talked about proof points there, demonstrating success.", "I do want to add with respect to process efficiencies and making us easier to do business with, that in group, we did launch additional digital capabilities in disability and these digital capabilities enhance and improve our claim submission and management results.", "Let me turn to individual annuities. Two quick highlights here -- the first is another dividend and you see in the bottom right-hand chart $285 million in the quarter. We've been highlighting free cashflow and attractive returns. That continues to be visible as we pay dividends from our annuity business.", "Then I also want to comment on the increase in sales. John mentioned it. The editorial on this is that sales in annuities are broader and deeper, reflecting growth in different products, diversification of products and also strength in our traditional channels.", "Before I leave individual annuities, just one additional comment, which is remember the wellness opportunity for secure retirement income. The individual annuity business, as are all of our businesses, has a role in our wellness initiative and the opportunity to put secure retirement income products on our wellness platform is something that we think is very important for us.", "Let me move to individual life on page nine -- I want to highlight two things here. I spent some time in the last call discussing a streamlined underwriting process that facilitates binding policies in as fast as 48 hours. During the quarter, we rolled that streamlined underwriting process out to third parties. Again, a substantial process improvement for us and something that we believe is a material benefit to our partners and our direct distributors in our individual life business.", "On the product side, during the quarter, we relaunched and improved VUL protector product in September, continuing our emphasis on matching the right products with the right opportunities and channels. So, we're optimistic about product enhancement as well as process enhancements in individual life.", "Let me turn to Life Planner and Gibraltar. Before I do, I want to briefly recap messages from our Tokyo investor day. We emphasized in our international businesses differentiated business models with superior execution. You should think of that as distinctive sales capability that drives high-return protection solutions in the market for us. We also talked about sustained growth with strong returns and steady capital generation and you should be thinking there that part of that growth opportunity is meeting evolving client needs.", "And then finally, we talked about strategic investments that enhanced our long-term prospects. So, those are the themes that run over both Life Planner and Gibraltar. So, I'm going to highlight a couple of more tactical aspects of where we are there. With respect to Life Planner, very good quarter for sales. Life Planner sales were up 11%. Sales in Prudential of Japan were up 17%. The Life Planner account in Japan and in Brazil has grown to an all-time record level. We had LP growth of about 5% in Japan. So, great dynamics there and I guess I'd emphasize the term we often use in international, which is that the vital signs look absolutely terrific.", "Turning to Gibraltar, I want to touch on the three distribution channels here because we have different things going on in each. With respect to the bank channel, our sales were down and this reflects the chronic discipline that we impose with respect to both pricing and product and the fact that we don't chase this market when it's moving in a direction in which we don't want to go, we will see declines in our product sales. So, we've seen it recently in the bank channel.", "On the other hand, the other independent agency channel is up about 9% and we are strategically expanding in the independent agency channel. So, that's a gratifying result for us. Then with respect to life consultants, we had been imposing higher standards. So, the emphasis on quality and productivity does result in a decrease in our life consultant count. We're down about 4%. But again, on the gratifying side, life consultant sales are just about flat.", "So, different stories reflecting the way in which we're approaching different channels in Gibraltar, but overall, a very good, consistent, strategic, and execution story, with respect to what's happening in Gibraltar. And I will stop there and hand it over to Rob." ] }, { "name": "Robert Falzon", "speech": [ "Thanks, Mark. I'll begin on slide 12 by highlighting the notable items which have impacted the current quarter adjusted operating results.", "As we introduced last quarter, in addition to the impact on results from the quarterly updated estimated of individual annuities profitability driven by market performance, notable items include the impact attributable to variances from our expectations for selected revenues and expenses.", "We highlight these latter items because while their contributions to the current quarter results are economic, they may not be indicative of future performance. The current quarter unfavorable impact of the market and experience unlocking in the annuities business was $36 million.", "The current quarter returns on non-coupon investments and pre-payment fees were about $35 million below our long-term expectations. The current quarter underwriting experience was approximately $65 million better than our average expectations, primarily driven by more favorable mortality experience in individual life, reflecting lower than expected large face claims.", "As an aside, while less favorable than our average expectations, our retirement business continued to demonstrate positive case experience in the quarter. In total, these notable items reduced pre-tax earnings by about $6 million or $0.01 per share. Excluding notable items, earnings per share would be $3.16, up 9% from the year ago quarter.", "In thinking about our earnings pattern, I would also note that we have historically experienced higher than average expenses in the fourth quarter. This includes the impact of seasonal items, such as annual policyholder communications, employee onboarding and severance, as well as business development, advertising, and other variable costs.", "Looking back over the past three years, this pattern has produced expenses on average about $125 million to $175 million higher in the fourth quarter than the average quarterly level for the respective year.", "In addition, we have completed the hedging of our expected yen earnings in our international business for 2019 and our hedging rate for the next year will be ¥105 per US dollar as compared to the ¥111 for 2018.", "Turning to slide 13, I'll provide an update on key balance sheet times and financial measures. Our cash and liquid assets at the parent company amounted to $5.2 billion at the end of the quarter. The sequential quarter increase of about $500 million was driven by proceeds from our $1.6 billion of junior subordinated notes issued this quarter, partially offset by senior debt maturities of about $700 million and a capital contribution to PICA to address the impacts of the Tax Act, as we've discussed on previous calls.", "I would also note that we have established a targeted range of cash and liquid assets at the parent company of $3 billion to $5 billion, with the low end of the range equal to approximately two times our annual fixed charges. Cash inflows from the businesses during the quarter supported the $755 million of shareholder distributions, which were roughly evenly split between dividends of $380 million and share repurchases of $375 million.", "And our share repurchases authorization for the remainder of the year is $375 million as of September 30th. Our domestic and international regulatory capital ratios are above our AA financial strength targeted levels. Further, we do not expect material impacts to target capital levels from the proposed variable annuity statutory framework that has been adopted by the NAIC variable annuities issues working group. Finally, our financial leverage and total leverage ratios remain within our targets as of the end of the third quarter.", "In summary, during the quarter, we generated a strong return on adjusted operating equity, double-digit growth in adjusted book value per share, and solid sales and net flows across our businesses while maintain a robust capital position. Our complementary mix of businesses, with leading market positions and integrated solutions for customers are executing on our strategies and producing attractive returns for our stakeholders.", "Now, I'll turn it over to the operator for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. Ladies and gentlemen, if you wish to ask a question, please press * then 1 at this time. Our first question comes from the line of Ryan Krueger with KBW. Please go ahead." ] }, { "name": "Ryan Krueger", "speech": [ "Hi, thanks. Good morning. If I look at your year to date run rate and adjust for tax reform, the growth has been on the high-end of the 6% to 11% guidance range that you gave last year and your ROE has been above the 12% to 13%. Can you help us think about -- have there been any major themes that would have impacted results this year that you wouldn't think would be sustainable going forward or is that a reasonable way to think about the growth and ROE power of the company, at this point?" ] }, { "name": "Robert Falzon", "speech": [ "So, Ryan, I think when we think about our ROE, the guidance that we gave was that in the intermediate term, we would continue to expect that to be in the 12% to 13%, given that we've gone through a fairly long period of sustained low interest rates. Obviously, interest rates have been moving up and we've had very favorable equity markets. The combination of those, particular very strong fundamental performance out of our businesses has resulted in our return on equity operating in a range that is at the very high-end of that guidance that we provided.", "At this point in time, given where we are in the cycle, that's probably to be expected. We talk about that 12% to 13% as being a return over a cycle. Over time, we're seeing the headwinds associated with sustained low interest rates are abating and we continue to see good fundamental performances in our businesses. So, over a longer period of time, we would expect that to allow us to return to that more normal long-term range of 13% to 14%. At this point in time, we're not ready to modify that guidance." ] }, { "name": "Ryan Krueger", "speech": [ "Okay. Thanks. Then on PRT, you had pretty good activity in the quarter. You've already announced on deal in the fourth quarter. Can you talk a little bit how the pipeline and how that looks there?" ] }, { "name": "Stephen Pelletier", "speech": [ "Ryan, it's Steve. I'll take that question. I think the pipeline looks very robust. Frankly, it looks as robust or even more so than we've seen in recent years. I think that's a combination of a couple of factors. First of all, the increase in interest rates and what that means in terms of higher funding levels for defined benefit pensions means that more and more companies are in a position to transact and propensity to transact continues to be powered by a growing awareness on the part of these companies of the longevity risk inherent in their plans.", "So, the combination of those two things makes the pipeline look very, very strong. We also feel very good about our ability to compete in the context of this pipeline. I say that in particular because we have visibility on a strong pipeline in the large case market, call it $1 billion, plus or minus, and above, in which we are particularly well-suited to compete due to the capabilities that we've built in the business around ability to bring transactions, to bring large transaction swiftly to an effective close and the ability to onboard large numbers of participants and give them the type of customer experience that the plan sponsors expect and that the participants deserve.", "Again, strong pipeline and we feel good about our position to compete in it." ] }, { "name": "Ryan Krueger", "speech": [ "Do you tend to see a desire by corporations to get things done before year end?" ] }, { "name": "Stephen Pelletier", "speech": [ "There does tend to be a tendency that we've seen for the third and the fourth quarters to be particularly strong in pension risk transfer activity. That's been in the case for the past few years now." ] }, { "name": "Ryan Krueger", "speech": [ "Okay. Great. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Jimmy Bhullar with J.P. Morgan. Please go ahead." ] }, { "name": "Jimmy Bhullar", "speech": [ "Good morning. I had a few questions on the international business. First, could you give some color on your other country sales, I think, were flat. So, which countries are you doing well in and where might sales be?" ] }, { "name": "Charles Lowry", "speech": [ "Sure, Jimmy. It's Charlie. Sales in Brazil continue to go up. As Mark said, we have a record Life Planner account. They have a high degree of productivity there. So, we see sales going up there. Sales in Korea and Taiwan were flat as we continue with our back to the basics strategy. The number of life planners have been decreasingly.", "Interestingly and one really good thing that's happening in Korea is that we have shifted a number of life planners, a significant number of life planners, over to be sales managers. As you've seen in Japan when we have done that in Prudential of Japan, our life planner business there, what happens is you have about a year lag, but then you start increasing the number of life planners. So, I think our transition of life planners to sales managers in Korea bodes well for sales in the future." ] }, { "name": "Jimmy Bhullar", "speech": [ "Okay. Do you expect an impact on your Japanese business from the expected increase in the consumption tax in 2019?" ] }, { "name": "Charles Lowry", "speech": [ "Not as much. So, much of the business we do isn't affected by the consumption tax. Some of it is in, say, the bank channel. A lot of it is not. The consumption tax has to do with where the business is done and also the size of the business. So, it may have a marginal impact, but when the consumption tax went up a number of years ago, we didn't see a significant effect from it." ] }, { "name": "Jimmy Bhullar", "speech": [ "Then just lastly, I think you mentioned that Life Planner expenses were lower because of either timing or other things. Can you quantify how much that was?" ] }, { "name": "Charles Lowry", "speech": [ "Not really. What happened in the POJ is there were a number of dominoes that all fell in the right direction. This was throughout, actually, the businesses in Japan. So, it happened with Gibraltar too. Some of the businesses had ones and twos fall in our direction and then we had some expense timing things, which will probably fall into the fourth quarter. We're not going to give you a number, but there were both those factors that led to what we would say an elevated income level this quarter." ] }, { "name": "Jimmy Bhullar", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Nigel Dally with Morgan Stanley. Please go ahead." ] }, { "name": "Nigel Dally", "speech": [ "Thanks. Good morning. On the annuity space, it's somewhat surprising to see the core earnings sequentially decline given the strength of equity markets that we saw last quarter. I'm hoping you can provide some color on what drove that and what we should expect with a return on assets, how we should expect that to trend." ] }, { "name": "Stephen Pelletier", "speech": [ "Nigel, it's Steve. I'll take your question. Thanks very much. This quarter's ROA of 118 basis points reflects a couple of things that we mentioned. First of all, while we didn't call them out in our release or anything like that, we did have some one-time costs associated with the systems migration that reflected about 2 basis points.", "Second, we also had higher variable selling costs, which are included in that ROA calculation and that comes with the higher sales that we saw in the business in the quarter. That, again, reflected for about another 2 basis points. So, if you build those things into the equation, we still see an ROA in the annuities business that is very consistent with the guidance that we've given before, 120-basis point range, give or take." ] }, { "name": "Nigel Dally", "speech": [ "That's helpful. Thanks. The second question is on losing the SIFI designation. I know you still group supervise in New Jersey, but are there going to be some expenses that you're likely to realize from losing that designation?" ] }, { "name": "Robert Axel", "speech": [ "Nigel, it's Rob. So, what we've expressed before, I think, still holds. If you look last year, our enhanced supervision costs were about $120 million for the full year. As we think about no longer being a SIFI, our expectation is about a third of those costs go away very rapidly, almost instantaneously, which is a combination of the fees that we're paying for Fed supervision and some consulting expenses that we would no longer need to incur.", "About a third of those costs are associated with projects that we're in the process of completing. They will sunset or go away in the course of 12 to 18 months. Then the remaining third probably represent ongoing costs of group supervision that we expect to incur, both in response to the group supervision in New Jersey as well as the engagement that we have on an international basis as well." ] }, { "name": "Stephen Pelletier", "speech": [ "Nigel, this is Steve. I'd like to jump back in and just expand a bit on the question you asked about annuities ROA. In my response to that, I mentioned the variable selling costs. I'd think I'd like to put overall expense profile of the US businesses year over year into context. In the overnight calls, a few different people inquired about increases in expenses in the US businesses. I think the numbers that you were looking at very much included those variable selling costs.", "We look at our operating expenses exclusive of those costs because those costs naturally go up and down with our sales levels and in a robust sales quarter, which we hope to continue, they were elevated this quarter.", "Year over year, the operating expenses in the US businesses, exclusive of variable selling costs were up 3%. That 3% includes normal inflationary adjustments. It also includes substantial investments that we're making in the current and future growth of our businesses and growth of their earnings.", "You're going to hear more about these investments in our guidance call next month. But sufficed to say for right now, we already see these investments paying off. I just called out a couple of examples. In PGIM, the investments we've made in our distribution capabilities and in our product range have continued to drive flows and profitability in the business. And in group insurance, the investments we've made, for example, in disability claims management has been a big part of the earnings progress of that business.", "We also are making significant investments in our financial wellness value proposition and advancing that into the marketplace. We're continuing to see a favorable impact, especially at the employer level. Since we embarked on this a year and a half-plus ago, the financial wellness initiative has accounted for about $100 million in group premiums, which we consider to be an early indication of the success of this.", "But, like I say, these investments are already included in that 3% growth. The reason we're able to make these types of investments and still show a moderate and well-controlled expense growth is that we continued to, as Mark mentioned in his comments, we continue to find opportunities to create cost effectiveness and cost savings in the kind of business-as-usual platforms for our businesses.", "It's not been our usual practice to make big announcements about finding these cost savings and to call them out with major charges taken in association. This is part of our DNA. This is what we do year in, year out, quarter in, quarter out. So, again, we're able to make significant investments while showing well-controlled expense growth." ] }, { "name": "Nigel Dally", "speech": [ "That's very helpful. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of John Nadel with UBS. Please go ahead." ] }, { "name": "John Nadel", "speech": [ "Good morning, everybody. I have two questions on PGIM. If we talk about the base asset management fees, it looks like that's trending very nicely and sort of in line with your expectations. Other revenues are maybe what we used to think of as the incentive and transaction revenues were pretty low this quarter, frankly the lowest we've seen in several years. I'm just curious if that's more of a function of a mix shift, where we ought to expect that contribution is going to be lower on a go forward basis or is there just a timing issue here?" ] }, { "name": "Stephen Pelletier", "speech": [ "John, it's Steve. I'll address that question. We don't think in terms of a run rate on other related revenue because of the inherent variability of it. Just to be helpful, we've observed in the recent past that the mathematical average of that over the past few years has been right around the $50 million range, but I think we've also been careful to caution against looking at that as a run rate.", "What drove the lower number this quarter was a couple of things. Lower agency production, which is, again, going to be inherently variable quarter to quarter, but where we continue to see solid growth year in, year out in our agency production, and the second is strategic investing. Strategic investing for us is very much associated with the extension of our product design and the launch of new product and the investment of seed money in those products.", "This quarter, we put some seed money and did some strategic investing in some global and emerging markets strategies and emerging markets had a tough quarter. That's kind of associated with the extension of the product design." ] }, { "name": "John Nadel", "speech": [ "Understood. That's helpful. A bit broader question -- I'm just wondering what the investment side of the house was thinking in terms of where we are in the credit cycle, how close to a turn and what, if anything, you're doing with the general account reposition to get a bit more defensive as we get later and later in the cycle." ] }, { "name": "Robert Axel", "speech": [ "So, John, it's Rob. Let me take a whack at that. We look at credit management investing as one of our core strengths. We have a very strong investment portfolio. We carefully manage that to concentrated limits and we're really disciplined about ALM. It is one of the core strengths of the organization. You're seeing the manifestation of that and how we perform cycle in and cycle out.", "Our standard portfolio, frankly, is more defensive and then you'll find if you look at the industry benchmarks. We have a large portfolio of government bonds driven in part by our business in Japan, but it's in excess of a third of the portfolio in the general account and in excess of 40% to 45% of our fixed maturities are actually in the US or JGBs or other government bonds.", "The below investment grade portion of our portfolio is only around 4% and within that, some 60% to two-thirds is actually in private placements, which is of a significantly higher caliber than what you're going to find if you look at below investment grade publicly traded securities.", "We underweight energy, finance, and telecom. By contrast, we overweight things like consumer non-cyclical, utilities, and transportation. Then when you look at the mortgages that we hold, the real estate portfolio, we're overweight multifamily and industrial and we're underweight in office and retail. So, that would play itself well to if you think about how cycles play out. We don't really manage the portfolio up and down in anticipation of the cycle. We do things on the margin, obviously, but if you look at how the portfolio is managed throughout the cycle, what you would find is it is conservative vis-à-vis our peers.", "Two other things I'd probably want to throw on to that -- we leverage PGIM. PGIM is one of the ten largest global investment managers with a real franchise in fixed income. Our general account benefits by that, very specifically with their regard to generate private placement and privately originated commercial mortgages for the portfolio. These are much higher quality than what we find in the public marketplaces that might be agented or underwritten by brokers.", "Those securities have a really attractive risk-return profile that's associated with them. All of that produces -- if you look at our 10-year loss experience, what you're going to find is it's below our benchmarks, below what we embed in our pricing. All of that includes having gone through the financial crisis when you look at the statistics.", "The second thing I want to mention, since you brought the topic up, if you don't mind, is I've seen a number of research reports that try to look at credit exposure for us and others in the industry that kind of look at a leverage ratio, looking at the assets on the balance sheet measured against the equity on the balance sheet. That's an interesting and potentially helpful way to look at exposure to credit but ought to be more nuanced than what I've seen to date.", "Particularly, when I look at our ratio on that, on a superficial basis, we would look to be on the higher end of our peers, but when you look at it on the actual underlying credit leverage that we have, we're actually at the very low end of the peer group. There are a couple of things that are particularly noteworthy there that drive that. The first is we have $80 billion of general account assets where we actually don't bear the credit exposure. It's past through the participating policies, like, for instance, our closed block, which is some $60 billion of that in assets.", "Incidentally, when you look at a leverage ratio, on a GAAP basis, that actually has negative GAAP equity to the tune of about $1.7 billion. So, it throws those ratios off when you include something like that.", "As I mentioned before, we hold a significantly larger than typical portfolio of government bonds and around a third or so of the general account. So, our credit leverage, when you pull out both the -- when you adjust for the government holdings and adjust for the participating assets, participating liabilities that we have, it's significantly lower. Then there are some other adjustments that feed into that that are worth thinking about as well, like our foreign exchange remeasurement adjustment that we made when we calculate our return on equity. That's about $2.5 billion of incremental equity that is temporarily hung up in AOCI and really belongs in retained earnings. And we have very little goodwill. So, when we look at those measures, our goodwill is like $850 million on the balance sheet.", "So, properly adjusted, when you think about our credit leverage ratio using the construct that I've seen in a number of the reports, what you would see is we are very, very pow on that ratio, reflecting all the conservative management of the portfolio that I was articulating in the first part to your question." ] }, { "name": "John Nadel", "speech": [ "If I can sneak one last one in -- you had mentioned that expenses were a bit higher, maybe to the tune of something like two to four basis points. Charlie, I know you don't necessarily want to talk about the ones and twos overall, but is it fair for us to think about the lower level of expenses in international being largely offset by the higher in annuities?" ] }, { "name": "Stephen Pelletier", "speech": [ "I guess that's how it works out mathematically, John, but I don't see any correlation between the two." ] }, { "name": "John Nadel", "speech": [ "I'm not saying there is, but I'm just saying they're roughly similar. That's all." ] }, { "name": "Robert Falzon", "speech": [ "We're not really giving out a number. We're just saying there were some expenses that were deferred to fourth quarter and there some good guys that fell our way. They added up to a material number." ] }, { "name": "Robert Axel", "speech": [ "John, it's Rob. Let me add one last comment to that. We look at the quarter holistically. There were puts and takes. So, when we look at that result on an overall basis, what you're seeing is having a diversified portfolio of businesses that are all high-quality in and of themselves but at any point in time, they produce results that are above or below what we would normally expect or see in a given quarter.", "What we saw in this quarter is international outperformed and some of our domestic businesses underperformed. Those things offset. So, when we look at the holistic result for the quarter, we think you can look at that as representative of the totality of our businesses." ] }, { "name": "John Nadel", "speech": [ "That's very helpful. Thanks, Rob." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Suneet Kamath with Citi. Please go ahead." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. If I look at your year to date capital return measured against your AOI, I think you're tracking less than the 65% free cashflow guidance. Any reason why maybe you're below that and is there the potential to accelerate buybacks starting down some of the holding company cash, which is at the high-end of your $3 billion to $5 billion range." ] }, { "name": "Robert Axel", "speech": [ "Suneet, it's Rob. As we've articulated, we think that about 65% of our operating earnings do translate into free cashflow. We've typically thought about redeploying that and we redeployed in a combination of dividends. Typically, without being mathematical about it, within a range, we think, about half that working its way in the form of dividends to shareholders and the other half of it we think about is as redeploying either in the form of returns to shareholders or if we have the opportunity to deploy it into investments, which can grow our businesses inorganically.", "So, as we think about that, there's no reason that our philosophy in that has changed at all. The mathematics of that can vary in a given quarter or for the year, but we have a very disciplined approach and a very thoughtful approach. As we look at establishing our expectations for buybacks in a given year and our dividend policy in a given year, we refer back to just the way you articulated.", "We've got 65% and that's available to either return to shareholders or to redeploy otherwise in order to grow earnings on behalf of shareholder returns as well." ] }, { "name": "Suneet Kamath", "speech": [ "Okay. I guess my follow-up question -- if I think about Lincoln's earnings call from last week, they brought up this idea of using some of the legacy blocks and reinsurance transactions bringing capital to even do more on the share repurchase side. Just given where your valuation is and reasonably similar to where LinkedIn's is, is that something that you guys have in the toolkit around capital? I really haven't heard you guys talk about it that much." ] }, { "name": "Robert Axel", "speech": [ "Suneet, Rob again. We are always reviewing opportunities to optimize capital management and we're engaging with market participants to understand the range of opportunities that might be out there. I would note with respect to the specific Lincoln example that we generally have very well underwritten books and we are not a distress seller. So, any transaction would need to be economically compelling to us in light of what we think are the highly attractive economics associated with the portfolio that we've got, but I'll end with where I started, which is we are absolutely reviewing those opportunities and seeking to optimize our capital management." ] }, { "name": "Suneet Kamath", "speech": [ "If I could sneak one more in on a related topic, just on long-term care, we've heard on different calls that private equity is going to stiffen around long-term care blocks. Are you guys hearing anything in that regard with respect to your block?" ] }, { "name": "Robert Axel", "speech": [ "I wouldn't change the answer I gave you to the prior question, which is long-term care would be included in that evaluation that we do and the things that we evaluation." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks, Rob." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Erik Bass with Autonomous Research. Please go ahead." ] }, { "name": "Erik Bass", "speech": [ "Thank you. Your group margins continue to be favorable relative to your guidance at the beginning of the year. This has been a consistent trend we've seen across the industry and others have talked about expecting this to continue near-term. I guess as you look at your experience, is there any reason to think that you couldn't continue to turn the favorable end of your guidance range?" ] }, { "name": "Stephen Pelletier", "speech": [ "Erik, this is Steve. I'll address your question. You're quite right in observing that we've been on the positive end of the range, the low end of the range or below. That's for certain fundamental reasons that we've spoken about, including well underwritten business and effective claims management.", "We do think that these trends that we've created in the business are for solid fundamental reasons and that that bodes well for sustainability. We're not prepared right now to offer any change in the guidance we've previously given, but you're quite right in noting where we are in the fact that that favorable positioning is driven by fundamentals." ] }, { "name": "Erik Bass", "speech": [ "Thank you. I'm curious if there's any change in your areas of focus, I guess particularly given the wellness initiatives and your belief in the ability to cross-sell and leverage employee relationships, does this change your level of interest in group or retirement businesses or other platforms that would bring on more employer/employee relationships?" ] }, { "name": "Stephen Pelletier", "speech": [ "This is Steve again. We are quite interested in various opportunities as they may arise. We feel very good about our ability to build the customer engagement funnel that we have in our financial wellness offering.", "Obviously, the top of that funnel starts with the employer businesses, as you mentioned, group and full-service retirement and we're very alert to opportunities as they exist, in addition to the organic growth that we've been able to sustain and, in fact, accelerate in various lines of business, as witnessed by our strong group sales earlier in the year and our strong full-service sales throughout this year, including in particular this quarter.", "As we assess those opportunities, we will very much look at them in the context of the lifetime value of the customer because we feel like we have built the capability to engage with customers throughout that engagement funnel in ways that will enable us to offer solutions to those customers that help them achieve their financial objectives and help us achieve that lifetime value.", "Having said that, we will continue our long-standing approach of being a disciplined acquirer and as we previously noted, some of the group transactions that have taken place in the marketplace have taken place at multiples that, let's just say, have been highly elevated, but that's not to say that we don't continue to look for those opportunities, even as we continue to build momentum in our organic ability to expand that top of the funnel." ] }, { "name": "Erik Bass", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our lost question come from the line of Alex Scott with Goldman Sachs. Please go ahead." ] }, { "name": "Alex Scott", "speech": [ "The first question I have is just a follow-up on the annuities ROA. I think in the past, you guys have talked about a 115 long-term ROA target. Are you seeing any of the drivers that would drive you down toward the 115 from the 120s that you've seen previously? Are hedging costs ticking up and is there any offset from interest rates that might allow that long-term target to be higher?" ] }, { "name": "Robert Axel", "speech": [ "Alex, it's Rob. Let me take part of that and then I'll turn it over to Steve to talk about some of the longer-term trends, specifically around the hedging piece of it. If you look at our hedge effectiveness during the course of the quarter, it was 97% effectiveness and then if you roll that forward and look at the month of October, given there was significantly higher volatility in October, we were still in excess of 90% hedge effectiveness. So, on a year to date basis through the end of October, we actually had 99% hedge effectiveness.", "When we talk about hedge effectiveness, that includes the cost of hedging in that effectiveness and that cost of hedging is included in the AOI results that you're seeing in the current quarter or in prior quarters. So, when you look year over year, we called out in our release the increase in hedging costs.", "But that wasn't sequential. That was year over year because when you look at the third quarter of last year, that was before we put in place the refinement in the hedging strategy that we introduced in the fourth quarter, which allowed us to reduce the level of variability and outcomes given the very high economic results that we're getting out of the annuities business by adjusting the equity hedges that we had in the portfolio.", "That was in place both in last quarter and this quarter, it just wasn't in place a year ago. So, when you look at the hedging costs, there isn't a bias toward that producing pressure on our ROAs on a go-forward basis. The costs recurring from hedging are within a range of our expectations.", "So, with that, let me turn it over to Steve to talk about longer-term prospects." ] }, { "name": "Stephen Pelletier", "speech": [ "Alex, I spoke earlier about a couple of specific costs that are affecting this quarter's ROA. In addition to that, as we previously pointed out, there is one factor that will produce very, very gradually over a multi-year period some pressure on the ROA and that is the emergence of more of our business, the maturation of more of our business and its emergence into lower fee tiers.", "This is a very common pricing practice in the annuities industry that the fee tiers lower sometime at or after the end of the surrender charge period. The facts are simple. We wrote a lot of highly profitable business in annuities in the 2009, '10, '11 years when equity markets were suppressed and it was a good time to take on this risk. We were writing this business even as many participants in the market were pulling way back.", "So, we do have a meaningful amount of business now emerging beyond the surrender charge period and into these lower fee tiers. But the emergence of that impact, I will emphasize, again, is very, very gradual and occurs over a multi-year period." ] }, { "name": "Alex Scott", "speech": [ "Got it. Thank you. Maybe just a quick follow-up on full-service -- can you quantify how much the positive flow experienced in volume growth you've been getting has been from some of the initiatives you've been undertaking with LINK and expanding your platform?" ] }, { "name": "Stephen Pelletier", "speech": [ "Alex, it's Steve again. We feel that over the past several quarters, as we've advanced the financial wellness value proposition into the marketplace that that financial wellness offering has been accountable for some $5 billion of our full-service sales. So, a healthy contribution to our momentum in the business." ] }, { "name": "Alex Scott", "speech": [ "Got it. Thanks very much." ] }, { "name": "Operator", "speech": [ "Thank you. That concludes our question and answer session. We'll turn the call back to John Strangfeld for closing remarks." ] }, { "name": "John Strangfeld", "speech": [ "Thank you very much. I'd just like to bring this back and close it with a few final thoughts. It's been a privilege to lead our company over the last 11 years, parenthetically 44 earnings calls, during which we've significantly evolved and grown our business and delivered innovative solutions to our customers and I'd like to personally thank all of our employees for their support as they are the cornerstone of the company's success, success in delivering value to our customers, our community, and our stakeholders.", "I'd also like to recognize the extraordinary partnership I have enjoyed with Mark over the last 11 years, which has been highly productive, personally enriching, and an incredible and unforgettable example of the power of partnership, one that's based on mutual respect, complementary skills, and trust. I look forward to Charlie and Rob experiencing the same kind of partnership as they move forward working together with an outstanding management team.", "With that, I'd like to thank you very much for your time and attention and wish you a good day." ] }, { "name": "Operator", "speech": [ "Thank you. Ladies and gentlemen, that does conclude your conference for today. We thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect." ] }, { "name": "Alex Scott", "speech": [ "More PRU analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
PRU	2019-08-01	[ { "description": "Head of Investor Relations", "name": "Darin Arita", "position": "Other" }, { "description": "Chairman and Chief Executive Officer", "name": "Charles F. Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Robert M. Falzon", "position": "Other" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Executive Vice President and Chief Operating Officer, International Businesses", "name": "Scott Sleyster", "position": "Executive" }, { "description": "Vice President Key Accounts", "name": "Steven Shorey", "position": "Executive" }, { "description": "", "name": "Unidentified Speaker", "position": "Other" }, { "description": "Morgan Stanley", "name": "Nigel Bailey", "position": "Other" }, { "description": "Wells Fargo -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Evercore -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Citi. -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Credit Suisse", "name": "Andrew Kligerman", "position": "Other" }, { "description": "Dowling & Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "John Nadel", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by and welcome to the Prudential Quarterly Earnings Call. [Operator Instructions]. Later, we will conduct a question-and-answer session, instructions will be given to you at that time. [Operator Instructions]. I would now like to turn the conference over to Mr. Darin Arita. Please go ahead." ] }, { "name": "Darin Arita", "speech": [ "Thank you. Cynthia. Good morning and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, Chairman and CEO, Rob Falzon, Vice Chairman, Steve Pelletier, Head of Domestic Businesses, Scott Sleyster, Head of International Businesses, Ken Tanji, Chief Financial Officer and Rob Axel, Controller and Principal Accounting Officer. We will start with prepared comments by Charlie, Rob and Ken and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements. Please see the slide titled forward-looking statements and non-GAAP measures in the appendix to today's presentation, which can be found on our website at investor.prudential.com. Also in response to your request, we are changing the timing of our earnings release date starting next quarter. We will report our Q3 results on Monday, November 4 and host the conference call on Tuesday, November 5 at 11:00 AM.", "With that I will hand it over to Charlie." ] }, { "name": "Charles F. Lowrey", "speech": [ "Thank you Darin. Good morning everyone and thank you for joining us. As we outlined in our Investor Day in early June, we are accelerating our strategy to bring greater financial opportunity to more customers and to enhance the value we provide to our investors. Across each of our businesses, we are energized by our purpose of making lives better by solving the financial challenges of our changing world. As the expectations of our customers rapidly evolve, it's imperative that we would move quickly and with urgency to achieve our purpose. Despite what we would characterize as a mixed quarter, we remain confident about the financial goals, we shared with you during our Investor Day. At that time, we increased our return on equity goal to a range of 12% to 14% from the prior range of 12% to 13%. We also articulated, how we can achieve a high single-digit earnings-per-share growth rate over the intermediate term with potential for a low double-digit growth rate over the longer term.", "The strength of our distinct business model and ability to execute our strategy gives us confidence that we will achieve our financial results. Our US financial wellness businesses, PGIM and our international business offers unique scale and growth opportunities that cannot be easily replicated. In the near term, however, we expect several factors to impact our level of earnings. First, as we discussed on Investor Day, there will be implementation costs from accelerating our strategy. Second, the significant decline in long-term interest rates over the past six months, obviously affects our spread income and reinvestment rates of our general account. Third, this quarter's assumption update in Individual Life reduced future earnings. And fourth, we expect lower earnings in Gibraltar.", "Now we have ways to mitigate some of these effects, we believe the actions to accelerate our strategy will lead to $500 million of margin improvement of which we expect to realize a run rate level of $50 million by the end of this year. In addition, we can adjust our pricing streamline distribution and optimize our in-force book, all of which we are seriously pursuing. As we said during our last call and on Investor Day, we're also very focused on connecting our track record of operating fundamentals with commensurate financial outcomes. Quite frankly part of this is on us to produce better financial results, and we get it, but part of this relates to better aligning external expectations with our internal forecast. And part of this call is focused on trying to do that. As a result, we enhanced our disclosures this quarter to help give you better visibility on our expected results and Ken will cover this in more detail.", "We also continue to explore ways to reduce the variability of our quarterly earnings, which as you know has been and remains an ongoing effort. Turning back to the second quarter financial results, we generated a return on equity of 12.9%, which is in line with our 12% to 14% goal. We grew adjusted book value per share by 5% from a year ago to a record level of $97.15. We also maintained a rock solid balance sheet, this provided the foundation for us to return $911 million to shareholders through share repurchases and dividends. Our quarterly dividend of $1 per share represents a 4% yield on our adjusted book value. Our holding company's highly liquid assets stood at $4.9 billion at the top end of our target range of $3 billion to $5 billion.", "Turning to slide three, our adjusted earnings per share was $3.14, up from $3.01 a year ago. Our sales and net flows varied by business and were mixed in this quarter, but we continue to see a robust pipeline of opportunities. During the quarter, PGIM had net outflows, driven by a large client withdrawal, which was unfortunate, but frankly inevitable from time to time when you are the 10th largest asset manager in the world. Also Gibraltar had lower sales as we focused on recurring premium product and profitability over the total sales amount, which is consistent with the way in which we run this business. On the positive side, our retirement business achieved record account levels of $478 billion and net flows of $15 billion, driven primarily by a robust pension risk transfer pipeline. And our individual annuities and individual life sales were up 29% and 27% respectively.", "Our Individual Annuities business, continue to generate consistent quarterly dividends to the parent company with more than $1.1 billion produced over the past 12 months. Finally, our Life Planner head count in our International business reached an all-time high.", "And with that, I'll turn it over to Rob to touch on strategic highlights from the quarter." ] }, { "name": "Robert M. Falzon", "speech": [ "Thanks, Charlie. I will provide more color on how we are growing our three differentiated businesses. US Financial Wellness, PGIM and International. As shown on slide four US Financial Wellness represents our workplace and individual solutions businesses that produce a diversified source of earnings from fees, investment spread and underwriting income. A broad set of integrated capabilities, including advice, retirement investments and insurance solutions continue to help people with their financial wellness needs. Our financial wellness proposition is resonating with workplace customers in the higher sales and this is resonating with the employees at those customers, driving higher participation rates in the employer benefit programs and increased engagement with our advice platform.", "We believe the success has the potential to increase the intermediate term earnings growth rate of our underlying US businesses into the mid to high single digits. There are three drivers of this earnings growth in financial wellness. First, we expect increased operating margins across our workplace in individual solutions businesses. This will result from the comprehensive at scale solutions that our businesses provide and the investments that we're making to enable our broad capabilities, while enhancing the customer experience. The current quarter, we incurred about $20 million of implementation costs to support programs that will accelerate our financial on the strategy. We believe these actions along with the other programs over the next three years, will lead to $500 million of margin improvement by 2020. Second, we expect increased revenues in our workplace solutions businesses due to the competitiveness of our financial wellness platform and the increased utilization of the existing employer offered benefits by our clients, employees.", "Since the end of the first quarter of this year, the number of people who have activated our digital financial wellness platform has increased from $8.1 million to $8.6 million as of June 30. This platform provides a digital venue to address a variety of needs, including education on financial wellness topics, assessment of financial health and tools that enable people to take action and improve their financial outcomes. In addition, Prudential pathways program has been adopted by 650 of our workplace clients. In this program employees of our workplace customers participate in financial seminars delivered by Prudential's financial advisors and designed to help educate people so they can improve their financial outcomes. And third, we expect increased revenues in our individual solutions businesses business due to our ability to provide additional solutions to the employees of our workplace customers and to other retail customers.", "One way we deliver these solutions is through linked by Prudential which is our highly interactive personalized online resource that enables people to create a path toward achieving their financial goals began to deploy link on our workplace platform last quarter and we have already made it available to roughly 1.3 million people, up from 200,000 at the end of March.Our goal is to double this 2.5 million people by year-end. Ultimately, we believe our solutions can change the way people approach their financial health produce better results for employers and significantly expand our addressable market. Thereby enhancing our long-term growth potential.", "Turning to slide five PGIM or asset management business has $1.33 trillion of assets under management is a top ten global asset manager ranking as the fifth largest investor in fixed income, and the third largest investor in the alternative investment area with significant real estate and private platforms. PGIM is the investment engine of Prudential and benefits from a symbiotic relationship with our US financial wellness and international insurance businesses. PGIM's asset origination capabilities and investment management expertise, provide a competitive advantage to our businesses helping those businesses to bring enhanced solutions and more value to our customers both retail and institutional.", "At our businesses in turn provide a differentiated source of growth for PGIM to affiliated AUM flows that complement its successful third party track record. Consistent with our historical earnings growth we expect PGIM to generate mid to high single-digit earnings growth through a market cycle. This is driven by revenue growth from our proven ability to capture industry flows and market share in the areas where we already have leading capabilities while expanding our margins.", "Our strong investment performance and expertise across a broad range of asset classes has allowed us to attract flows into higher returns higher return strategies, such as emerging markets and alternatives.This focus on higher yielding strategies and asset classes has resulted in our ability to maintain a 22 basis point overall asset management seed yield. 90% or more of the assets under management have outperformed their benchmarks over the last five and ten year periods and this investment performance has driven 16 consecutive years of positive third party institutional net flows, which we're confident will continue despite the $5 billion third party net outflows that we experienced in the current quarter.", "These institutional outflows were mainly driven by a single fixed income client withdrawal of $5 billion. We serve many of the world's largest pension funds and other institutional investors and as a result, we will experience large idiosyncratic inflows and outflows from time to time. Our third party net retail inflows were $1billion driven by fixed income flows, partially offset by equity outflows. We are encouraged by our pipeline of mandates and our ability to continue to grow PGIM the investments we've been making to expand our global distribution.", "The growth opportunities we see in markets such as alternatives US defined contribution in retail, and international and the investments we're making in technology. I'm turning to slide six , our international business includes our world-class Japanese life insurance operation where we have a differentiated business model with unique distribution as well as other expanding businesses in high growth markets like Brazil.", "We anticipate being able to grow earnings in our international business at a mid-single digit rate over the intermediate term driven by sustainable revenue growth and stable margins while continuing to produce ROEs in the [Indecipherable]. Life Planner sales which are about half of the total international sales in the current quarter increased by 5% compared to the year ago quarter. This was driven by higher US dollar sales in Japan and continued growth in our Brazil operations,.", "Sales for Gibraltar, which represents the other half of international were 26% lower than a year ago. This reflects lower single-pay US dollar fixed annuity sales in our life consultant channel as we continue to focus on recurring pay protection products . In addition, the recent decline in US interest rates resulted in lower crediting rates which also affected sales.", "Additionally, sales were affected by continued competitive conditions in the bank channel and lower production in our independent agency channel, expect these channels to be more volatile sources of growth measured in the short-term due to competitive market pricing dynamics .", "We'll continue to innovate new products and consider pricing actions while focusing on maintaining our target level of profitability to improve sales over time, particularly in our life consultant channel.", "In summary, our differentiated businesses waffle strategies and quality execution continue to serve our customers well and will generate profitable at attractive returns consistent with the intermediate term expectations that we articulated during our recent Investor Day.", "And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I will begin on slide seven, with some enhanced disclosures that we've added this quarter to provide more insights about our earnings for the upcoming Q3 and beyond. Relative to our current Q2 earnings.", "First, we begin with our Q2 pre-tax adjusted operating income, which was $1.7 billion and resulted in earnings per shares of $3.14 then when we adjust for these items, we get a baseline of $3 per share for the third quarter before including the impact of future share repurchases business growth and market impacts. Now there are three categories to consider.", "First, the Q2 included a net unfavorable impact of $49 million in this year's annual actuarial review, which will not occur in the Q3. Second, we assume variable investment income will return to a normalized level, which is worth $90 million. And third, there are other considerations we expect will lower results by $30 million in the Q3. Gibraltar earnings are expected to be $15 million lower due to lower sales and lower interest rates and corporate and other is expected to have $15 million of higher expenses.", "While we have provided these items to consider there may inevitably be other factors that affect Q3 earnings per share. Also as Rob mentioned, we incurred about $20 million of an implementation costs to accelerate our financial wellness strategy in the current quarter.", "We hope this slide provides enhanced visibility for future EPS considerations.", "Also, on slide 18, we have provided information regarding seasonal items by business. One item to note is the end of the Wells Fargo fee arrangement in the first quarter of 2020 which has recently been approximately $15 million per quarter.", "Turning to slide eight, I'll provide an update on capital deployment liquidity and leverage. We feel very good about the overall strength of our capital position. We returned $911 million to shareholders during the current quarter through dividends and share repurchases.", "Our share repurchase authorization for the remaining year is $1 billion as of June 30 and over the last five years, we've increased our dividend per share by 16% per year on average. As Charlie noted, our quarterly dividend of $1 represents a 4% yield on our adjusted book value. We also continue to maintain a rock solid balance sheet, our regulatory capital ratios continue to be above our financial strength targets and our financial leverage ratio remains better than our target.", "We are also pleased that Moody's recently acknowledged our financial strength with our credit upgrades, our cash and liquid assets at the parent company was 4.9 billion at the end of the quarter, consistent with the first quarter of 2019, and at the top end of our $3 to $5 billion liquidity target range. We look to continue to invest in our businesses to grow assess acquisition opportunities to build scale or gain capabilities and return capital to shareholders. Turning to slide nine, and in summary, we are focused on accelerating our strategy and remain confident in our planned initiatives for growth. We have generated in ROE that is within our goal of 12% to 14%, along with a record high adjusted book value per share. We continue to generate strong cash flows that support consistent growth in dividends and other distributions to shareholders and we maintain a robust both capital and liquidity position, with financial flexibility. Now, I'll turn it back over to the operator for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. And ladies and gentlemen [Operator Instructions]. We'll go to the line of Nigel Bailey with Morgan Stanley. Your line is open." ] }, { "name": "Nigel Bailey", "speech": [ "All right, thanks and good morning. So looking at slide seven, you baseline the earnings that $3 would annualized to 12. This is quite a significant reduction from the 12.75 midpoint guidance you provided at the outlook now in your prepared remarks, you highlighted a a number of factors behind that. But hoping you can get run through each of those in some more detail ?" ] }, { "name": "Ken Tanji", "speech": [ "yeah , sure, this is Ken. So we don't want to update guidance, but what I thought I can do is highlight a few items to consider that we're not in our guidance that we gave last December. Now first, as we've articulated the Financial Wellness implementation cost, we announced at Investor Day that's going to trim EPS in the second half of the year. We also updated this quarter, our mortality assumptions in individual life, and that will have an ongoing impact into the Q2. And then interest rates that we assumed in our guidance, we are now where we find ourselves where about over 100 basis points below below that. Now that is partially offset by equity markets that are higher, but those two net to a negative. So if you added all those together that's worth about $0.50 relative to our guidance for the second half of the year." ] }, { "name": "Nigel Bailey", "speech": [ "Okay and just say also the things it looks like Gibraltar earnings are going to be somewhat softer than expected just details behind that." ] }, { "name": "Ken Tanji", "speech": [ "Yeah and that's also captured in the interest rate comment that I made, but maybe I'll turn it over to Scott for a little bit more background on that." ] }, { "name": "Scott Sleyster", "speech": [ "Yes, so in terms of Gibraltar earnings were impacted by several factors, some of which will persist through year-end, net of the favorable assumptions in Gibraltar earnings were down about $35 million year-over-year and the key contributors to this decline were really driven by two factors. Underwriting which was still favorable to our pricing assumptions was less favorable than last year and that represents about a third of that. And then the balance of the decline was largely driven by higher expenses related to certain technology in end of life system spends, process improvements in automation and investments that we're making to support future growth.", "At Investor Day, I noted that PII is starting to leverage some of the capabilities that have been deployed in the US as part of the customer office and financial wellness initiatives. And additionally, given increased scrutiny on suitability and sales compliance, we're also investing in process and systems that support our distribution, including those that ensure appropriate oversight. So, we are accelerating some of these efforts and we expect this level of spend to persist through year-end and into early 2020. I think looking forward to the balance of the year, as Ken noted the recent decline in rates and lower sales will also weigh own Gibraltar's year end results. Meanwhile, the total Japan operations continue to generate strong cash flow to PFI, we distributed $1.1 billion in the Q2 alone." ] }, { "name": "Nigel Bailey", "speech": [ "That's very helpful. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question will come from the line of Elyse Greenspan with Wells Fargo. Your line is open." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi, thanks, good morning. My first question, so you guys updated expanded your ROE range at your Investor Day, which obviously was pretty close to the end of the quarter and now you've reset your forward earnings expectations for a couple of your main businesses. And so I guess, does this push back in your mind you hitting kind of the top end of that ROE target that you would just related to the street?" ] }, { "name": "Scott Sleyster", "speech": [ "Yeah, our ROE objective is 12% to 14% and that is a range and for the first half of the year we are at 12% when we set that objective, we did assume rates at the time when would continue to increase, consistent with the forward curve. We've given the sensitivities that show the impact of rates, which is gradual over time. And so as we think about that, if rates were persist, you would see that have some impact into our ROE, but our initiatives that we have to expand margins and to accelerate our strategy, we think we'll keep us within our 12% to 14% ROE objective in the intermediate term." ] }, { "name": "Elyse Greenspan", "speech": [ "Okay. And then in terms of the Financial Wellness plan, you guys at the initiative there you guys called out some expenses in the quarter when you guys believe that out at the Investor Day, you told us what the expenses were and then also the sales obviously takes a little longer for the sales to start rolling into the numbers. Can you just give us a sense of when we should start seeing some of the sales come into the numbers? And then also in terms of sequentially how much higher, those expenses could be as we think about them building up from the Q2 to Q3?" ] }, { "name": "Robert M. Falzon", "speech": [ "So Elyse, it's Rob, our view on the initiatives that we're undertaking with respect to Financial Wellness and both the costs and benefits from that or it's still consistent with what we outlined on Investor Day, we think through the year we'll have about $135 million in expenses, 20 of which you saw in the current quarter. And then we would expect that those expenses will generate about $50 million of run rate earnings by the end of the year, you'll see those fully in 2020 given that they sort of build into our run rate through the course of the year. The initiatives are all in flight, but are back-ended in the context of, sort of when we'll be incurring the costs on a quarter-to-quarter basis. So less in the Q\" comparable to slightly more well there's kind of a level in the Q3 that included in the slide that can walk you through in terms of expectation for costs that related to corporate and other Q3, and then a net more elevated level in the Q4." ] }, { "name": "Elyse Greenspan", "speech": [ "Okay, great. And one last quick question for corporate in the past you guys have guided to higher expenses in the Q4. I know slide seven we're setting the base for the Q3, but are you still expecting that in this year Q4 corporate expenses would be higher than what we see the average of the first three quarters?" ] }, { "name": "Ken Tanji", "speech": [ "Yes, that's been our -- that's been the pattern of our expenses and we would expect that to continue this Q4, and we'll give you a little bit more specific guidance around that at the end of the Q3." ] }, { "name": "Elyse Greenspan", "speech": [ "Okay, thank you for the color." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of Ryan Krueger with KBW. Your line is open." ] }, { "name": "Ryan Krueger", "speech": [ "Hi, good morning. You mentioned that you still believe you can generate high high-single digit intermediate term EPS growth is that, -- does that contemplate the some of the step-down function in the near-term earnings power? Or is that or should we think about that more as the growth rate off of the lower near term EPS base?" ] }, { "name": "Robert M. Falzon", "speech": [ "Ryan, it's Rob. The change in expectations with regard to this year vis-a-vis the guidance we provide you this, it's not material in the context of what we would expect in terms of that intermediate term growth rate. So I don't think we would do that is being a material input into our ability to achieve that more elevated level of growth." ] }, { "name": "Ryan Krueger", "speech": [ "Okay. And then as you mentioned potential in actions that's one of the possible offsets, can you expand some in terms of what you might be contemplating there?" ] }, { "name": "Steven Shorey", "speech": [ "Ryan, it's Steve, I'll take that part of your question. In individual like we're looking at three main drivers in an effort to improve returns in that business over the next few years, what you mentioned is one of them I just first I've mentioned though that we continue to generate strong sales of the business. The new business that we've been writing over the last few years, I should point out has been priced using much more current assumptions that are very different from the assumptions used to price the legacy products that have generated some of the recent charges we've taken. We remain quite disciplined in our pricing and our new sales have a very well-diversified mix. And we think these newer sales will help significantly and profitably growing the business over the next several years.", "Second part of the plan is exploring different options for optimizing our reinforced management as you referenced, that largely refers Ryan to exploring a wider range of reinsurance options. And third, we continue to be focused on the cost effectiveness of the individual life business platform, that certainly includes ongoing and continuing efforts to enhance the cost effectiveness of the business is operating platform, but we're also exploring some innovative new ways of delivering our life insurance products to the marketplace in a cost effective way. All of this is intended to improve returns in the business, that remains an important part of our overall business mix, it serves an important need in the marketplace and is a critical part of our financial wellness value proposition." ] }, { "name": "Ryan Krueger", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Tom Gallagher with Evercore. Your line is open." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning, first question I wanted to ask is on Japan. Can you provide a little perspective on what's going on in that market more broadly Gibraltar, I know you highlighted the weaker sales levels on the FX products, POJ looks like it held up better. Are you seeing significant significant increase in competitive pressures from the Domestics and also I think you heard a mention of some regulatory scrutiny is that on the FX product and maybe some elaboration there? Thanks." ] }, { "name": "Scott Sleyster", "speech": [ "Hi, Tom. This is Scott . Let me start. I think I gave you a pretty good run down on Gibraltar, let me, let me start with POJ then and then come back to you more details on your question. So in the case of POJ our in-force block, continues to grow and the enforced block was actually up almost 5% year-over-year.", "And additionally our life planner count in Japan was also up about 5%. I think a little more than 5% year-over-year. And you may recall that's comfortably ahead of the 2% to 3% Life Planner overall growth that we noted on Investor Day. So I would say, the fundamentals of the of the POJ business remain quite strong and sort of most of the challenges that we're facing, have been on the Gibraltar side.", "I talked a little bit about the spends on accelerating some of the customer office in financial wellness, I also alluded to just enhancing the overall collection of data and automation that we have in light of the, I would say really global not really restricted to Japan of focus on sales suitability. So we're trying to get that in place and probably accelerating that in the case of Gibraltar sales. I think that's really where the market dynamics have been more more challenging for us, as you know, particularly in our third party distribution channels we try to be very focused and disciplined about the products that we sell and meeting our return hurdles and with that in mind, we are experiencing sales declines.", "We try to focus on recurring premium death protection products we find those to be much more persistent and so in the long run we view those as really the most attractive products for us to sell, but we also think there are the most beneficial to our customers so, therefore we're focusing less on single premium products which tend to be more variable and subject to more pricing and I'd say other market factors like interest rates.", "The good news is that our recurring premium sales have in fact increased nicely within the life consultant channel. However, this is being more than offset with lower sales on single-pay US dollar annuities that are impacted both by competition and by the change in rates. I'd say the other notable decline in sales was in the bank channel, which primarily relates to trying to maintain the pricing discipline that I commented on earlier.", "And then lastly, we experienced a smaller decline related to the tax law change in the independent agency channel And as you know, those, the new regs are out, but there is a big backlog going developing new products at the FSA,", "I guess the point I would make or add on that is that despite these challenges Gibraltar's in-force block actually grew 2% year-over-year, which again goes back to reflecting the high persistency of the recurring premium products that we sell there that's." ] }, { "name": "Tom Gallagher", "speech": [ "That's helpful. Scott, I just as a quick as a follow-up on Japan POJ or life planner in total is, it does have very good persistency as well it's still above 90 but that's actually been declining and it declined 90 basis points sequentially. Is there anything going on persistency and that in that part of the business." ] }, { "name": "Scott Sleyster", "speech": [ "I don't really think. So that was a really that was a very small change. And if you look at over in the way we tend to do is look at over longitudinally over a long period of time, it still remains quite stable. So I don't think we see anything at this point that we view as significant. We, of course, watch it every quarter." ] }, { "name": "Charles F. Lowrey", "speech": [ "And Tom, this is Charlie. Let me just give a little sort of a history of the bank channel because it's important to understand how we think about the bank channel and that is the marginal sales aspect of it. So in a bank channel sales can get away from me pretty quickly and we watch that like a hawk. And so what we're really what focused on what Scott said is the profitability of the business and the type of product that we sell and that the sales volume will vary as a function of that.", "So there is more competition, especially on the yen-based side and that's hurt our US dollar sales and recurring premium sales but in our minds what we're doing is protecting the level of profitability and the type of sale, we have and letting sales volume vary as a result of that, and that's the way we've approached the bank channel in the past and it's completely consistent with the way we're doing it now." ] }, { "name": "Tom Gallagher", "speech": [ "Understood, thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Suneet Kamath with Citi. Your line is open." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. On the assumption review are there going to be any impacts on your statutory results either in terms of stat earnings or year-end cash flow testing from these changes?" ] }, { "name": "Ken Tanji", "speech": [ "Yes, no, the for life, the the stat assumptions are prescribed. So there is, there wouldn't be a stat impact for the update and then there would be. And then the favorable impact on on the retirement update would be would flow through to stack.", "So that's the, that's it. The extent of it." ] }, { "name": "Suneet Kamath", "speech": [ "Okay. And then on the life assumption review. I mean we have been tracking obviously every year and it seems like over the past call it four years. You've had maybe 900 million or so of these assumption changes just in the Life business alone, so maybe some color on why is it this business that's getting so much of this impact. And are you confident that going to have this behind us now in terms of the current assumptions?" ] }, { "name": "Steven Shorey", "speech": [ "This is Steve. Let me make some kind of overall comments and then I'll invite Kenny to expand further. You're right about our experience over the past few years in the individual life business in the in the annual reviews and most of that, experience has been around adjustments on the mortality front including including this year's.", "As a reminder though if you extend the look back over the past six or seven years our mortality experience has been largely aligned with our expectations. Over that period. In addition, when you look at it from a prudential total company standpoint as we've seen the negative mortality experience in individual life that's been offset to a quite meaningful degree with positive longevity experience in our retirement business very much as as designed and intended. With that said though, as I mentioned earlier, the ongoing impact of the assumption updates that we've taken cumulatively over the past few years have brought us to a place where we want to bolster and improve the current levels of return in the business and the 3.0 plan that I mentioned earlier is really how we think about that going forward over the next few years." ] }, { "name": "Ken Tanji", "speech": [ "Yes, the only thing I'd add is just a reminder that some of the updates that we took a few years ago were related to systems conversions and going through that process and that part is behind us and then also in terms of assumptions and evaluating the experience where it's credible. We call it like we see it and we stay current with that. So that's the, that's our philosophy with assumptions" ] }, { "name": "Suneet Kamath", "speech": [ "Okay, thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of into Kligerman with Credit Suisse. Your line is open." ] }, { "name": "Andrew Kligerman", "speech": [ "I think you just trying to digest the response to Suneet question just simply because, it's happened so many times in the last four years. But I think Ken just said you call it like you see it, but. Steve, you mentioned that you're exploring different options for the in-force management including reinsurance. So if you're doing that and the reinsurer is taking a look at your block, why wouldn't we expect another charge to come as they may be uncomfortable with the, with the block." ] }, { "name": "Steven Shorey", "speech": [ "As I mentioned, Andrew, we're looking at a, at a range of of reinsurance options. We already have, of course, an active reinsurance program. And that's been one where our dealings with the reinsurers have been quite productive or even over the past few years, as as we've had some of these updates.", "And we will continue to explore different options, including as I mentioned an expanded and expanded range of them, so it's Inc. It's part of the picture, but not the but not by any means the totality of" ] }, { "name": "Andrew Kligerman", "speech": [ "Could that conceivably end up in another charge?" ] }, { "name": "Ken Tanji", "speech": [ "Yes, we don't want it on the specifics in the theoretical, so but reinsurance can also be used to narrow volatility as we reinsure more business and trim some of the larger case exposure. So there is a number of various ways that we can think about the benefits associated with reinsurance. And we're looking at that." ] }, { "name": "Andrew Kligerman", "speech": [ "Got it." ] }, { "name": "Robert M. Falzon", "speech": [ "It's Rob, the only thing I'd add on is to repeat essentially Ken said is we intend to the assumption update was to bring current evaluation of the liability to our best estimate of what mortality experience we're actually seeing in the underlying block. So we would not expect a third party to look at that and they come to some different conclusion than we did." ] }, { "name": "Andrew Kligerman", "speech": [ "Got it. And then just in the earlier questions, I think your response was it, there is some backlog with the FSA in some regulatory considerations. Could you elaborate on that?" ] }, { "name": "Robert M. Falzon", "speech": [ "That was simply related to the change in the tax law that occurred in February and then was reiterated in July, so carriers like Prudential are designing some new products, but you have to file those products and go through the Q. So it's kind of the usual thing, but since it was related to a single action by the JFSA, there's just a cue." ] }, { "name": "Andrew Kligerman", "speech": [ "Got it. And then just with the recent activity of the Japan Post, they had some selling any higher degrees of scrutiny occurring with the regulators?" ] }, { "name": "Ken Tanji", "speech": [ "I guess what I would say, we are not really, we don't distribute through Japan host on the one hand, but to the broader question, I think it was about two years ago the FSA shifted to more of a principle based kind of a framework kind of moving to global standards. And as they do that, I think they're rolling out there exam process and focusing more and I think people are as they go through that process, they're saying want to make some modifications or change this or get in line. So I think that's really, it's a fairly, I would say a fairly orderly and expected process, but it is in fact a process that's under way, it's already a couple of years out, and my guess is it has a couple of more years to go before it's fully rolled out." ] }, { "name": "Andrew Kligerman", "speech": [ "Thanks so much." ] }, { "name": "Operator", "speech": [ "Thank you.Our next question comes from the line of Humphrey Lee with Dowling & Partners. Please go ahead." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning and thank you for taking my questions. A follow-up question related to broaders earnings headwind. I think in Ken's remarks you talked about roughly kind of 15 million lower earnings power from lower sales and also high investments. I think on -- I just wanted to see if that is kind of your expectation for the foreseeable future, as you mentioned deed headwinds will be kind of through 2020?" ] }, { "name": "Ken Tanji", "speech": [ "I guess what I would say is we're trying to just based on some of the things we are going on and the benefits from putting some of these things in place, we're trying to get that done more quickly. So I don't think I'd say on the expense side, you'd expect a lot of that to run through all of 2020. But I guess I would say I expect this over the next three to four quarters, not the next two." ] }, { "name": "Humphrey Lee", "speech": [ "Okay. And then in terms of the lower sales and expense impact how should we think about that, because I recall from your Japan Investor Day you highlighted for both of your POJ and launch a broader business like sales doesn't really affect your in-force earnings. So I tell a little surprised to see earnings drop, as a result of more. So just wondering, it just more of a expenses as opposed to sales?" ] }, { "name": "Ken Tanji", "speech": [ "I think I gave you a proportion that it was skewed a little heavier to expenses, but when you're looking at multi-year sales, we've come down, and it appears that we're bottoming out at these new levels. And by the way, we are taking actions, whether it'd be in products or incentives, and some new designs to help offset. So we're not, if you will, standing still, while we are experiencing that, but the cumulative effect of the sales levels being off where they are, and kind of plateauing at this level is also part of the equation." ] }, { "name": "Humphrey Lee", "speech": [ "Okay. And then shifting gear to retirement, looking at the kind of the earnings run rate and outlook seems to be a little bit weaker than where it has been granted low interest rate definitely is the pressure, but I was just wondering if there is any other things that may have affected the earnings outlook for retirement in general." ] }, { "name": "Steven Shorey", "speech": [ "Humphrey, it's Steve, I'll address that part of your questions. The impact on retirement, run rate earnings is largely in the net interest income area, part of that is what you just spoke about some spread compression as a result of the current rate environment. But another aspect of it is that at the end of last year, we released a significant amount of AAT reserves in the retirement business and transfered the assets backing them back to the parent company. And that also contributes to lower investment income for the business in 2019." ] }, { "name": "Humphrey Lee", "speech": [ "So in terms of I guess when we wanted to mentioned that at the impact of the AAT reserve releases on diversement income like how should we think about that?" ] }, { "name": "Ken Tanji", "speech": [ "Yes, so when we updated our assumptions in our Retirement business for AAT that led to a release to those reserves, but also if you recall we, last year we did strengthen our long-term care reserves and so that led to essentially a net -- no net impact overall for the company. So, although you will see lower earnings in the retirement segment related to that those reserves went to long-term care, which is not included in AOI." ] }, { "name": "Humphrey Lee", "speech": [ "Got it, thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Next we'll go to the line of John Nadel with UBS. Your line is open." ] }, { "name": "John Nadel", "speech": [ "Hey, thank you. Good morning, I have a couple of quick ones. Rob It sounded like with your commentary about PGIM and an expectation that institutional net flows will continue the string on an annual basis, a positive. I assume that's within toward your pipeline for the back half of the year, could you just maybe expand on that?" ] }, { "name": "Steven Shorey", "speech": [ "John, this is Steve. I'll address that part of your question. Yes, I think the circumstances around this particular outflow this quarter were mentioned by Charlie I just mentioned a little bit more about it really was a matter of a client looking to consolidate the number of managers. They work with, we're quite familiar with that dynamic, we have very frequently been the beneficiary of it. This was one particular time when the dynamic worked against us, but we still have a great deal of confidence in the ability of the business to continue to demonstrate strong fundamentals and strong net flows, continuing the sixth year -- 16 year string on the institutional front. I would say that's born out of a number of things, number one we do see an attractive near-term pipeline in the marketplace and we like our prospects for competing for that opportunity set, given strong investment performance, deep expertise across a range of asset classes and investment strategies and investments that we've made in our distribution platform. All of those things taken together, have been the contributors and the drivers of solid net flows and we expect -- we expect they'll continue to be." ] }, { "name": "John Nadel", "speech": [ "Thank you. And then maybe for Ken or Rob in looking at slide 18 of the deck, I wanted to make sure that they understand how to interpret this, because I think the seasonal portion of this is tremendously helpful and thank you for that. I'm looking at the column that provides the baseline range and I just want to understand the width of the range by segment. Are we to take that to mean that driven by seasonal and other factors in some quarters, the earnings can be at the low end of the range and in some the high end of that range, is that the way to interpret that?" ] }, { "name": "Steven Shorey", "speech": [ "Yes, let me maybe explain what that is, this is really just factual. So it is just, if you look at the last four quarters and you adjust for assumption updates market experienced updates variable investment income, the things that are noted in the footnotes, that's the actual range that has occurred over the last four quarters." ] }, { "name": "John Nadel", "speech": [ "Each of the last four, got it." ] }, { "name": "Steven Shorey", "speech": [ "Yeah, just, is there to give you a sense for what the highs and the lows have been." ] }, { "name": "John Nadel", "speech": [ "Got you. Okay. So this isn't sort of a guide saying this is the kind of -- this is just actual it doesn't include any growth expectations without no" ] }, { "name": "Unidentified Speaker", "speech": [ "No assumptions. It's just, the facts of the last four quarters." ] }, { "name": "John Nadel", "speech": [ "Got you, perfect. And then my last one is, I wanted to try to differentiate between run rate and actual dollar contribution. Thinking about the wellness initiative you've talked about a $50 million run rate contribution to earnings. By the end of this year. But my sense is that the actual dollar contribution there earnings in 2019 will be negligible and and first I wanted to make sure I understand that correctly. And then second, if we fast forward and think about 2020. How should we differentiate between run rate and actual contribution?" ] }, { "name": "Robert M. Falzon", "speech": [ "So, John, it's Rob. Let me try to address that. With regard to 2019 specifically. Recall that the expenses are largely back-end weighted as well. And so what you'll see. Yes, so the idea is in 2019, we'll incur those expenses and get to that run rate level of savings by the time we've incurred all those expenses, but because it happens so late in the year, to your point, there will be a relatively modest contribution in 2019.", "From an earnings standpoint simply because both the expenses on the earnings are going to be concentrated in the latter part of the year as you get into 2020 and beyond. What you see that is from a pure standpoint, you'll see a combination of the benefit of the earn the run rate from the prior year and then some portion of the building run rate during the course of that year, contributing into the current year. What we intend to do is and will begin at the end of this year will provide better visibility into both the sources of the expenses.", "So you understand what initiatives they linked to and then importantly how much and where we should expect to see the earnings of benefits associated with those initiatives. Right now, it's just not material enough to provide that kind of detail as we get further into this year and we have more materiality will provide that kind of insight as I think that we'll provide you a better basis to end for being able to assess, not just the run rate impact, but how much of that run rate would be in the current year as opposed to for the succeeding year." ] }, { "name": "John Nadel", "speech": [ "That's helpful. If I can just squeeze one more follow-up on that. So if you achieved $500 million. What's the calendar year, where we should see the full contribution of that 500 million." ] }, { "name": "Robert M. Falzon", "speech": [ "That would be, we will achieve that by the end of 2022 and so you would see in 2023, the full year benefit of that.", "Perfect, thank you.Welcome." ] }, { "name": "John Nadel", "speech": [ "Perfect, thank you." ] }, { "name": "Robert M. Falzon", "speech": [ "Welcome." ] }, { "name": "Operator", "speech": [ "Thank you. We will go to the line of Alex Scott with Goldman Sachs. Your line is open." ] }, { "name": "Alex Scott", "speech": [ "Hi, I just wanted to touch on individual annuities. I guess the seems to continue to trend down there and I know the long-term ROE target was a bit lower than where you have been running, but I guess equity market has been strong, a little bit of a surprise me that we would see that kind of accelerating down to the long-term ROE trend is to is, it has with that economic backdrop appreciating the rates have gone down too. But can you help us think through that, should we just assume we're at that long term ROA now. Any color would be appreciated." ] }, { "name": "Ken Tanji", "speech": [ "Yes, sure. It's Ken on. So first our away is evidence is the high profitability of our variable annuity business and the strong ROE. And as we've mentioned in the past, we expected the ROA would trend down over time as our business persist and and moves into lower fee tiers, but also as a result of our strategy to diversify our product mix.", "Now, it should also probably useful to know that our earnings are less sensitive to markets than our account values and that's due to our hedging program. And so in the Q2, you saw as you mentioned, the combination of two things. Equity markets rising and interest rates falling and both of those lead to increases in account values and so it was really the denominator that led to the trimming of the ROE and the point is here is our hedging program makes our earnings more stable than our account values" ] }, { "name": "Alex Scott", "speech": [ "Got it, OK. And then maybe a follow-up just thinking more high level you guys up to the high end of the ROE guide for the intermediate term, but the outlook has anything changed since that time or just thinking through how much lower the earnings power is today from from what I'd thought at this time you are making those comments, it seems a bit more aspirational sitting here today than it did at that time. So can you help me think through, is there anything other than the financial wellness program I should be thinking about that would get you closer to the mid point of that intermediate range?" ] }, { "name": "Robert M. Falzon", "speech": [ "So, Alex, it's Rob, I think Ken did a good job of walking through sort of the impacts of if you sort of think about the guidance that we gave. And then the change in that guidance being reflected in sort of a handful of items that we've articulated. And when we think when we thought when we think about, but what we've articulated on Investor Day, I think what's important to understand is that when, when we're at Investor Day, we're talking about direction and we're talking about strategy. And then the associated financial outcomes that are so that results from that direction and strategy.", "And as we think about those we measure those in years, not in quarters obviously in guidance and calls like this, we talk about sort of the more near term results on Investor Day, I think what I can reflect on this first Charlie had in his remarks indicated that we that march toward what we continue to believe is an achievable level of higher earnings and higher ROE, would be non-linear. I mean, I think you're seeing some of that non-linearity in the current in the current quarter.", "Ken talked about both the potential for the life assumption updates you told I think prevention that we are taking a hard look at those assumptions. During the, during the Investor Day. And also we provided then in previously market sensitivity. So a lot of that I would consider to be particularly new information and Scott even when he talked about the international business, as you mentioned earlier spoke to the fact that we would be adopting many of the initiatives that we have begun in the US into Japan and that that we would expect to be making similar type investments there.", "So I think that Charlie's opening remarks that we remain very confident in the messages that we delivered on Investor Day regarding both the intermediate and long-term prospects for our businesses and nothing that's occurred in the current period causes us to feel any differently about what we messaged on Investor Day ." ] }, { "name": "Alex Scott", "speech": [ "Thanks for the responses" ] }, { "name": "Operator", "speech": [ "Thank you. We will go to the line of Erik Bass with Autonomous Research. Your line is open." ] }, { "name": "Erik Bass", "speech": [ "Hi, thank you. I just wanted to come back to mortality topic and I was curious, is the deterioration related to any specific vintages or types of policies are you really reflecting a broader trend?" ] }, { "name": "Steven Shorey", "speech": [ "Eric, it's Steve, I'll address your question. The main point is that the updates really related to longer-dated vintages earlier vintages in our, in our book of business. In regard to looking at specific product categories.", "The one-time impact is largely experienced in the in the universal life block the ongoing impact is primarily in universal life, but with some impact in in other parts of the business as well including term." ] }, { "name": "Erik Bass", "speech": [ "Got it. And then, I mean you're having not quite a complete offsetting adjustment , but obviously the retirement business is benefiting on the longevity side, but you have differences in business mix there. So what is it, I guess it's driving the positive adjustment on that side? Yes, the way we look at that," ] }, { "name": "Steven Shorey", "speech": [ "Yes, the way we look at that Eric, is that when we perform or annual review of assumptions and other refinements the nature of the updates we make just as you're commenting they vary from business to business and will naturally lead to differences in the extent and magnitude of one-time impacts versus ongoing impacts the nature of the updates we made in our retirement business led us to record the more meaningful one-time adjustment that we mentioned an expected benefit payments.", "And while there were some ongoing benefits from our review in the retirement business, they are not of the same magnitude of the of the negative ongoing impact that we see an individual life, so that's why we are we emphasize that point about about individual life ." ] }, { "name": "Erik Bass", "speech": [ "Got it. And just to be and so we're, make sure we have a correct what would you size is that ongoing impact for individual life, and is it something that should persist into perpetuity?" ] }, { "name": "Ken Tanji", "speech": [ "Yes, it's a about 25 million a quarter. And it would, it would be reoccurring for the foreseeable future." ] }, { "name": "Erik Bass", "speech": [ "Okay." ] }, { "name": "Ken Tanji", "speech": [ "But I want to mention the things that Steve has in mind in the business has in mind to help offset some of that that we talked about earlier." ] }, { "name": "Erik Bass", "speech": [ "Thank you. That's helpful." ] }, { "name": "Operator", "speech": [ "Thank you. And due to the elapsed time I'd like to turn the conference back over to Mr.Charles Lowery in the rate for any closing comments." ] }, { "name": "Charles F. Lowrey", "speech": [ "Thanks. I'd like to summarize our thinking and the actions we're taking because we've talked about a lot of different things on this call, and I'll divide into a couple of categories. One is a clarity of earnings into our, some of the operational actions that we've highlighted. So in terms of clarity of earnings. We are in the process of simplifying our earnings and clarifying the visibility of our drivers and financial outcomes and we're taking efforts to help you understand our earnings trend and it's taken some material steps this quarter to do so, and we will continue to do so. In terms of actual operations we position 2019 and our guidance in 2019 in terms of a year of transition and making investments that would enable us to grow in subsequent years, and we're taking actions accordingly.", "So we talked about the investment in future work, which should produce $500 million of margin improvement over the next three years. Now there are costs associated with that. As Rob indicated and these and these initiatives are beginning to come through this year. And so those costs are upfront, which means there is a lag in terms of payback.", "So that's the first point. The second is we aren't happy with the performance of our life business and consistent with Steve comments. We are seeking to increase the performance of the business as well as looking at ways to optimize the enforced book. And finally, there have been higher expenses in certain businesses like Scott called out when Gibraltar and as we think about changing the way in which we operate, we have to spend money on new ways of becoming more efficient investing in technology and platforms etc.", "And some of these costs will be ongoing. It's really a cost of doing business in the current environment and others will be transitory surge and then levering leveling off and Gibraltar falls into the latter category with higher expenses tapering off during the first half of probably next year.", "Now all of this is to say the not everything can be solved overnight, nor will the results coming from the solutions be linear, but we do have a real sense of urgency as you would expect us to have and that we spoke about on Investor Day, and what I can assure you is that we firmly believe that many of these initiatives and challenges actually provide extraordinary opportunities over time, which is why we have high conviction around the ROE and EPS targets that we stated on Investor Day. Now on a personal note and speaking for the entire management team we don't like disappointing, our investors or other constituencies.", "On the contrary, we like to excel and while I can't make any statements as to what the next quarter or quarters will provide, what I can absolutely assure you of is that we're working on executing our plan with the intended results of changing the trend line in the right direction. We look forward to keeping you updated on our performance in the tangible progress that we make, as we strive to develop better financial outcomes for our customers and just as importantly sustainable results for our shareholders. Thank you all for taking the time to join us today." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
PRU	2023-05-03	[ { "description": "Vice President, Investor Relations", "name": "Bob McLaughlin", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Executive Vice President and Head of International Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Head of U.S. Business", "name": "Caroline Feeney", "position": "Other" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Michael Ward", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to Prudential's quarterly earnings conference call. At this time, all participants have been placed in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time.", "[Operator instructions] As a reminder, today's call is being recorded. I will now turn the floor over to Mr. Bob McLaughlin. Please, go ahead." ] }, { "name": "Bob McLaughlin", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of international businesses; PGIM, our global investment manager, Caroline Feeney, head of U.S. businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions.", "As a reminder, our financial results reflect the long-duration targeted improvement accounting guidance that was adopted at the beginning of the year and prior-year results have been adjusted accordingly. Today's presentation may also include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures.", "For a reconciliation of such measures to the comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-Looking Statements and Non-GAAP Measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com. And now, I'll turn it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Bob. And thanks to everyone for joining us today. During the first quarter, we continued to transform our business to be less market-sensitive and better positioned to deliver sustainable long-term growth. Our financial strength, disciplined asset liability management, and robust risk management position us well to navigate the current macroeconomic environment while maintaining our balanced approach to capital deployment focused on creating value for our stakeholders.", "Turning to Slide 3. I'll begin this morning with an update on the progress of our strategy to become a higher-growth, less market-sensitive, and more nimble company. We are investing in long-term sustainable growth by expanding access to our products and services and markets around the world, including through programmatic M&A and organic growth opportunities, creating the next generation of financial solutions and delivering industry-leading customer experiences. Let me provide a few recent examples.", "Yesterday, we announced that Prudential is acquiring a majority stake in Deerpath Capital Management, a leading U.S. private credit, and direct lending manager with more than $5 billion in assets under management. The acquisition will expand PGIM's alternative capabilities while providing additional fee-based revenue and complementing PGIM's existing direct lending origination capabilities. In addition, Deerpath is a great example of we are building our self-reinforcing business model, which will benefit both third-party investors, as well as our insurance and retirement customers.", "Our institutional retirement strategies business had strong first quarter sales, largely driven by our pension risk transfer business, which had its best first quarter ever with more than $2.8 billion in total new business transactions. In addition, we experienced continued momentum in international reinsurance with a $500 million longevity risk transaction. We also achieved new growth milestones in our international business, especially in Latin America, where Prudential of Brazil's sales reached double-digit year-over-year growth through our three distribution channels. In particular, we are driving growth in Brazil through our expanded third-party distribution channel, which allows more consumers to access our products and services.", "During the quarter, we also expanded our distribution through the Mercado Libre platform into Mexico to sell life and accident, and health products. In the U.S., our individual retirement strategies business continued to expand its suite of next-generation protection solutions. We expanded our FlexGuard distribution and introduced new product enhancements to meet the evolving needs of our customers. We are also diversifying our sales mix to meet increasing customer needs in a higher interest rate environment.", "Sales of fixed annuities represented one-third of total individual annuity sales in the first quarter, a significant increase from a year-ago quarter. We continue to enhance the ways in which customers engage with our products and solutions, to drive more digital experiences and better customer outcomes. Let me give you a couple of examples. First, an industry survey ranked Prudential as a top three carrier in e-signature adoption.", "A majority of annuities applications are now submitted with e-signature, which has reduced processing time by several days and improved our environmental impact. Second, we launched a new electronic claims portal for life insurance customers that allows beneficiaries to file claims in minutes and to receive payments in days rather than weeks. By using the portal this quarter, we have experienced a 300% increase in digital claims processing and overwhelmingly positive customer feedback. Turning now to Slide 4.", "Prudential's rock-solid balance sheet and robust risk and capital management frameworks have allowed us to confidently navigate the current macroeconomic environment. Our financial strength, including our AA rating, is supported by $4.6 billion in highly liquid assets at the end of the first quarter, as well as a high-quality, well-diversified investment portfolio and a disciplined approach to asset liability management. We've also taken advantage of opportunities to further optimize our financial flexibility and liquidity position. We proactively issued a contingent capital facility to replace the one that matures in November of this year and issued $500 million of hybrid debt to pre-fund the maturity of the same amount next year.", "Moving to Slide 5. Our disciplined approach to capital deployment also enables us to effectively balance investing in the long-term growth of our businesses with returning capital to shareholders. In the first quarter, we returned $700 million to shareholders and increased the quarterly dividend by 4%, our 15th consecutive annual dividend increase. Looking ahead, we will maintain our disciplined approach to capital management and redeployment.", "We are confident that this approach, coupled with our robust financial position, mix of mutually enhancing businesses and growth strategy, positions us well to be a leader in expanding access to investing, insurance, and retirement security for people around the world. Thank you for your time this morning. And with that, Rob will now provide an overview of our first quarter financial results and an update on our business performance." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results and business performance for our PGIM, U.S., and international businesses. I will also provide an overview of our investment portfolio and specifically our commercial real estate holdings, given the increased focus on the risks associated with a potential near-term credit cycle. I'll begin on Slide 6 with our financial results for the first quarter of 2023.", "Our pre-tax adjusted operating income was $1.3 billion or $2.66 per share on an after-tax basis. These results reflect underlying business growth, including the benefits from a higher interest rate environment, offset by lower variable investment and fee income, as well as elevated seasonal mortality experience. While elevated mortality improved compared to the year-ago quarter as COVID has transitioned to an endemic phase. Turning to the operating results from our businesses compared to the year-ago quarter.", "PGIM, our global investment manager, had lower asset management fees due to lower assets under management resulting from the higher interest rates, equity market declines, and net outflows. Other related revenues increased primarily from seed and co-investment earnings. Results of our U.S. businesses primarily reflected lower fee income, less favorable variable investment income, partially offset by the impact of higher rates on spread income, and more favorable underwriting.", "The decrease in earnings in our international businesses primarily reflected lower spread income largely due to less favorable variable investment income. Turning to Slide 7, PGIM, our global active investment manager, has diversified capabilities in both public and private asset classes across fixed income, equities, and alternatives. PGIM's investment performance remains attractive with 80% or more of assets under management outperforming their benchmarks over the last three, five, and 10-year periods. PGIM experienced third-party institutional and retail net outflows of $14 billion in the quarter, primarily from fixed-income strategies.", "Institutional outflows were mainly driven by client redemptions for liquidity needs, including derisking actions of defined benefit sponsors. Retail outflows were driven by investors rebalancing amid higher interest rates and inflation, consistent with the industry. As the investment engine of Prudential, the success, and growth of PGIM and of our U.S. and international insurance and retirement businesses are mutually self-reinforcing.", "PGIM's asset origination capabilities, investment management expertise, and access to institutional and other sources of private capital or a competitive advantage helping our businesses bring enhanced solutions and create more value for our customers. Our insurance and retirement businesses, in turn, provide a source of growth for PGIM through affiliated net flows, which totaled $2 billion in the first quarter of 2023, as well as unique access to insurance liabilities. In addition, we continue to grow our private alternatives and credit business, which has assets of approximately $235 billion across private, corporate, and infrastructure credit, real estate equity and debt, and secondary private equity and will be further enhanced through the acquisition of Deerpath Capital, as Charlie previously stated. Turning to Slide 8.", "Our U.S. businesses produced diversified earnings from fees, net investment spread, and underwriting income and benefit from our complementary mix of longevity and mortality businesses. We continue to shift toward higher growth and less market-sensitive products and markets, enhance our customer and advisor experiences, and further expand our addressable market. Retirement strategies achieved strong sales of $5.5 billion in the first quarter across its institutional and individual lines of business.", "Our institutional retirement business has market-leading capabilities with first quarter sales of $3.8 billion, including a jumbo pension risk transfer transaction, which contributed to record account values at the end of the first quarter. In individual retirement, product pivots have resulted in continued strong sales of more simplified solutions like FlexGuard and FlexGuard Income, representing over $13 billion of sales since inception, as well as increased fixed annuity sales that comprised approximately one-third of our sales. Our individual life sales reflect our earlier product pivot strategy with variable life products representing about 70% of sales for the quarter. And we continue to diversify group insurance sales with strong growth in supplemental health and disability products and driving 25% growth in the premier segment from the prior-year quarter.", "Turning to Slide 9. Our international businesses include our Japanese life insurance companies, where we have a differentiated multi-channel distribution model, as well as other businesses aimed at expanding our presence in high-growth emerging markets. In Japan, we are focused on providing high-quality service and expanding our geographic coverage and product offerings. Our needs-based approach and protection product focus continue to provide important value to our customers, as we expand our product offerings to meet their evolving needs.", "We continue to enhance customer experience and agent support, including through digital tools. Prudential of Japan ranked number one in two out of the three categories in the 2023 J.D. Power Life Insurance customer satisfaction survey. We are proud to be recognized for the value we provide customers.", "In emerging markets, we are focused on creating a carefully selected portfolio of businesses in regions where customer needs are growing, where there are compelling opportunities to build market-leading businesses, and where the Prudential enterprise can add value. Our international businesses experienced their highest sales since the third quarter of 2020. Compared to the prior-year quarter, Gibraltar sales were up 16%, mainly driven by the life consultant channel, primarily from higher U.S. dollar sales.", "Life planner sales were up 13%, driven by the continued momentum in Brazil, as well as higher sales in Japan. Now turning to our investment portfolio on Slide 10. We have a disciplined approach to our investment portfolio construction and management. It reflects our robust asset liability management practices, commitment to broad diversification, and a rigorous underwriting security selection and credit management framework.", "We also leverage PGIM's expertise across multiple asset classes, including its deep and long-standing experience in private placements and real estate. With respect to our investment portfolio, here are a few key points. 30% of the portfolio is invested in government securities, primarily comprised of U.S. treasuries and Japanese government bonds.", "43% of the portfolio is invested in corporate securities, of which over 93% are investment grade. Private placements represent almost 40% of these corporate securities and over half of our BBB and below-rated securities. These privates have financial covenants and structural protections that have consistently resulted in lower losses than comparable public securities. In past cycles, the loss experienced on our BBB private placements have been comparable to single A public credits.", "Mortgage loans represent an area of interest; I'll provide more detail on Slide 11. Our mortgage loans represent 13% of our portfolio and reflect our conservative underwriting with an average loan-to-value of 57% and debt service coverage of 2.4 times. The portfolio is broadly diversified by property type, overweight in more defensive sectors such as multifamily and industrial, and underweighted in both office and retail. Specifically, office properties represent only 2% of invested assets, with loan-to-values and debt-service coverage ratios that are in line with the overall portfolio.", "We have a disciplined portfolio monitoring process to review all investments at least annually and a robust risk management framework, which includes stress tests under cyclical and tail scenarios. Any potential credit losses in these scenarios are factored into our capital management framework and are expected to be manageable. As we look ahead, we are well-positioned across our businesses to be a leader in expanding access to investing, insurance, and retirement security. We continue to be focused on investing in growth businesses and markets, delivering industry-leading customer experiences, and creating the next generation of financial solutions to better serve the diverse needs of a broad range of customers.", "And with that, I'll now hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 12, which provides insight into earnings for the second quarter of 2023 relative to our first quarter results. As noted, pre-tax adjusted operating income in the first quarter was $1.3 billion and resulted in earnings per share of $2.66 on an after-tax basis. To get a sense of how our second quarter results might develop, we suggest adjustments for the following items.", "First, variable investment income was below expectations in the first quarter by $150 million. Next, we adjust underwriting experience by $85 million to normalize for first quarter experience. And last, we expect other items to increase adjusted operating income by $25 million, primarily due to the seasonally elevated expenses in the first quarter. These items combined get us to a baseline of $3.20 per share for the second quarter.", "I'll note that if you exclude items specific to the second quarter, earnings per share would be $3.29. The key takeaway is that our underlying earnings power has improved due to business growth, including the benefit of higher interest rates. While we have provided these items to consider, please note there may be other factors that affect earnings per share in the second quarter. Turning to Slide 13.", "Our capital position continues to support our AA financial strength rating. Our cash and liquid assets were $4.6 billion at the high end of our liquidity target range. We have substantial off-balance sheet resources, including contingent capital and liquidity facilities. As Charlie noted, we replaced a $1.5 billion contingent capital facility that will mature in November.", "We remain thoughtful in our capital deployment, balancing the preservation of financial strength and flexibility, investment in our businesses, and shareholder distributions. Turning to Slide 14 and in summary, we are transforming our businesses for sustainable growth. We continue to navigate the current macro environment with the financial strength of our rock-solid balance sheet, and we maintain a balanced and disciplined approach to capital deployment. Now I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We'll now be conducting your question-and-answer session [Operator instructions] Our first question today is coming from Tom Gallagher from Evercore ISI. Your line is now live." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. First question is just on the potential for the rules being changed on the interest maintenance reserve. Can you -- I know that I think that was around the $1.8 billion negative adjustment for you guys last year based on the mark-to-market impacts from interest rates from derivatives. Curious if -- I think there's a proposal within the NAIC out there that suggests there will be some changes.", "Can you talk about whether you think that will go through and whether or not at least some portion, if not all, of the $1.8 billion could be recaptured if it has changed? Thanks." ] }, { "name": "Ken Tanji", "speech": [ "Hi, Tom, it's Ken. Yeah, the NAIC is in the process of addressing what is uneconomic issues with the IMR. They -- as you mentioned, they've released a proposal, and that's out for comment until June 9th. So, they're giving some time to receive input for the industry to work collectively on this.", "We think it's a big step in the right direction as both the industry, the ACOI regulators that -- they're focused on addressing this issue. Having said that, the proposal needs some changes in a few areas, but there is a process to sort that out. We and many others are engaged in very constructive discussions. It's hard to predict the regulatory process, but it seems it's on the path for changes this year." ] }, { "name": "Tom Gallagher", "speech": [ "And Ken, would you -- is kind of your base case assumption based on what's out there now that you'll potentially get all of it back, or would it be just a part, maybe a partial clawing back of some of that negative impact on RBC?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah, Tom, again, it's hard to predict. There are things that are being discussed and until that those things get sorted out, I wouldn't want to give an indication of how that plays out. But again, they are taking input, it's a very constructive process, I think all the intentions are there to put this on the path for resolution, but that will play out in time." ] }, { "name": "Tom Gallagher", "speech": [ "And then just for my follow-up, I just -- a question on leverage. I think you've announced you're going to redeem $1.5 billion of sub-debt in June. And I think you issued $500 million this quarter as well -- or sorry, in Q1. The -- where do you stand now on leverage? Can you just talk about -- do you have upward capacity to issue more debt? Are you at about the right level? Because I think there's been some changes in -- certainly, from an accounting perspective, it's a bit of an elusive calculation to do from our perspective.", "But can you provide some help there? Thank you." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Sure. Yeah, at the end of first quarter, we were in line with our leverage objectives and then when we call the $1.5 billion of debt, which has always been in our plans to do that in June, that would increase our debt capacity. Our overall debt capacity, though, is a function of rating agency criteria and other objectives, as we look at profitability, free cash flow, fixed cost coverage, and stress testing, which we believe is important.", "So, it's not just leverage that would determine our debt capacity. But again, calling that debt was part of our plans. It was prefunded and that will improve our debt capacity going forward. And overall, we're on track for our plans for the year." ] }, { "name": "Tom Gallagher", "speech": [ "OK. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Next question today is coming from Ryan Krueger from KBW. Your line is now live." ] }, { "name": "Ryan Krueger", "speech": [ "Hey. Thanks. Good morning. Could you talk a little bit more about the drivers of PGIM flows in the quarter? And then I guess how are you thinking about the outlook going forward? Do you -- would you anticipate further liquidity-driven repositioning impacts, or do you think a lot of that's behind you now?" ] }, { "name": "Andy Sullivan", "speech": [ "Good morning, Ryan. It's Andy. I'll take your question. As we always discuss, flows are going to vary quarter to quarter.", "So, we stay focused on the long-term track record.In Q1, we experienced third-party net outflows of $14 billion, driven both by retail and the institutional. On both fronts, as you heard Rob say upfront, it is very much a fixed-income story. Our retail outflows were $3.8 billion in the quarter. The fact is we continue to see money flowing out of active U.S.", "mutual funds and into money market funds, CDs, and other short-term solutions. That being said, we did see a slowing of the retail outflows in the quarter consistent with the industry. We would expect this outflow trend to reverse once inflation moderates and the rate environment stabilizes. On the institutional side, net outflows were $10.2 billion for the quarter.", "That was driven almost entirely by redemptions from public fixed income as institutional investors sought that liquidity, as you mentioned, and DB sponsors de-risk their plans. We would expect that the near-term, flow volatility in the institutional business will remain volatile, given the heightened macroeconomic, geopolitical, and market uncertainty. That being said, our long-term investment performance remains very, very strong with over 80% of our benchmarkable assets outperforming the three, five, and 10-year marks. We have high confidence in the power of our platform, particularly as sustained higher rates are going to be good for the fixed-income business, and we will benefit over time from the synergy between our insurance and asset management businesses.", "So by paying attention to the fundamentals, we know we'll be a net grower." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks. And then, a follow-up on other related revenues in PGIM. What -- how sensitive is that to transaction-related real estate fees? And I guess, in other words, in the current environment where there's less commercial real estate activity, would you expect that to remain a little bit lower than normal because of the lack of incentive fees, or can you give some perspective on that?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Again, it's Andy. Thanks, Ryan. As you know, last quarter, we lowered our run rate expectations for ORR, specifically due to as you're speaking to the expected slowdown in real estate-related revenues.", "And that shows up in a variety of ways, obviously, both in the agency side, but also as you're talking about in transaction fees and incentive fees. So in the quarter, we came in lower than our expected average, because we saw that real estate slowdown as we expect it. And I guess, the only other thing I would mention is, just a reminder that incentive fees tend to be seasonally low in Q1. So that was definitely a contributor as well.", "So I think over time, the expected average of about $50 million is still the right ballpark, but definitely, the real estate slowdown will have an impact." ] }, { "name": "Ryan Krueger", "speech": [ "OK, great. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question is coming from Erik Bass from Autonomous Research. Your line is now live." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. You mentioned stress testing your credit portfolio and including that in your capital management plans. So I was just hoping you could provide a bit more color on what you're assuming and what those capital impacts could look like in a moderate or severe recession scenario." ] }, { "name": "Rob Falzon", "speech": [ "Erik, it's Rob. I'll take the first stab at sort of describing how we think about stress testing. And then, Ken, perhaps I'll turn it over to you and you can talk about how we factor that into our capital planning. So we perform -- we have a very robust enterprise risk management capability and perform a whole series of stress tests that vary between our outlook on a base case basis, which includes sort of a moderate decline from an economic standpoint, a full board recession, and particularly with respect to our real estate portfolio, we look at -- we run some of the CCARs more severe stress tests that the banks are subject to as well.", "The results of those are factored into both our capital planning and our reserving. We haven't, Erik, updated any disclosure on that. But what I would say is if you look back to when we first -- or last, I should say, provided some disclosure on that was back in the first quarter of 2020, the order of magnitude that we articulated then in terms of the impact coming from the portfolio from a credit cycle is roughly same order of magnitude today. Ken, I don't know if you want to elaborate further on that." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Just on your second part of your question, Erik, on sort of what underpins our plans -- what is underpinning our plans is sort of the expectation of a slowing economy and the early stages of a mild recession, which would include an elevated level of credit losses and in-rating migration. And beyond that, though, we also, as Rob just described, we have a variety of stress testing that we also consider. And those are the -- that's what we look at when we set our plans for the year." ] }, { "name": "Erik Bass", "speech": [ "Got it. Thank you. And then I was hoping you could talk a little bit about your strategic view of the U.S. individual life business going forward.", "Just under LDTI, I think your guidance implies this business will be roughly breakeven, are almost slightly profitable on a GAAP basis. So are there any actions that you're considering or that you could take to improve the profitability of this business?" ] }, { "name": "Caroline Feeney", "speech": [ "Hi, Erik. It's Caroline, and I'll take your question. So obviously, as you state, LDTI is expected to result in a meaningful decline in earnings this year for the life business as AOI recognition will be deferred. While this impacts the earnings pattern, it doesn't change the economics of the business.", "So, however, even under the impact of LDTI, we are proactively looking at ways to enhance the earnings power of the business. And we do remain encouraged by the actions we've taken to pivot to less interest rate-sensitive products, as well as to diversify our overall product portfolio. And, Erik, this obviously also includes the recent launch of our indexed variable universal life product, FlexGuard Life, which is ramping up nicely. We do expect our AOI to grow over time based on core growth, the compounding impact of new business written at attractive returns.", "And also higher reinvestment rates. And overall, we remain very committed to the individual life business. We do continue to believe that this business is core to Prudential's purpose and we like the growth potential with our overall brand, as well as our product breadth and certainly our distribution strength. And we also like the additive mix that the life business brings, particularly the longevity and mortality balance.", "And in terms of our pivot, our business -- our new business, Erik, it's really a much more favorable risk profile and we're writing new business at attractive returns." ] }, { "name": "Erik Bass", "speech": [ "Great. Thank you." ] }, { "name": "Caroline Feeney", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question today is coming from Jimmy Bhullar from J.P. Morgan. Your line is now live." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hey. Just a question first on your commercial mortgage loan book. If you could discuss your confidence in that portfolio? And any stats that you could give us in the loans that have either been restructured and how that sort of trended over the past several months?" ] }, { "name": "Rob Falzon", "speech": [ "Jimmy, it's Rob. I'll handle that. First, just from a sort of a high-level standpoint, the real estate portfolio is a very high-quality portfolio, broadly diversified both by geography and in the underlying property types. And we really benefit from PGIM's direct origination capabilities in this arena.", "They've got a management team there that's got well over 25 years industry experience and deep knowledge of the markets and a proven track record in that area. When we look at the quality of the portfolio, it's actually holding up quite well. You can see that our CECL reserve for that portfolio is just a little under $200 million. That's about 39 basis points against the portfolio, then that is up from about 21 basis points a year ago.", "But that's primarily a general reserve. We only have a single loan with a specific reserve in there, an office property. But outside of that, the reserve really comprises our estimation of losses across the portfolio based on historical data." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. And then the acquisition of Deerpath, should we assume that there's going to be sort of a diversion of funds from buyback to fund this, or should we not expect any impact on your buyback plans." ] }, { "name": "Charlie Lowrey", "speech": [ "So, Jimmy, let me take that and just raise it up a level and then I'll answer your question directly. We have said when we think about buybacks and the application of capital, that we want to be good stewards of capital. And we have and will continue to demonstrate a very disciplined and balanced approach to the redeployment of capital within our businesses and to our shareholders and other stakeholders. And you saw in the first quarter, we returned over $700 million to shareholders, which included the 15th consecutive annual increase in our dividend.", "So -- but if I take a step back for a moment, let me share with you some observations about how we think about capital allocation and particular optimization, which fits to your point. We look across all our businesses, both domestically and internationally, to ensure that we're optimizing capital deployment. So we'll continue to look for ways to optimize capital to maximize outcomes for all our stakeholders by balancing investments in our businesses and business growth, programmatic M&A, and returning capital to shareholders while maintaining our financial strength. And you saw examples of all four of that this quarter, right? We continue to invest in our businesses.", "We did programmatic M&A with the Deerpath Capital. We returned capital to shareholders, both in the form of dividends and share repurchases and we made an announcement to repay hybrid, which lowers our -- the hybrid, which lowers our leverage. So we'll continue to evaluate all these things as we go forward, especially in the current macroeconomic environment. But as an example, this quarter, we were able to do all of that given the strength of our capital position, given the cash flow we've generated, and given our strategy going forward." ] }, { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our next question is coming from Elyse Greenspan from Wells Fargo. Your line is now live." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi. Thanks. Good morning. My first question is on the capital side of things.", "When we -- after the $1.5 billion debt pay down, right, you guys at around are at 3.1 at the holdco. So can you just give me -- I'm just looking for a sense of where you want to run relative to that target? And then the answer to that question, can you give us a sense of just the timing of dividends that you're going to take out of PICA this year, as well as any repatriation of capital from Japan?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Elyse, it's Ken. As I mentioned before, we've been planning for the -- all of the $1.5 billion for some time. That's how we built our plans and then in terms of trends and timing 1Q is typically a lower quarter for cash flow from subsidiaries and that's what we saw this quarter, first quarter and it tends to be higher in subsequent quarters.", "All of our businesses are profitable in generating cash flow. That includes PICA and PGIM, and we expect cash flows from them as we progress through the year and we expect to operate within our $3 billion to $5 billion of holdco HLA range. It will be higher in some periods and lower in others and that's why we define the range. But overall, we're proceeding very in line with our plans." ] }, { "name": "Elyse Greenspan", "speech": [ "Thanks. And then the second quarter baseline, the 320 EPS, that assumes normal PII, but prepays and alternative real estate income could be lower just given the volatility we're seeing in markets. So how should we think about just PII, not only for the Q2 but also for the balance of the year?" ] }, { "name": "Rob Falzon", "speech": [ "Elyse, it's Rob. I'll try to address that. First, with regard to the returns on the alternatives portion of the portfolio, distinguishing that from the prepayments part of your question, market performance is going to continue to impact returns. That's primarily in the private equity component of our portfolio.", "That correlation is directional. How it manifests in any given quarter is kind of dependent on the conditions in the quarter. And I'd also note that within that PE allocation that we've got, about a quarter of that is actually allocated to mezzanine distressed debt and infrastructure. So not entirely correlated with the markets.", "And also remind you that the PE is reported on a one-quarter lag. So if you look at equity performance in the first quarter, that would be some indication of the portfolio on a go-forward basis. With regard to prepayments, we did see a reduced level of prepayments on a higher interest rate environment. And I think it's -- that's a trend that we're anticipating on a go-forward basis.", "Maybe I'll just close with going back to the alternatives portfolio, just to emphasize, we're -- our alternatives are invested for the long-term. And over that horizon, we expect to continue to benefit from the dedicated team that we've got. And from the diversification that we have in the portfolio and the efforts we've had around manager selection, including within the real estate component of that to the part of your question, real estate is actually a relatively modest component of our alternatives, it's 15-ish or so percent." ] }, { "name": "Elyse Greenspan", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Alex Scott from Goldman Sachs. Your line is now live." ] }, { "name": "Alex Scott", "speech": [ "Hey, good morning. First one I had is on annuities. That was a place where, I guess, relative to the presentation, you all put out at the time of the LDTI recast, the result came in much, much stronger this quarter. So I just wanted to see if you had a perspective on sort of what changed there versus what you were expecting at the time of the LDTI recast.", "And one of the things that struck me was NII, and I know you all have talked about sensitivity to the NII on shorter-duration collateral securities and cash. And I just wanted to see if you could provide any kind of sensitivity to help us think through how to model that, as we think through federal funds at the levels they are today versus some of the projections that have them declining?" ] }, { "name": "Caroline Feeney", "speech": [ "Yeah. So, Alex, it's Caroline, and I'll take your questions. So first of all, I would point out that the strong earnings in our retirement strategies business continues to reflect the ongoing growth that we're experiencing in this business. And I'll just start with the institutional retirement business, which ended the quarter with record account values of $253 billion.", "Our account values benefited from nearly $4 billion in sales, including the best first quarter ever in our pension risk transfer business. And then if I move to the individual retirement strategy side, we continue to see strong sales here as well, anchored by our FlexGuard suite of indexed variable annuities. In less than three years, we've delivered over $13 billion in total sales, clearly reinforcing our leadership position as a top-five player in the indexed variable annuity space. And complementing that success, our fixed annuity offerings saw continued strong growth and represented over 30% of our sales for the quarter.", "Compounding this growth story from an earnings perspective, Alex, is our robust disciplined pricing. So when we go to market, our pricing clearly is fair, competitive, and also accretive to shareholder value. We're also able to maintain this profitable growth trajectory, thanks to the strength of our brand, our leading distribution capabilities, as well as strong execution. I would also point out that earnings in the Retirement Strategies business are seeing a benefit from tailwinds provided by the current interest rate environment in both short-term, as well as long-term rates, which are driving favorable spread income.", "And then finally, we remain focused on expense discipline and continuous improvement in operating efficiency with an eye toward protecting the bottom line. So it's really a combination of all of these factors that contribute to the strong earnings we continue to see in the retirement strategies business, which are well-positioned for continued growth." ] }, { "name": "Alex Scott", "speech": [ "Got it. Maybe just a follow-up to that, I mean, the portion that's the sensitivity to shorter-term interest rates, is there any way for us to gauge how that may react if the fed-run trade begins to decline. It just seemed like there's maybe a bit more leverage than I would have guessed on the upside to that. So I don't want to overlook – estimate?" ] }, { "name": "Caroline Feeney", "speech": [ "So Alex, clearly, the earnings, as I mentioned, are seeing a benefit from the current interest rate environment, and that's both on the short-term as well as the long-term rates, driving the favorable spread income. And if we were to see rates decline, then clearly, we would see a reduction in the spread income that we earn. But I also want to reiterate the point that I made that business growth continues to be a driver of earnings as well. And so even if there was a reduction in rates, we would clearly expect that to persist." ] }, { "name": "Alex Scott", "speech": [ "Got it. Yeah, I understand. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from John Barnidge from Piper Sandler. Your line is now live." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much for the opportunity, and good morning. My question is around the group insurance. Persistency decline in both group life and disability, can you maybe talk about the drivers, seeing any impact from deployment reductions as the larger jumbo into the market?" ] }, { "name": "Caroline Feeney", "speech": [ "Of course, John. It's Caroline, and I'll take your question. So let me just start by taking a step back and pointing out that at core focus of our group business is to remain price-disciplined and profit-focused. And that just really means pursuing smart growth.", "We saw a 2% growth from the year-ago quarter and earned premiums and fees, and that was primarily driven by growth in disability and supplemental health. And while we saw strong sales in the first quarter in group life, the year-over-year decline in annualized new business premiums is attributable to our strong discipline when it comes to pricing new sales. So specific to your question on persistency, John, I'll highlight our approach to and as well as our experience with renewals, which, as you know, are heavily weighted toward the January 1st effective date. When it comes to pursuing renewals, if we are unable to achieve our desired level of profitability through appropriate rate action, we choose not to retain that business, which is, in fact, just really addition by subtraction.", "So from a group life persistency perspective, you're actually seeing those principles in action here in the first quarter. And the trend in the persistency ratio in our group disability business remains strong. John, you also asked about unemployment and the impacts there. With regard to any signs of impacts from workforce reductions, we really aren't seeing any impact on our business at this point in time.", "While there clearly have been quite a few large layoff announcements that have generated their share of headlines, overall employment conditions continue to be strong. We're seeing tight labor markets with low current unemployment and a large number of job openings. So this favorable employment trend is evident in the results of our group disability business and our results reflect favorable macroeconomic tailwinds, as well as strong execution on proactive claims management. So broadly, we view the risk of unemployment impacts to our business as low over the short to medium-term.", "And also, I would mention, John, historically increases in unemployment rates over a sustained period could drive an increase in disability claims. However, they would typically take six to 12 months to cycle into our results." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much. And another question around Japan. I believe they're lifting pandemic-related restrictions, categorizing COVID like infectious disease or like the influenza. Can you talk about -- is that anticipated to improve or enhance distribution, or are there any product launches planned around that? Thank you." ] }, { "name": "Andy Sullivan", "speech": [ "So, John, it's Andy. I'll take your question. But let me lift it up a bit and just talk about Japan sales overall. Our Japan operation is competitively advantaged with outstanding distribution, really strong product, and a great brand.", "We were very pleased with the quarter sales results where we had a 4% improvement over the sequential quarter and a 10% improvement year over year. That success was well spread out as we experienced material year-over-year growth in the life planner, life consultant, and bank channels. To your question on product, our work on innovating our product designs continues as we drive to ensure that we meet the needs for retirement, wealth transfer and unmet health and care needs. We also continue to drive our efforts around customer experience with a particular focus on strengthening the product and the offering and the experience to small to midsized enterprises.", "As far as the pandemic-related effects and restrictions, we are seeing the COVID related sales challenges begin to subside. But that being said, we are still seeing impacts from a recruiting and retention perspective. But if you look at everything in aggregate, we're quite optimistic about our ability to grow these businesses over time as it always is, our priorities are to deliver strong value to our customers while achieving very, very healthy levels of profitability." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question today is coming from Suneet Kamath from Jefferies. Your line is now live." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. I just want to go back to Charlie, an answer that you gave to a previous question on capital, I think it was Jimmy's question. So I just wanted to confirm, are you committing to the $1 billion of buyback for the year, or it just felt like maybe there was a little bit of vagueness in your response? I just wanted to give you the opportunity to clarify." ] }, { "name": "Charlie Lowrey", "speech": [ "No, thanks, Suneet. There is no vagueness in my response. But to be clear, the board has authorized $1 billion of buybacks, and we will evaluate that each quarter according to the macroeconomic conditions. So there is no wavering per se, but we can't guarantee that we are going to -- that would be a forward-looking statement, which we can't make.", "So no equivocation in our desire to execute on the program. But again, we can't make forward-looking statements." ] }, { "name": "Suneet Kamath", "speech": [ "OK. That's clear. Thanks for that. And then I guess, I don't know if it's for Rob or Ken, when you talk about on Slide 11 about the mortgage loan portfolio and the process that you go through evaluating at least once a year, what is that process like? Is that an internal process where you use your team, or do you go externally and hire firms to kind of confirm or validate your approach? Just curious how you think about that." ] }, { "name": "Rob Falzon", "speech": [ "Hi, it's Rob, Suneet, and I'll take the question. So it's a rolling process, first of all. So it goes on throughout the year. It's not a single date point in time when we do appraisals.", "We have a very rigorous process around this which is we have a central team that sort of runs the appraisals on all of the properties, and that's a combination of using outsourced appraisers in order to give us input into those appraisals, but ultimately, the appraisal is an internal appraisal. We use outsiders for inputs into the appraisal and even both from a data standpoint and from a valuation standpoint, we -- the internal appraisal process is one that will look at all that external data and valuations but we put constraints around it. For instance, we have floors on cap rates that vary according to different property types that we use in our own internal valuations. That's resulted as we've noted in the past, in a phenomenon where our internal appraisals have generally been at the time in which we make them about 10% lower than what the external appraisals are that we've received in those processes.", "So what you see when we quote our valuations, we're doing it based on that internal view informed by external appraisals, but very much in an internal number with a level of conservatism that's applied on it." ] }, { "name": "Suneet Kamath", "speech": [ "Makes sense. And if I could sneak one more in just on Japan again. So higher rates in Japan is a relatively new phenomenon. So I'm just curious, one, is that changing kind of customer behavior in terms of products? And then relatedly, I think maybe a quarter or so ago, you guys were having some issues with lapses in the foreign currency products.", "So just curious if there's an update there in terms of if that's continuing or if it's stabilized, that would be helpful. Thanks." ] }, { "name": "Andy Sullivan", "speech": [ "Sure. It's Andy. I'll take the question. Let me start with the second half of your question.", "So on surrenders. So as we discussed last quarter, our elevated level of surrenders began to decelerate in December. And we've absolutely seen that continue into quarter one, as the surrenders continue to subside all the way through the quarter. So we're seeing that come back and subside pretty consistently.", "As far as the higher rates, and obviously, when we say that, higher yen rates, higher U.S. interest rates, I would -- as I would always say, higher interest rates are good for Prudential, are good for our businesses, and they're good for our Japanese business. Obviously, that's from an earnings perspective, but also higher yields give us greater flexibility in our product designs and allows us to deliver additional value to our customers while delivering additional value to our shareholders. So, all-in-all, we see these as good trends and good things." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. OK. Thank you, guys." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question is coming from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. What drove elevated mortality in the first quarter versus what you typically see? I guess, I'm just curious if you saw an early flu season last quarter that was a pull-forward or not." ] }, { "name": "Caroline Feeney", "speech": [ "Sure, Tracy. It's Caroline. And thanks for your question. The life business typically experiences elevated seasonal mortality in the first quarter, and that's consistent with what we see across the industry.", "And certainly, this year was no exception. And along with the industry, we even saw some excess seasonal mortality, and that was due to the impact from COVID, flu, and also other respiratory illnesses. We also saw a higher incidence of large face-value claims within our life business. And going forward, Tracy, we do believe that COVID has transitioned to an endemic state and therefore, may still contribute to some amount of elevated mortality over the near to medium term.", "I would just point out, however, that the overall trend is better than the two previous winters, reinforcing our belief that we will return to pre-pandemic mortality levels in the long term. And finally, even though we did see some unfavorable mortality experience in the quarter, our diverse mix of mortality and longevity businesses helps to mitigate some of that experience over longer-term horizons. Tracy, you also asked about flu season last year and there was no evidence of an early flu season in our book last year." ] }, { "name": "Tracy Benguigui", "speech": [ "Very helpful. I appreciate that. The next question, I'd like to ask you about your office loan maturities in the next 24 months. Our review of stat filings, it looks like it's about $500 million.", "Can you speak to the feasibility of extension? Do you feel like borrowers could either purchase an interest rate cap if the loan is floating or reduce the loan balance by putting in more equity with the current debt yields allow that?" ] }, { "name": "Rob Falzon", "speech": [ "Sure, Tracy. It's Rob. The -- about -- actually a little over 10% of the portfolio matures in the next two years. So you think about it, just looking at a little further from the statistic that you quoted.", "The -- recall that our portfolio is almost exclusively a fixed rate portfolio as opposed to floating rate. And so, when you look at the differentiation, the differences on the rollover of the portfolio are going to be looking at what's happened at the long end of the curve versus the short end of the curve where obviously been more dramatic at the short end of the curve for those that have been borrowing on a floating-rate basis. Because of the relatively low loan to values we have across our portfolio, and we gave the statistics on that, it's mid-50% on average LTV as we roll over loans. And incidentally, the office portfolio is very much in line with that overall portfolio statistic.", "So as we're rolling over our loans, we're not particularly concerned about the sufficiency of equity in order to be able to refinance, even if it requires a higher level of loan and LTV from where we are." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. Very helpful." ] }, { "name": "Operator", "speech": [ "Thank you. And your next question is coming from Michael Ward from Citi. Your line is now live." ] }, { "name": "Michael Ward", "speech": [ "Thanks guys for squeezing me in. Maybe just on commercial real estate. I was wondering about the slide on the REIT debt. I was just wondering if you could expand on that and help us understand how it fits in the spectrum and how -- if we should think about the credit risk they're similar to like a direct commercial mortgage loan?" ] }, { "name": "Rob Falzon", "speech": [ "It's Rob again. Mike, I would think about the REIT portfolio as more akin to our private placement portfolio than the mortgage portfolio. So while mortgages of the underlying assets within the businesses, they are larger, more diversified businesses than what you're going to find in a typical single asset mortgage loan, it's about -- that REIT portfolio is about 2% of our assets. It's 97% investment grade.", "It's very well-diversified by geography and property type. And like all of our private placements and benefits a strong package of covenants as a result of our direct origination capabilities and that loan portfolio is primarily, if not almost entirely a result of that direct origination within PGIM. So like we do across the rest of the private placement portfolio, we actually feel quite good about the strength of those loans and the performance of them in the down cycle vis-à-vis comparatively rated public securities." ] }, { "name": "Michael Ward", "speech": [ "Thanks, Rob. And then somewhat and relatedly, I believe PGIM's one of the bigger CLO managers, I was just wondering if you had any perspective or outlook for that asset class, given broader credit risk?" ] }, { "name": "Rob Falzon", "speech": [ "It's Rob. I'll take it again. And I'll defer to Andy if he wants to jump in on me to talk more specifically about PGIM. But Mike as we – to think about CLOs, first of all from our own portfolio, we are solely a holder of AAA securities within the CLO, within the general account portfolio.", "We have some minuscule exposure below AAA as a result of being a CLO manager, PGIM being a CLO manager. We do European CLOs, we need to have retention there of a relatively modest amount, so it's inconsequential. But outside of that, it's exclusively a AAA portfolio. As we look at the CLO space, we find good value in the AAA and even the AA space and -- but we're more conservative in our views as to what can happen in a stress environment once you get into the single A and obviously the BBB and subordinated tranches of that." ] }, { "name": "Michael Ward", "speech": [ "OK. Thanks very much." ] }, { "name": "Operator", "speech": [ "Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Lowrey for any further or closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "OK. Thank you again for joining us today. I hope we demonstrated to you the progress we're making in transforming Prudential to deliver sustainable long-term growth and to meet the evolving needs of our customers. We're confident in our strategy and the strength of our company.", "For nearly 150 years, Prudential has been focused on creating value for our customers and other stakeholders who we will continue to serve as we strive to be a global leader in expanding access to investing insurance and retirement security. Thank you again for joining us, and have a good day." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2021-05-05	[ { "description": "Senior Vice President, Investor Relations", "name": "Darin Arita", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Executive Vice President and Head of U.S. Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Andrew Kligerman", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Head of International Business", "name": "Scott Sleyster", "position": "Other" }, { "description": "Goldman Sachs -- Analyst", "name": "Yaron Kinar", "position": "Analyst" }, { "description": "Dowling Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Josh Shanker", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to the Prudential quarterly earnings conference call. [Operator instructions] And as a reminder, today's conference call is being recorded. I would now like to turn the conference over to Mr. Darin Arita.", "Please go ahead." ] }, { "name": "Darin Arita", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of U.S. [Technical difficulty]" ] }, { "name": "Charlie Lowrey", "speech": [ "OK. Now, we can hear -- sorry, everybody. We're having a little bit of difficulty. It's Charlie.", "Darin will start over." ] }, { "name": "Darin Arita", "speech": [ "Let me start over here. So good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of U.S. businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer.", "We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions. Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures.", "For a reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled forward-looking statements and non-GAAP measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at prudential -- at investor.prudential.com. With that, I'll hand it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Darin, and thank you all for joining us this morning. As always, I hope you and your families have remained safe and healthy. Despite the ongoing challenges created by the pandemic, Prudential reported strong results for the first quarter, including record adjusted operating income and robust sales and flows across many of our businesses. Our performance reflects strong underlying demand for our products; continued execution on our strategic initiatives; the complementary nature of our retirement and life insurance businesses, which has helped us mitigate mortality risk; favorable markets; and the commitment of our employees around the world.", "We're on track with our key transformation initiatives and have increased returns to shareholders, supported by our strong performance and the strength of our balance sheet. I'll cover each of these topics in more detail and begin with a brief review of the transformation initiatives we highlighted for you in February. Turning to Slide 3. We are on track to deliver $750 million in cost savings by the end of 2023, $400 million of which were targeted for 2021.", "Cost savings for the first quarter were $110 million. The initiatives generating these cost savings are also producing better customer and employee experiences and, as a result, enhancing the competitiveness of our businesses. We are also in the process of reallocating $5 billion to $10 billion of capital by pursuing programmatic acquisitions to grow in asset management and in international emerging markets. In addition, we'll remain focused on investing in our other businesses to expand our addressable market and to continue to improve expense and capital efficiency.", "In parallel, we're actively executing on other means of changing our business mix and earnings profile by pivoting to less market and rate-sensitive products, such as our buffered annuity product, FlexGuard; running off certain blocks of business; and actively pursuing potential derisking transactions. As a result, we expect Prudential to emerge as a higher-growth, less market-sensitive, and more nimble company. As we execute against our transformation initiatives, you can expect that we'll continue to demonstrate discipline in the redeployment of capital within our businesses and to our shareholders. Turning now to Slide 4.", "In the first quarter, we increased our shareholder dividend by 5% and repurchased $375 million of common shares. In addition, based on our progress with our initiatives, as well as the improving macroeconomic outlook and the more favorable equity market and interest rate environment, we announced a $500 million increase to our 2021 share repurchase authorization. We expect to repurchase these additional shares starting in the second quarter. As a result, we now expect to return $10.5 billion to shareholders through 2023.", "Moving to Slide 5. Our expanded shareholder return program is supported by our rock-solid balance sheet, which included $5.4 billion in highly liquid assets at the end of the first quarter. Our operating subsidiaries continue to hold capital to support AA financial strength ratings, and we have a high-quality investment portfolio. Turning to Slide 6.", "We are also executing on behalf of our stakeholders through our commitment to environmental, social, and governance actions. This work has long been reflected in our purpose as a company of solving the financial challenges of our changing world and is as important as ever. Of recent note, on the environment, we have made significant progress reducing emissions, waste, and paper. And we continually evaluate how we can improve our impact on the environment.", "On social issues, we have invested further in our people with training and development programs and continued to maintain a high level of pay equity throughout the firm. We also achieved our three-year goal that we created in 2017 of increasing representation of diverse persons among our senior management by 5 points over that time period. We followed this by establishing new goals and are continuing to tie our goals to management compensation as we did in the prior period. And we're already making progress on our commitments to advance racial equity, which we announced last summer.", "On governance, we continually refresh our board with people who are highly skilled and who also reflect the diverse communities and geographies that we serve. Today, 82% of our independent directors are diverse. You can see more details on how we're progressing against our goals and commitments in our ESG summary report that we published in March. Before closing, I would like to thank all of our employees around the world.", "It's through their continued hard work and dedication that we've been able to support our customers and colleagues during these challenging times, all while advancing our company's transformation and purpose of making lives better by solving the financial challenges of our changing world. With that, I'll turn it over to Rob for more specific details on our business performance." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results and business performance for our U.S., PGIM, and international businesses. Turning to Slide 7. I'll begin with our financial results for the first quarter.", "Our pre-tax adjusted operating income was a record high of $2.1 billion, or $4.11 per share on an after-tax basis. Earnings exceeded the year-ago quarter across all of our businesses. Results of our U.S. businesses were up 38% and reflected higher net investment spread results, driven by higher variable investment income and higher fee income, primarily driven by equity market appreciation, partially offset by less favorable underwriting experience driven by COVID-19 related mortality.", "PGIM, our global asset manager, had record-high results, including a gain on the sale of our Italian joint venture. Our partner was acquired by another firm with an existing asset management business and expressed the desire to purchase our interest, which was a right it retained under the joint venture agreement. Nonetheless, assets under management of $1.5 trillion were up 12% from a year ago, driving asset management fees to a record level. And earnings in our international businesses increased 25%, reflecting business growth, higher net investment spread, more favorable underwriting results, and higher earnings from our Chilean pension joint venture.", "Turning to Slide 8. Our U.S. businesses produced diversified earnings from fees, net investment spread, and underwriting income to benefit from our complementary mix of longevity and mortality businesses. As Charlie noted, we continue to make progress in shifting away from capital-intensive and interest rate-sensitive products.", "Our product pivots have worked well with sales of our buffered annuity FlexGuard growing to $1.6 billion in the first quarter, representing 84% of total annuity sales, up from $1.2 billion in the fourth quarter of 2020. Our sales reflect increasing customer demand for investment solutions that offer the potential for appreciation from equity markets combined with downside protection. In addition, we benefit from having a strong and trusted brand, as well as a highly effective distribution team that has significant reach with Prudential advisors and third-party advisors. We are engaging with a broad range of advisors with FlexGuard.", "We also leverage our broad multidimensional relationships with our strategic partners that both distribute our products and manage the assets of our clients. With respect to Individual Life, we increased sales by 9% compared to the year-ago quarter as higher variable life sales offset lower sales of other policies, in particular, Universal Life sales consistent with our product pivot strategy. In our Retirement business, account values were a record high, up 23% from a year ago driven by business growth and market appreciation. Net flows in the quarter were $6 billion, including a longevity reinsurance transaction in excess of $8 billion.", "With respect to Assurance, total revenues, our primary financial metric as we concentrate on scaling the business, were up 80% over the prior quarter. We grew all business lines, particularly in Medicare, where we expanded distribution to increase sales outside of the fourth-quarter annual enrollment period. Now turning to Slide 9. PGIM continues to demonstrate the strength of its diversified active management platform as a top 10 global investment manager.", "PGIM's diversified global investment capabilities in both public and private asset classes across fixed income, alternatives real estate, and equities position us favorably to capture flows. In addition, PGIM's investment performance remains attractive with approximately 90% or more of assets under management outperforming their benchmarks over the last three-, five- and 10-year periods. Our diversified capabilities and strong investment performance helps contribute to more than $5 billion of third-party net flows during the quarter, including $4 billion of retail and $1 billion of institutional flows. Offsetting the growth in net flows was a decrease in the market value of our fixed-income assets, reflecting the increase in interest rates.", "As the investment engine of Prudential, PGIM also benefits from a symbiotic relationship with our U.S. and international insurance businesses. PGIM's asset origination capabilities and investment management expertise provide a competitive advantage, helping our businesses to bring enhanced solutions and more value to our customers. And our businesses, in turn, provide a differentiated source of growth for PGIM through affiliated flows that complement its successful third-party track record of growth.", "PGIM's asset management fees increased 15% compared to the year-ago quarter in a record -- to a record level as a result of market appreciation and continued positive third-party net flows. This contributed to an 8-point increase in PGIM's net adjusted operating margin, including the gain on the sale of the Italy joint venture -- excuse me, excluding the gain on the sale of the Italy joint venture compared to the year-ago quarter, consistent with our expectation of 30% across the cycle. Turning to Slide 10. Our international businesses include our Japanese life insurance operation, where we have a differentiated multichannel distribution model, as well as other operations, focused on high-growth markets.", "While sales across both Life Planner and Gibraltar operations were lower than the prior year, reflecting the disruption from Japan's metropolitan areas being in a state of emergency this quarter, as well as lower demand for our U.S. dollar-denominated products following price increases last year, profitability increased significantly. We remain encouraged by the resiliency of our unique distribution capabilities which has helped to continue to grow our in-force business. And with that, I'll now hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 11, which provides insight into earnings for the second quarter of 2021 relative to our first-quarter results. Pretax adjusted operating income in the first quarter was $2.1 billion and resulted in earnings per share of $4.11 on an after-tax basis. Then we adjust for the following items.", "First, variable investment income outperformed expectations in the first quarter, which is worth $275 million. Second, we adjust underwriting experience by $160 million. This includes a placeholder for COVID-19 claims experience of an additional $70 million based upon 55,000 COVID-19-related fatalities in the U.S. during the second quarter.", "Third, we expect expenses and other items to be approximately $500 million lower in the second quarter, primarily as a result of favorable items in the first quarter, including the $378 million gain from the sale of PGIM's joint venture in Italy and seasonality. Fourth, we anticipate net investment income will be reduced by $10 million, reflecting difference between new money rates and disposition yields of our investment portfolio. These items combined get us to a baseline of $2.89 per share for the second quarter. I'll note that if you exclude items specific to the second quarter, earnings per share would be $2.97.", "The key takeaway is that our underlying earnings power increased from last quarter, including the benefit from business growth and higher equity markets. While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the second quarter. I would also note that we continue to expect the full-year 2021 corporate and other loss to be about $1.5 billion. On Slide 12, we provided an update on the potential impact of the pandemic.", "Consistent with the information we provided on our fourth-quarter call, the estimated sensitivity of operating income for $100,000 incremental U.S. debt due to the pandemic is about $85 million. As I noted earlier, our second-quarter baseline includes a net mortality impact of $70 million due to COVID-19. The actual impact will depend on a variety of factors such as infection and fatality rates, geographic concentration, and the continued speed acceptance and effectiveness of the vaccine rollout.", "Turning to Slide 13. We continued to maintain a robust capital position and adequate sources of funding. Our capital position continues to support a AA financial strength rating, and we have substantial sources of funding. Our cash and liquid assets were $5.4 billion, which is greater than three times annual fixed charges.", "And other sources of funds include free cash flow from our businesses and other continued capital facilities. Turning to Slide 14 and in summary, we are on track with our key initiatives, and we maintain disciplined capital management while returning additional capital to shareholders, and we continue to benefit from the support of our rock-solid balance sheet. Now, I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our first question will come from the line of Tom Gallagher with Evercore. Your line is open." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. Charlie, just wanted to see if we can get an update on potential timing and sizing of risk transfer deals, where things stand now for freeing up capital. And also, same question on the programmatic M&A you're targeting." ] }, { "name": "Rob Falzon", "speech": [ "Hey, Tom, it's Rob. Let me take a first shot at that if you don't mind. So thank you for the question. First, actually, let me start with a reminder.", "A large portion of the broader business mix objectives that we have are actually going to achieve -- be achieved organically. The internal growth objective we have, which essentially to double the growth of our -- double the size of our growth businesses, about a third of that is -- of that targeted increase will come from the organic growth in those businesses. And then with respect to the targeted reduction, specifically bringing our annuities business down to around 10% or so of total contribution, 40% to 45% of that comes from the runoff of our legacy block. The -- we didn't expect capital redeployment in the form of, on the growth side, programmatic acquisitions.", "And then on the reduction side, reinsurance and/or sales to largely close the remainder of the gap. And as Charlie indicated in his opening remarks, we are actively executing on that, including through derisking transactions on the reduction side. While we're making progress, we're not yet in a position, Tom, where we're going to speak any more specifically. Although I'd like to reiterate what we said before: First, these transactions are generally complex and therefore, they require time; and secondly, we intend to remain disciplined, transacting both with respect to dispositions, as well as acquisitions to ensure that we're creating value for our shareholders in any transaction that we undertake.", "It's why we indicated, sort of, a relatively broad range of the $5 billion to $10 billion and a multiyear period for accomplishing that. Probably the last thing I want to mention is that the product repricings and pivots that we've been undertaking are also important levers to changing that business mix. And maybe, Andy, if you don't mind, you can just sort of give a quick update on that." ] }, { "name": "Andy Sullivan", "speech": [ "Sure, Rob. Tom, good morning. So I'll make this very specific, so let's talk about annuities. So as we've talked about.", "Step 1 in derisking is the runoff. And that started with ceasing of sales. So you saw this quarter where we only had 1% of our sales that came from traditional variable annuities with guaranteed living benefits. And we very successfully have pivoted over to FlexGuard.", "We will expect to see about a $3 billion per quarter runoff in that traditional variable annuity block of business. This quarter, we saw about $3.8 billion. As we pivot at the FlexGuard, we're putting into the market a very different type of product that better balances consumer value with shareholder value. And we could not be more pleased with the success of that product.", "We had a 14.5% market share back in 4Q. And as you saw, our sales have continued to expand, where we had $1.6 billion in sales this quarter. That is really coming off of the strength of our brand and the strength of our distribution, and we're very happy with the returns and the risk profile of that new business that we're putting on the book. So it's a very good example of how Step 1 is all about the runoff and pivot." ] }, { "name": "Operator", "speech": [ "Thank you. Next, we will go to the line of Elyse Greenspan with Wells Fargo. And your line is open." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi. Thanks. My first question, maybe following up on Tom's question, just on the M&A side of things. You guys mentioned PGIM in emerging markets as areas where you would look to deals.", "As you're executing on that plan, can you just give us a sense of what you're seeing out there from the M&A perspective as you're kind of looking to execute there?" ] }, { "name": "Charlie Lowrey", "speech": [ "Sure, Elyse. This is Charlie. Let me just take a step back, if you will, and put what we're doing into context. And then I'll answer your specific question.", "But as we look at the journey we're on, if you will, we, as a management team, are laser-focused on three goals. Well, the first is to deliver strong and consistent performance, and hopefully, you've seen that. The second is to execute on the transformation that Rob and Andy just talked about, and there are three parts to that. One is pivoting our products to be less market-sensitive and capital-sensitive.", "The second is to execute on our cost efficiency goals, and you saw that we expanded our goals by 50% last year and are ahead of track. And the third is to lean into the higher-growth markets, as Rob talked about, the reallocation of the $5 billion to $10 billion of capital. So that's the second goal. The third goal is to be good stewards of capital.", "Balancing the return of capital to shareholders with investing both organically and inorganically in our businesses. And we think that by achieving that balance, we can maximize shareholder value over time. So those are the three goals: strong and consistent performance, executing on our transformation, and being good stewards of capital. And that will hopefully give you a framework around which we could look at any of the actions that we take, including, as you talked about the programmatic M&A, which Andy now can talk about." ] }, { "name": "Andy Sullivan", "speech": [ "Yes. So thanks, Charlie. And, Elyse, I'll build upon it. So first, when it comes to PGIM, I'd be remiss if I didn't say that we've had just great success organically growing this business.", "We've seen somewhere in the neighborhood of $55 billion in flows over the last five years due to the strength of our platform. And we will continue to invest in that organic growth. Having said that, this is an area we've identified where we want to augment through M&A. And that all starts with being very clear on our priorities and clear in our spots.", "As we talked about last quarter, we're very interested in expanding upon our already good capabilities in alternatives, as well as continuing to expand on our track record of success globally. Those are areas we're focused on because if you look at the overall asset management industry, they are faster growth areas of this space. As we're looking, everything and anything we look at would -- obviously, we need to vet for cultural fit and to make sure it fits with our multi-manager model. The way that I talk to my team and my team, we talk about this as being in the flow and in the know.", "And what I mean by that is we need to make sure that we see all potential opportunities, both what's already in the marketplace, but what might be in the marketplace. And I can tell you that we are very confident that we are in the know and in the flow. We will be very programmatic and disciplined in deploying capital toward these acquisitions. And we are very confident that it will meaningfully add to PGIM over time." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. That's great. Then my second question, in terms of the plans that you guys laid out, the exiting and the downsizing of businesses, we've all kind of focused on the U.S. individual solutions side of the house.", "But as we think about the workplace solutions, be that retirement or group, are those businesses that if there was an opportunity via a transaction to monetize some of the assets. Is that something that you would consider? Or are you still more focusing off on annuities and life as you look to free up capital?" ] }, { "name": "Charlie Lowrey", "speech": [ "So it's Charlie again, Elyse. We've spoken about the fact that we've taken a broad strategic review on our businesses within the context of having a business mix that is less market-sensitive, less capital-intensive, and higher growth. And we're going to be really thoughtful and diligent about how we execute on the process with the goal of maximizing value for shareholders. So when there's more to report, we'll let you know, but we're in the process of doing that." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. Thanks for the color." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Andrew Kligerman with Credit Suisse. And your line is open." ] }, { "name": "Andrew Kligerman", "speech": [ "Good morning, everyone. Just following up on Elyse's question. If you could give a little more clarity on the full-service retirement business, is that considered a core capital-light business?" ] }, { "name": "Charlie Lowrey", "speech": [ "So this is Charlie, Andrew. Again, we're not going to comment on any particular business. What I'll do is go back to our original premise, which is that we looked at all businesses. We're considering a business mix in totality that's going to be higher growth, less capital-intensive, less market-sensitive -- intensive, and less volatile over time.", "And we've evaluated all our businesses within that context. And as we go through that process, as we make decisions and execute, you will be one of the first to know, along with all your other colleagues." ] }, { "name": "Andrew Kligerman", "speech": [ "Maybe you can -- all right. Let me know a little before then. But anyway, moving on to Assurance IQ, I mean, these revenues look phenomenally robust. And yet, this quarter, you generated a pre-tax loss of $39 million.", "Could you give a sense of when you'd like to kind of turn the corner on profitability? Or is it still a little too early to say?" ] }, { "name": "Andy Sullivan", "speech": [ "So, Andrew, it's Andy. Thank you for your question. First, let me make sure I point out that in this quarter, we had $10 million of one-time, nonrecurring expense. And just to give you a feel and a flavor for that, as an example, we ended a couple of vendor contracts in distribution as we're maturing our model.", "As far as the path we're on to drive the business toward ultimate -- our ultimate revenue and margin objectives, nothing has changed. We bought this business and platform for its long-term strategic capabilities that it provides us, both from expanding the addressable market, as well as for shifting our mix to a more fee-oriented mix. So as such, we're investing and managing the business for the long term. We continue to invest in broadening and deepening the product portfolio.", "We continue to invest in deepening and making more capable the distribution system. And the results in the quarter, you see evidence of that. I'll point back to what we said last quarter: The key metric is revenue growth as we scale this platform up. And as you saw, we had 80% quarter-to-quarter revenue growth and had revenues grow in all lines.", "So we have a plan. We're executing against it. We're seeing the metrics go the right way. We need to scale the platform.", "And as such, in the near term, we will see operating losses." ] }, { "name": "Andrew Kligerman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Ryan Krueger with KBW. And your line is open." ] }, { "name": "Ryan Krueger", "speech": [ "Good morning. I noticed that you stopped breaking out the wellness implementation costs this quarter. Can you give us any context for why you did that? And also, I guess as we look -- if we think about the corporate segment losses of $1.5 billion for 2021, should we expect that to decline in the following years as implementation costs also decline?" ] }, { "name": "Ken Tanji", "speech": [ "OK. Ryan, it's Ken. We're making really good progress on our transformation and cost-saving initiatives, and that's being driven by our transformation office, and we're making great progress. We included the implementation cost that we expect this year in our estimated loss for corporate and other of $1.5 billion, so it's in there.", "And it's comparable to the amount that we had in 2020. At this stage, we don't expect the magnitude to vary significantly. So that's why we didn't feel the need to continue to separate and isolate it out. We are, as I mentioned, making very good progress toward our objective of achieving 100 -- or $750 million of cost saves by 2023.", "And over this period, we would expect to have implementation costs included in our corporate and other segment to continue." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks. And then on your retirement business, can you give us any rough breakdown since there's kind of a couple of different businesses in your reporting segment, what the rough breakdown in terms of earnings contribution is from full-service compared to institutional investment products?" ] }, { "name": "Ken Tanji", "speech": [ "We have an excellent full-service business, but it's part of our overall retirement segment. We haven't historically separated that out. It is part of that business line, and we're not going to separate that, those specifics out for just the full-service segment." ] }, { "name": "Ryan Krueger", "speech": [ "Got it. All right. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Suneet Kamath with Citi. And your line is open." ] }, { "name": "Suneet Kamath", "speech": [ "Great. Thanks. My first question is, I'm just trying to reconcile something, which is at the 2019 Investor Day, we spent a lot of time on the financial wellness initiative and how you're tracking a lot of these meetings that you were hosting with the employees of your corporate customers. So I'm trying to reconcile that strategy with comments that we're hearing today that a lot of your U.S.", "-- or your U.S. businesses are under review, including the retirement business. Because it felt to me that those two things were interconnected. So I'm trying to figure out, is there a change in that financial wellness strategy? Or what's going on?" ] }, { "name": "Andy Sullivan", "speech": [ "So, Suneet, it's Andy. I'll take your question. Financial wellness absolutely remains a key component of our organic growth strategy in the company. As we articulated at that Investor Day, and as you heard me say often, we're working to bring more solutions to more people and to address a broader swath of the American marketplace.", "That is both through the workplace, through the advisor channel, and direct-to-consumer. As we talked about our financial wellness capabilities that we've built out have really helped to activate a couple of value levers. And the two predominant ones would be institutional value, and the second would be converting individuals in the workplace to long-term loyal customers of Prudential. We've seen those value levers activated.", "We've talked in the past about institutional value that's been delivered, both from the net revenue growth in the group insurance business, but also from the growth of our full-service platform. And we are seeing the conversion to individual product sales from the financial wellness value product. So you should think of it as it is an important component of the organic piece of our strategy to grow and expand our addressable market. But it is that.", "It's a component of the broader strategy as we push the business system to be higher growth, less capital-intensive, and less market-sensitive." ] }, { "name": "Suneet Kamath", "speech": [ "OK. And then on the capital reallocation, I think when we were talking about growth businesses last quarter, you highlighted three: emerging markets, PGIM, and Assurance IQ. I think, Charlie, in your prepared remarks this morning, you didn't mention Assurance IQ. Should we take from that you're currently not planning on allocating more capital to either Assurance IQ or other sort of insured tech types of operations?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yes. I think that's a fair comment. In other words, as we think about programmatic M&A, in particular, as we've talked about it this morning, it's investing primarily in our other businesses in the U.S. and international.", "And what we mean by programmatic M&A is very -- it's a very specific strategy. We're going to be highly selective, and we're going to do targeted acquisitions that add either scale or augment capabilities to our existing businesses, like PGIM and like emerging markets." ] }, { "name": "Rob Falzon", "speech": [ "Hey, Suneet, it's Rob. I'll just add to Charlie's comments, which is to say that differentiate what -- the objective that we articulated was to have the combination of the three businesses that you mentioned equal to 30% of our earnings in the timetable that we have targeted. And then we separately said with regard to redeployment of capital, however, that we're focused on PGIM and emerging markets. We did not, at that point in time, had Assurance as an area for capital deployment." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of Erik Bass with Autonomous Research. And your line is open." ] }, { "name": "Erik Bass", "speech": [ "Hi, thank you. Can you provide some more details on your current emerging markets businesses and where they stand in terms of scale and profitability? How much earnings are you generating from emerging markets today? And how do you expect that to grow organically over the next three years?" ] }, { "name": "Scott Sleyster", "speech": [ "Thanks, Erik. This is Scott. I'll go ahead and take that question. Well, first of all, from a big picture perspective, following the sale of Korea, about 94%, 95% of our earnings come from Japan.", "So that's why we spend a lot of time focused on Japan. Within the emerging markets, I think I've said before that the bulk of the earnings from that sector comes from a combination of Brazil and Chile. So the good news is in our emerging markets platform is that we feel like we're in a lot of the right countries, and we've actually worked pretty hard to get the right partners in those countries where partners were required. The challenge that we faced is that we originally started in a lot of those markets with tied agency or an LP model, and we've now broadened that out to add independent agency and Bancassurance.", "But we're starting from a rather small platform. So the good news is we are seeing rapid growth in the emerging markets. For example, our in-force grew at high single digit in Brazil and double digit in Mexico last year. But for most of our emerging markets, we're starting off of a rather small base.", "And that's why Charlie talks about it in the context of markets that we'd like to grow. We tend to think we're in the right places. We have licenses and partners, and that's why we think a bolt-on strategy is probably the best strategy for growing those markets. Thanks." ] }, { "name": "Erik Bass", "speech": [ "Thank you. And then a follow-up on sticking with the international businesses. In the Life Planner business, you continue to show healthy growth in life planners at POJ, but the total Life Planner counts down year over year. I'm assuming the decline is coming from Brazil.", "I just was hoping you could provide some more color on what's going on and what we should infer about the underlying growth trends in that business?" ] }, { "name": "Scott Sleyster", "speech": [ "Yes, Erik, that's a good follow-up. And your observation is correct. I believe I commented last quarter, but we systemically or consistently kind of go through our LP models, and we change our contract terms. And we do that to maintain productivity, sometimes, adapt to regulatory changes, customer and regulatory needs, and the like.", "And we did implement some new contract terms in Brazil last year. We were expecting a decline to follow that. That, in fact, did occur. And so that really was the change.", "Actually, Japan Life Planner growth was actually up in POJ, 4% year over year, and that's our biggest market. And quarter over quarter, we were back up slightly in Brazil. So I would view that as kind of a contract-related change. Further, I would say that if you look back three or four years ago in Brazil, almost all of our sales were coming from the Life Planner channel.", "And we've had a lot of growth in our bank segment. And increasingly, we've been making progress in our group segment. So that recently, almost 30% of our sales have been coming from outside the Life Planner model. So we're actually quite pleased with how things are going in Brazil.", "Thanks." ] }, { "name": "Erik Bass", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next, we will go to line of Yaron Kinar with Goldman Sachs. Your line is open. Please go ahead." ] }, { "name": "Yaron Kinar", "speech": [ "Thank you. Good morning, everybody. My first question goes to the increase in the buyback authorization. Less so about, I think, 2021, but the thought of, kind of, seeing that $0.5 billion increase flow through to your kind of three-year target.", "I guess, conceptually, I want to maybe get your sense. Is that something that you think you'll be revisiting on a quarterly basis based on the performance of the company? Or is this kind of a one-off? How should we think of this new $10.5 billion target?" ] }, { "name": "Ken Tanji", "speech": [ "Hi. This is Ken. We've had a very consistent approach to capital management. We use both share repurchases and dividend as a way to distribute capital to shareholders.", "We've prioritized dividends. And our earnings have been about three times dividends. Our free cash flow has been about 65% of our earnings and about two times our dividend. So while we seek to use dividends and grow them, we'll use a level of share repurchases, but it will vary over time.", "Our recent decision to increase that by $0.5 billion, and again, just not just for '21, but we also, as you mentioned, increased our three-year outlook. It really reflects where we are at this point in time with our capital position, as well as our outlook on the economy. And again, it's consistent with returning excess capital to shareholders. As time passes, we will continue to reassess our capital position and determine if adjustments are appropriate.", "So again, it's just -- it's really consistent with the approach we've had for many years. And if we have excess capital, we'll make the practice of returning that to shareholders." ] }, { "name": "Yaron Kinar", "speech": [ "OK. But a quarter ago, you were also talking about the other pillar there, which was the $5 billion to $10 billion that you deployed into shifting business mix and then shifting to a more capital-light structure. So I'm just trying to think of -- is this additional $0.5 billion, does that mean that you're seeing less opportunity to deploy into shifts in business mix? Or is it just that identifying more excess capital than you initially thought, and therefore are increasing the other pillar?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. It's really a reflection of our current position of excess capital. As Rob mentioned, we're making great progress toward our objective of $5 billion to $10 billion of capital reallocation. And again, it's a wide range because we will be disciplined about transactions to release and redeploy.", "So it's primarily the result of how we feel about our current capital position and the economic outlook." ] }, { "name": "Yaron Kinar", "speech": [ "Understood. And then my second question goes to PGIM. So clearly, very strong net flows, but kind of a tale of -- I don't want to say a tale of two stories, but you are seeing very, very robust retail flows, which I think is pretty consistent with what we are hearing in the market. Whereas institutional flows slowed down a little bit sequentially.", "And I think that -- I don't know if I should call that a trend or not. But maybe any color you can give us in terms of what you're seeing in both institutional and retail? And are you seeing trends there?" ] }, { "name": "Andy Sullivan", "speech": [ "So, Yaron, it's Andy. Thanks for your question. Yes. And I would not draw any conclusions or say we're seeing any trends.", "I guess the way we'd frame it is we are a very diversified business across our multi-managers, across both public and private sectors. We serve a very wide range of clients. The only thing I'd say on the institutional side is, obviously, institutional clients can tend to be more lumpy, and you'll get variability quarter to quarter versus on the retail side. On the retail side, we have seen a lot of money in money markets, and we think that could be a tailwind coming -- continuing to come into the marketplace.", "But more broadly, we have a broad suite of products. And I think at the end of the day, we're very confident that we'll be a net winner from a flows perspective given the strength and the balance that we have across product types and across institutional and retail. But to your question of should you draw any trends or conclusions, I would say no." ] }, { "name": "Yaron Kinar", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Humphrey Lee with Dowling and Partners. And your line is open." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning. And thank you for taking my questions. My first question is related to retirement in general. I think in your 10-K, you indicated that the spread compression in your full-service business is a key headwind to earnings for retirement.", "Just looking back the past couple of years or at least the past several quarters in terms of the interest rate headwind that you highlighted, how should we think about the portion of spread compressions in full service versus that in the IIP business?" ] }, { "name": "Ken Tanji", "speech": [ "Hey, Humphrey, it's Ken. We do see spread compression in our Retirement business, and that's a combination of full-service and our institutional business. In the baseline roll forward that we provided, you'll see that. Of the $10 million impact, half of that or $5 million is in our retirement segment.", "But we don't split that out between full-service and institutional." ] }, { "name": "Humphrey Lee", "speech": [ "I guess kind of directionally, which one would you say would be a heavier point of that?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Again, we don't want to get into the breakdown of that." ] }, { "name": "Humphrey Lee", "speech": [ "OK. I guess it's just a follow-up to just the fixed-income portion of the business in general. How should we think about the capital that you have that's currently backing the stable business -- the stable value business in full service." ] }, { "name": "Ken Tanji", "speech": [ "Again, our full-service business is part of our overall retirement segment. That's where the earnings are reported and the capital is held, but we're not going to break down the split of it by subsegment." ] }, { "name": "Humphrey Lee", "speech": [ "OK. All right. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Tracy Benguigui with Barclays. And your line is open." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. I'm wondering if you could reconcile some comments made. On one hand, you mentioned deemphasizing higher market and rate-sensitive business. But on the other hand, Charlie, you mentioned previously that none of your businesses are sacred cows, that you look at everything.", "So it would be helpful to understand how open-end at your quest is, or if you have a pecking order in mind." ] }, { "name": "Charlie Lowrey", "speech": [ "Thanks, Tracy, for the question. Yes, I'll just go back to what I said before, which is we have looked and are looking at all our businesses. Our objective is to create and maximize shareholder value over time. We're not going to talk about a pecking order, if you will, of businesses at this time.", "But rest assured that we're looking carefully at all our businesses and understanding specifically how they fit into an overall business mix and the objective that we articulated in the first quarter, which was to expand our higher growth businesses and to reduce annuities and our market-sensitive businesses to a smaller extent. So that's about all we want to say at this point, but we are in the process of doing that. And as I said before, you all will know when there's more to report." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Understood. Moving to a different topic. I mean, there's a lot of talk about COVID-19.", "But I'm wondering if you had experienced better non-COVID-19 mortality losses for the quarter. I understand the first quarter is usually a heavy flu quarter. But looking at CDC data, it looks like excess mortality, ex COVID was unusually low. Did you have that experience?" ] }, { "name": "Ken Tanji", "speech": [ "Hey, Tracy, this is certainly an unusual stretch of time during a pandemic. But generally, we did not see any significant or credible trend or variance in our underwriting experience, other than what seems to be related to COVID. So I really can't give any other comments other than that." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next, we will go to the line of John Barnidge with Piper Sandler. And your line is open." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much. And don't worry, it's not a question about risk transfers. So I was curious, with some short-term disability claims seemingly then going to long-term disability because of the natural things that occur with economic shock lapses a few quarters out, can you talk about your expectations for that, as well as associated elevated administrative expenses?" ] }, { "name": "Andy Sullivan", "speech": [ "Sure, John. It's Andy, and appreciate the new topic to cover. So as you would expect, last year, given the impact of COVID and the pandemic, we absolutely saw an increase in short-term disability claims. We've actually seen those claims volumes coming back down, obviously, as the pandemic is getting more under control with vaccines and the like.", "We continue to expect, due to our experience, the impact on the economy to have an effect on long-term disability claim incidents. We have not seen that tick up as of yet. That does not necessarily mean that we won't. There's generally a six-month healing period on the long-term disability plan.", "That's why you saw us put up an IBNR last quarter, and we put up an additional IBNR this quarter. So we're still expecting that. And that directly flows to your question about increased administrative expenses. One of the things that we consider very, very important to managing this business is having the right number of claims professionals, nurses, and folks specialists.", "We have beefed up our staffing in the claims part of the business to be ready to properly help individuals return to work that go on long-term disability claims. And you're seeing that reflected in the elevated admin ratio." ] }, { "name": "Operator", "speech": [ "And will that do it for you, John?" ] }, { "name": "John Barnidge", "speech": [ "Sorry, I was on mute. Thank you. A follow-up to that related to it. Do you think the corporate push, not Pru, but industrywide, to return to office in, say, the summer to fall may actually add another layer dynamic to that long-term disability dynamic?" ] }, { "name": "Andy Sullivan", "speech": [ "So, John, it's Andy. I'll take your question. That's a really hard one to predict. And where my thoughts going at is we have a very diversified book of business across size, segments, and geographies.", "And I think the patterns of what we're going to see from a return to the workplace perspective are going to be pretty varied across those different industry size segments and geographies. So really hard to tell what influence that might have on the disability claims incident site." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much for your answers." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of Josh Shanker with Bank of America. And your line is open." ] }, { "name": "Josh Shanker", "speech": [ "Yes. Thank you for slipping me in here at the end. Two quick ones, I think. The first one is, obviously, first quarter is very interesting from an interest rate perspective move, and it affected the mark-to-market results at the PGIM strategies in a negative sort of way.", "I guess, look, there might be an argument that interest rates are going to continue to rise, probably not at the pace they did in the first quarter. But does PGIM have the right set of strategy to entertain inflows in a rising interest rate economy that PGIM customers will embrace?" ] }, { "name": "Andy Sullivan", "speech": [ "So, Josh, it's Andy. Thanks for your question. So yes, as you're referring to, if we were to see a consistently rising rate environment, that very likely has an impact on fixed income flows in general across the space and could impact growth for that sector. But I'd go back to something I said earlier, which is we're a top 10 asset manager with a very broad and well-diversified portfolio in both public and private.", "And in any economic environment, we feel that we'll be a net winner across those set of businesses from a net flows perspective. So we feel very well-positioned. And then obviously, I'd be remiss if I didn't add. Remember, a rising rate environment overall is a net positive for Prudential." ] }, { "name": "Josh Shanker", "speech": [ "That's – yes, I understand that. And two, I just understand the financial advisor new sales on the annuity side of the business. Obviously, the buffer annuity sales have been very strong. But I just want to break down, if I have a variable annuity with living benefits with Prudential, can I keep contributing into it? And how much of the new sales are legacy living benefits customers who are putting more money into their older policies?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. So again, it's Andy. Thanks for the question. So depending on the product, depending on the regulatory territory, there are various rules on what we call those sub pays, how much additional money can be dropped into the policies.", "We have actually closed off to the degree we're able, and it is, to a large degree, sub pays going into those products. That's why when we report that only 1% is in the traditional variable annuities with guaranteed living benefits, that is reflective of the sub pays as well. So when we're really talking about runoff, those products truly are not only sales to new customers, but additional money is being dropped in, it really is a hard stop on." ] }, { "name": "Josh Shanker", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. We will go to a follow-up from Tom Gallagher with Evercore ISI. And your line is open." ] }, { "name": "Tom Gallagher", "speech": [ "Thanks. Andy, just a follow-up on the buffer annuity sales, which are now the majority of your annuity sales. That's obviously a very big pivot into that product. Can you talk a bit about the risk profile of that business, the capital intensity of this product compared to your legacy VA business? And why you obviously feel a lot of confidence with this volume of sales if you're looking to exit legacy VA.", "But maybe just to compare and contrast about why you have confidence and clarity on the risk profile there." ] }, { "name": "Andy Sullivan", "speech": [ "Yes, Tom. So it's Andy. Maybe I'll take sort of two sides to that question, risk and return. From a risk perspective, the product is vastly different from our traditional variable annuities, like the highest daily income.", "If you think about it, we're sharing risk with the consumer. We're giving them a buffer on the downside for a little bit of upside, but they have the tail downside risk. And obviously, the upside is capped. So at the end of the day, we're not taking interest rate risk like we were in HDI.", "The interest rate risk, because of the design of the product, could be nearly perfectly hedged with simple options. So the risk profile, we're very, very comfortable with from a go-forward perspective. Your question around returns, I think what I've talked about in previous quarters, we did a lot of work to be able to more rapidly price our products and adjust our product pricing. We're quite pleased with the returns that we're seeing on the business that we're selling.", "And obviously, that might be begging the question of, well, why have you been so successful? So let me hit that. Number one, we are one of the very best and top brands in the space with a lot of history through the third-party advisor channels. Number two, we have great distribution people and relationships, inclusive of Prudential advisors, which is a very big strategic advantage for us. And that has led to the sales results and the very, very positive results.", "But we like the risk profile, and we like the return." ] }, { "name": "Rob Falzon", "speech": [ "Hey, Tom, it's Rob. Just to add on to one thing Andy said. You talked about the interest rate risk profile. Just implied in his comments as well, but to make sure it's clear, the equity risk profile is also quite low.", "We're able -- the structure of the buffer is something that we're able to actively hedge with options in the marketplace. So we're not taking that equity market risk on ourselves. Thanks." ] }, { "name": "Tom Gallagher", "speech": [ "Ok. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Thank you. And with that, Mr. Lowrey, I'd like to turn it back over to you for any closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you very much. So thank you for your time and interest today. I hope we've conveyed the increased sense of momentum and the steady progress around our transformation initiatives. We remain confident in our strategy and the additional steps we're taking to build a nimbler and higher growth business and one which continues to focus on the evolving needs of our customers.", "We look forward to sharing more details on our progress with you in the coming quarters. And thank you again for joining us today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2019-02-07	[ { "description": "Head of Investor Relations, Senior Vice President", "name": "Darin C. Arita", "position": "Executive" }, { "description": "Chief Executive Officer", "name": "Charles F. Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Robert M. Falzon", "position": "Other" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Dowling & Partners Securities -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Executive Vice President and Chief Operating Officer, U.S. Businesses", "name": "Stephen Pelletier", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Nigel Dally", "position": "Analyst" }, { "description": "Executive Vice President and Chief Operating Officer, International Businesses", "name": "Scott Sleyster", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "John Nadel", "position": "Analyst" }, { "description": "Keefe, Bruyette & Woods -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Sandler O'Neill and Partners -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by and welcome to the Prudential quarterly earnings conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, today's conference is being recorded.", "And I would now like to turn the conference over to the Head of Investor Relations, Darin Arita. Please go ahead, sir." ] }, { "name": "Darin C. Arita", "speech": [ "Thank you, Brad. Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, CEO; Rob Falzon, Vice Chairman; Steve Pelletier, Head of Domestic Businesses; Scott Sleyster, Head of International Businesses; Ken Tanji, Chief Financial Officer; and Rob Axel, Controller and Principal Accounting Officer. We will start with prepared remarks by Charlie, Rob, and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-looking Statements and Non-GAAP Measures in the appendix to today's presentation, which can be found on our website at investor.prudential.com.", "With that, I will hand it over to Charlie." ] }, { "name": "Charles F. Lowrey", "speech": [ "Thank you, Darin. Good morning, everyone, and thank you for joining us today. While equity market movements affected our fourth quarter results, our fundamentals remained strong across our businesses as did our earnings, adjusted for the notable items that Ken will address later. We feel good about our outlook for our business and our ability to continue building the momentum in our business by helping our customers with their financial needs, especially through turbulent times and we're going to dive into this subject in a little more detail today.", "For the full year, 2018 marked another important chapter for Prudential, as we continue to generate meaningful value for our customers and to grow our business in a sustainable way. As a result, we grew operating earnings and adjusted book value per share, produced a double-digit return on equity and returned more than $3 billion via dividends and share repurchases. We also maintained a solid balance sheet even amid the large equity market movements in the fourth quarter.", "Looking forward, we are excited about the opportunities to create more value for our existing customers and forge relationships with new customers. Our market-leading businesses, complementary capabilities, and global reach allow us to expand markets and grow in a way that few others can. At the highest level, we're bringing more financial opportunity to more customers. We accomplished this through our U.S. Financial Wellness businesses; PGIM, our asset management business; and our International business.", "We are also working with institutional clients and distributors around the world to help individuals adopt behaviors that enable financial security. By addressing evolving societal needs for financial advice, services and solutions, we seek a unique opportunity to reach new market segments across different income brackets, ages and other demographic groups and to deepen our relationships with existing customers.", "PGIM enables the success of our businesses through its investment capabilities, including proprietary private asset classes. This provides a competitive advantage for Prudential, which allows us to innovate new products and services such as pension risk transfer to support our customers. At the same time, PGIM benefits from continued growth in affiliate flows and assets under management, which supports its position as the top 10 global asset manager.", "Our businesses have an established, trusted presence in more than 40 countries, engaging in relationships with approximately 50 million individuals. In addition to this wide reach, our businesses create earnings and capital diversification for our shareholders.", "Turning to slide 3, I'll provide some additional financial highlights on the fourth quarter and full year. Fourth quarter earnings declined from a year-ago period, primarily due to equity market impacts. For the full year, adjusted earnings per share increased by 11% to $11.69. We generated an adjusted return on operating equity for the full year 2018 of 12.7% at the high end of our near-to-intermediate target of 12% to 13% and our book -- our adjusted book value per share grew by 8.3%. We deployed our capital in growing our business, repurchasing shares, and paying dividends. And we achieved all of this while maintaining a robust capital position consistent with our AA standard.", "As we look to 2019, our share repurchase authorization is $2 billion and we increased the quarterly dividend by 11%. This year's performance was supported by strong drivers across our businesses, including significant milestones. Within our U.S. Financial Wellness businesses, we achieved record account values in the institutional investment products supported by our pension risk transfer capabilities. We also had record Full Service retirement sales. Within PGIM, we achieved our 16th consecutive year of positive institutional net flows.", "Within International, we reached a record level of Life Planners, our highly productive distributors of protection and retirement solutions. Maintaining this growth and executing on our strategy starts from within. We focus on culture and talent enabled by technology to achieve a meaningful purpose, which is a point I'd like to close with as we turn to slide 4.", "There's a growing body of evidence that purpose-driven companies outperform their competition in recruiting and retaining top talent, in strengthening customer loyalty and in driving business performance, all of which are core elements of our strategy. At the start of this year, we unveiled a new purpose statement to our employees that reflects their collective feedback of our vision for the future which is, we make lives better by solving the financial challenges of a changing world. We recognize this as a bold and highly aspirational statement, but it reflects who we are and what we do through our U.S. Financial Wellness and global businesses. And to that effect, I'm proud to note that we continue to be recognized for our purpose-driven work. Prudential was once again ranked as number one on Fortune Magazine's 2019 World's Most Admired Companies list for the fourth consecutive year in our sector, with high marks in areas such as innovation and people management. Additionally, as we noted last quarter, Prudential was named to Fortune's Global Change the World list, where we are the only company in our sector to be recognized.", "Finally, we were cited as one of the top 50 companies for diversity by DiversityInc in 2018 for the 17th year in a row. These distinctions serve as a strong endorsement for the culture we cultivate at Prudential every single day and which we will continue to build on to drive shareholder value and make a positive contribution to society. With that, I'll turn it over to Rob, who will provide an update on how our businesses are executing on their key priorities. Rob?" ] }, { "name": "Robert M. Falzon", "speech": [ "Thank you, Charlie. I'll begin on slide 5. Consistent with our aspiration to solve the financial challenges of our customers as Charlie described, we are all already advancing our purpose through our financial wellness initiative in the US and through our needs-based selling approach in our international business. Our resiliency to the equity market fluctuations in the fourth quarter was the result of what we believe are the hallmarks of Prudential, thoughtful strategy and quality execution that build strong fundamentals and produce attractive financial outcomes.", "Our objective is to apply these strengths in ways that produce similar outcomes for our customers who can benefit from our integrated solutions, market access and enduring financial strength. In the US, we do this through financial wellness. We engage with individuals and in particular the employees of our workplace clients to identify and solve their unique financial challenges through multiple channels and with simplified solutions. This also benefits our employer clients by enhancing the effectiveness and engagement of their employees. Our value proposition is resonating as we generate outcomes such as reduced financial stress, improved understanding and utilization of company benefit programs and increased productivity.", "As shown on slide 6, U.S. Financial Wellness represents our workplace and individual solutions businesses and produces a diversified source of earnings, including fees, net investment spread and underwriting income delivered through our Retirement, Group Insurance, Individual Annuities and Individual Life platforms. Workplace Solutions covers 20 million people and Individual Solutions serves over 5 million people. The capabilities we have in this platform enable us to engage with our clients through a continuum of channels, including with third-party distributors directly with our in-person or phone-based financial advisors and with our digital tools. Our goal is to meet individual's needs where, how and when they want.", "I'll highlight three of our key priorities for growth. First, we continue to develop solutions to address customers' financial needs. As an example, we recently launched emergency savings feature for our retirement plan clients. This solution allows individuals to access funds for short-term needs while maintaining their contributions toward their long-term goals. Second, as we continue to provide our Financial Wellness solutions to our existing workplace clients, these solutions are also contributing to new client acquisition efforts. Since the launch of our financial wellness capabilities in 2015, we have generated about $9 billion of Full Service retirement plan sales and over $100 million in Group Insurance case wins that we can attribute to this initiative. Third, we are working to deepen individual relationships in the workplace. We activate these relationships through our Prudential Pathways program, our digital financial wellness platform and LINK by Prudential. Our Prudential Pathways program has been adopted by nearly 500 of our workplace clients. In this program, employees of our workplace clients can participate in worksite financial seminars on a wide range of topics delivered by Prudential's financial advisors. Employees can also request a personal consultation, which has helped drive new retail clients for Prudential Advisors.", "Our digital financial wellness platform has been adopted by over 3,000 clients, representing over 5 million individuals. This platform provides a digital venue to address a variety of individuals' needs including education on financial wellness topics, assessment of financial needs and tools to take action. We launched LINK by Prudential in the second half of 2018. Our workplace clients can make LINK available to their employees as part of our digital financial wellness platform. This is a highly personalized online experience that helps those employees customize financial goals, connect with advisors digitally or via phone and obtain savings, investment, protection and income solutions. As we continue to help employers and individuals, we ultimately believe our solutions can significantly expand our addressable market and enhance our long-term growth potential.", "Turning to slide 7, which highlights our Global Asset Management business, PGIM. PGIM continues to leverage its scale of over $1 trillion of assets under management via a distinctive multi-manager model with broad asset class capabilities. 2018 marks the 16th consecutive year of positive institutional third-party net flows for PGIM. These positive net flows from third parties are in part driven by our strong long-term investment performance. I would specifically highlight the five-year performance and note that 97% of the assets under management have outperformed their benchmarks over that period.", "In the current quarter, we experienced net third party outflows of $3 billion, including a $9 billion fixed income withdrawal by a single institutional client. This was a client-specific decision and was not based on our investment performance. We serve many of the world's largest pension funds and other institutional investors, and as a result, we will experience large idiosyncratic flows from time to time. These flows are generally to the benefit of PGIM's AUM.", "Our third-party retail flows were affected by trends consistent with the industry during the quarter. Retail investors reduced credit exposure, held more cash and sold investments for tax purposes. Our total net inflows including affiliated flows were positive $9 billion in the quarter. These flows included significant assets from pension risk transfer, where PGIM's origination and differentiated asset management capabilities provide a competitive advantage. Positive flows helped to keep PGIM's total assets under management fairly stable for the quarter despite the market decline and in contrast to significant declines experienced by other asset managers. Despite industrywide fee compression, our overall asset management fee yield remained stable at 22 basis points, as we continue to diversify our product suite into higher yielding strategies.", "I'll highlight three other key priorities to grow PGIM's earnings. First, with respect to expanding our global footprint. As of year-end 2018, 29% of PGIM's assets under management were sourced from outside the US. We continue to grow organically, driven in part by our strong international private origination capabilities. In fact, PGIM had a record year for non-US private credit originations. In addition, PGIM's European mutual fund platform has grown to include 28 funds with assets under management in excess of $3 billion.", "Second, we have also made disciplined bolt-on acquisitions to strengthen our global presence and complement our capabilities. For example, we recently announced the acquisition of a London-based Quantitative Investment Manager that will expand our alternative investment solutions. The manager will have significantly greater growth potential by tapping into PGIM's global distribution network.", "Third, with respect to products. We launched our first actively managed exchange credit fund last year, and by year end, the ETF platform has grown to six strategies across both equity and fixed income. In addition, we continue to grow our market-leading alternatives capabilities and have established a dedicated group in our leading private client franchise focused on mezzanine financing, energy finance and direct lending.", "Now, turning to slide 8. Our International business includes a world-class Japanese life insurance operation as well as other businesses including in high-growth markets with large population such as Brazil, India, Indonesia, China and Africa. Our differentiated business models and proven ability to execute our strategy has led to steady growth, attractive returns and significant capital generation. In addition, we continue to make strategic investments in digital, mobile and data capabilities to enhance our long-term growth prospects. I will highlight a few operating metrics that reflect our strong fundamentals and continued growth during the fourth quarter.", "Life Planner sales, which were about half of total international sales in the current quarter, increased by 12% compared to the year-ago quarter. This was driven by higher US dollar sales and the number of life planners in Japan increasing by 6% to a record level of 4,183. Gibraltar sales were lower than a year ago, as growth in Life Consultant and Independent Agency sales were offset by a reduction in bank channel sales. Bank channel sales reflect our discipline on pricing and underwriting in response to a more competitive market. Life Consultant channel sales were 5% higher than the year-ago quarter, even as Life Consultant count was 4% lower, consistent with our continued focus on high-quality distribution, and Independent Agency channel sales increased by 10%, driven by an increase in US dollar sales, including a new term life insurance product rolled out earlier in the year.", "In summary, our momentum remains positive across all of our businesses, U.S. Financial Wellness, PGIM and International. We have thoughtful strategies and quality execution that continue to build strong fundamentals as we serve our customers well. And we are monetizing those fundamentals to generate profitable growth at attractive returns. And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Okay. Thanks, Rob. Slide 9 includes the notable items, which had an impact on adjusted operating results in the current quarter. We highlight these items, because they may not be indicative of future performance. There were three primary drivers of the notable items.", "First, the equity market movements resulted in $109 million adjustment for the recognition of certain benefits and cost associated with variable annuities and variable life policies. In addition, non-coupon investment income and prepayment fees were about $140 million, below our long-term expectations, driven primarily by hedge fund returns.", "Second, underwriting experience was generally in line with our average expectations, which highlights our complementary mortality and longevity profile as presented on page 22 in the appendix.", "And third, we recorded a provision of $30 million for legal matters. In total, these notable items reduced pre-tax earnings by $289 million or $0.54 per share. Excluding the notable items, earnings per share would be $2.98, up 14% from the year-ago quarter. And then thinking about quarterly earnings patterns, please note that we've included a summary of seasonal items in the appendix.", "Now, turning to slide 10, I'll provide an update on capital deployment, liquidity and leverage. As Charlie noted, we returned more than $3 billion to shareholders during the year through dividends and share repurchases. And for 2019, we increased our share repurchase authorization by 33% to $2 billion. And yesterday, we announced a 11% increase in our quarterly dividend. Our cash and liquid assets at the parent company amounted to $5.5 billion at the end of the quarter. The sequential quarter increase of $300 million was driven by cash flows from our businesses that exceeded shareholder distributions. Shareholder distributions of $752 million in the quarter were roughly evenly split between dividends and share repurchases. We also maintained a strong balance sheet. Our hedging programs were highly effective in mitigating the large equity movements in the quarter. Our regulatory capital ratios continued to be above our AA financial strength targeted levels and our financial leverage ratio as of year-end 2018 remains better than our target. Also, as credit remains a topic of investor interest, we provided details of our high-quality CLO portfolio in the appendix.", "In summary and turning to slide 11, our market-leading global businesses with complementary capabilities are providing integrated financial wellness solutions to more customers. For the year, we generated a strong adjusted operating return on equity along with significant growth in adjusted operating earnings and book value per share and also delivered solid shares and net flows across our businesses, and we distributed more than $3 billion to shareholders and sustained a robust capital position with capital flexibility.", "Now, I'll turn it to the operator for questions." ] } ]	[ { "name": "Operator", "speech": [ "(Operator Instructions) Our first question today comes from the line of Humphrey Lee with Dowling & Partners. Please go ahead." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning and thank you for taking my questions. Regarding PGIM's net outflows, I mean the $9 billion outflow from single client, I was wondering if you can elaborate in terms of the reason for the redemption. Was it related to hedging cost, has it been a foreign investors or maybe the client picking the investment in-house? I was just hoping you can share a little bit more color. And then also, do you still have any more exposure to this particular client?" ] }, { "name": "Stephen Pelletier", "speech": [ "Humphrey, this is Steve. I will take your question. Thank you very much for it. I would say that the reason for this outflow was the client looking to consolidate managers and that was really the main driving factor. It was not due to our performance either on a relative or an absolute basis. So that's the story there. If you don't mind, even on a no-names basis, I don't think I'll talk too much about -- at the granular level of our dealings with an individual client. I will just emphasize, Humphrey, that, as Charlie talked about, our PGIM business represents a top 10 global asset manager. In particular, I'd highlight that on the institutional front, we truly have a world-class client franchise. We do business with 23 of the largest 25 corporate US pension plans. We do business with eight of the top 10 Fortune 500 companies. We do business with over half of the 300 largest global pension funds. We're very proud of and grateful for that client franchise, but it also means that business gets done in large blocks. And on occasion -- on rare occasion on a quarterly basis, we may have more outflows than inflows due to something like this a single large case. However, on an annual basis, as mentioned earlier, we have had 16 positive years of institutional net flows. And also I'd like to point out that on the quarterly basis, despite that one large outflow of $9 billion, we almost got institutional net flows to a draw, which signifies that gross sales were actually very strong for the quarter and that gives us confidence as we begin 2019 in our ability to attract robust flows, both gross and net, and at a good and sustainable average fee level as Rob mentioned in his comments." ] }, { "name": "Humphrey Lee", "speech": [ "Understood and I agree. The $8.5 billion of other net inflows definitely speaks volume to your -- the demand for your product. My second question is related to the weak non-coupon investment income in the quarter. My understanding is that most of your hedge fund exposure has no reporting lag and the underperformance in the fourth quarter was fully reflected in the numbers in the quarter. So that included the weaker -- this December results. And then on that note, of the $140 million of under -- of below plan non-coupon investment income, how much was -- of that was related to hedge fund underperformance and how should we think about the first quarter expectation like obviously private equity will be weaker, but I guess your hedge fund results could be an offset." ] }, { "name": "Robert M. Falzon", "speech": [ "So, Humphrey, it's Rob. I'll take that question. So first, yes, our hedge funds are not lagged. So, the full effect of the market performance in the fourth quarter is reflected in our hedge fund performance and therefore our overall alternatives performance. And if you look at the performance, vis-a-vis our long-term expectations, the vast majority of that would be attributable to that hedge fund performance. In the quarter. There were small pieces from other components, but I would say again the vast majority of it was related to the hedge funds. Hedge funds are about 25% or so of the overall alternatives portfolio, Humphrey. And if you look at the performance in the quarter just helpful to put some context around that, the performance in the quarter for our hedge fund portfolio overall was down around 2.5%. I would compare that to the overall market being down 14%, both the S&P and the MSCI World Index.", "If you look over a little longer time frame, look at the full fiscal year, our hedge funds actually had positive performance for the year. They were up about 0.5% or so. And again, contrasting that to the S&P, which was down around 6% for the year and the MSCI World Index, which was down over 10% for the year, I think it speaks to the diversification and quality of the hedge fund performance that we have and the portfolio that we've got. It's a well-diversified portfolio. We're in about 40 or so different funds and it's diversified by strategy and its sources of alpha including things like the asset class, its geography, sector and time horizons.", "Bigger picture, if you look at our alternatives performance, I think it's also helpful to keep in mind that that performance over a long period of time has actually been quite strong. So, if we go back to the inception of the program, which was back in the fourth quarter of 2012 and you look at that performance versus our long-term expectations, we've actually exceeded it by around $550 million or about 20%, of the total returns over that period of time. So again speaks to the discipline that we have around the management of that alternatives portfolio.", "With respect to the first quarter of 2019 and PEs as you sort of specifically asked, most of our PE funds are lagged. They're also about 25% of the overall alternatives portfolio. And our private equity or PE has some positive correlations with the market, but it's less direct than which you would see in the hedge funds, because it's influenced by things like realizations and there were a number of those in the fourth quarter and also a number of the hedge -- of the private equity funds are mark-to-model versus mark-to-market and you come up with different results as a result of that as well.", "So, more broadly, If we look at the performance over the long term, we have the statistics that I mentioned before and we think that that's the appropriate emphasis of this as opposed to kind of looking at a quarter-by-quarter kind of analysis.", "If I can just sort of head off a follow-on question which I know is coming from either from you or some quarter or another, let me just sort of hit it, because I think as you're talking about the outlook for the first quarter and alternatives there is sort of the broader issue of the 2019 outlook versus the guidance that we've provided.", "As you know, we don't provide forward-looking statements in the context of guidance, but I can make some observations about our current conditions. First, fundamentals, as you heard in our opening remarks, for the fourth quarter are actually quite strong across our businesses and they're demonstrating good momentum as we head into 2019.", "And adjusting for the impact of the December market decline, our fourth quarter financial results actually reflect that very strong performance. With respect to the markets, we've provided the assumptions that underlie our guidance in our guidance deck that we went through at the end of last year. And while the markets swooned in December, the current levels are actually pretty consistent with the assumptions that underlie the guidance that we provided. So I'll then leave you and others to draw your own conclusions from those observations, but I thought that that might be helpful additional context." ] }, { "name": "Humphrey Lee", "speech": [ "Definitely appreciate the color and I definitely agree that the fundamentals in the forth quarter, the underlying trend seems to be strong despite the market impact. But, thank you." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of Nigel Dally with Morgan Stanley. Please go ahead." ] }, { "name": "Nigel Dally", "speech": [ "Great. Thanks. Good morning. Broader question on the investment portfolio. Can you discuss your views as to where we are within the credit cycle and what repositioning you're looking at making not in escalating concerns about a turn in the cycle, also in light of that, just given the performance metrics that you highlighted for your non-coupon, would it be fair to say that they're performing as you originally intended? And if so, you're not looking to change any of your allocation to hedge funds looking forward?" ] }, { "name": "Robert M. Falzon", "speech": [ "Nigel, it's Rob again. So, let me take the second part of your question first, which is, yes, our performance is consistent with expectations given where we are in the cycle, and our discipline around that portfolio of construction is consistent and we're not looking to make any significant changes in that either with regard to sort of the ultimate size of the portfolio or the component parts of the portfolio and the relative weightings that we have in there. Obviously, there's variability quarter-to-quarter or year-to-year depending on draw-downs that we get particularly from private equity and in real estate, but largely no strategic changes in that.", "With respect to your first point in terms of the portfolio and positioning for the credit cycle, I'll start with two points. One, portfolio is really well diversified and we manage it within credit limit exposures for things like individual names, sectors, asset types and credit ratings. So a lot of discipline around making sure that the diversification goes deep into the portfolio. Second, positioning the portfolio for a downturn is actually not new for us. We started this over the last year or two. And as we've gotten further into the cycle, we've been further taking risk off the table. Couple of examples of that. First, we've been diversifying our corporate exposure, particularly in longer durations. So I think as we've noted multiple times in the past, we hold a larger-than-typical portfolio of government bonds. It's about 36% of the general account, and almost half of our fixed maturities. We've been adding to munis in lieu of corporates, and we've been rotating out of bonds that have been at risk of credit migration ahead of the downgrades.", "And as we've also noted before, we're underweight in energy, finance, and telecom, and we're overweight in consumer, non-cyclical utilities and transportation. We've also been selling our high-yield public exposure and shortening the duration of that portfolio, and where we've had appetite, we've been replacing it with privates, which now account for about 60% of our below investment grade portfolio and about 16% of our overall private portfolio.", "Our history, experience with our privates in below investment grade and actually in investment grade as well is that they have significantly lower defaults and higher recoveries. Combination of that leads to loss experience, which is substantially in excess of the benchmarks on a credit quality equivalent basis that we find in the public marketplace. In aggregate, our below investment grade portfolio is only about 4% of the general account. Our commercial mortgages are underweight in multifamily and industrial -- I'm sorry, overweight in multifamily and industrial and we've underweighted the more cyclically sensitive property types like office and retail and like our private placements, it's directly originated. So it's a very high-quality portfolio with structural protections built into it by virtue of the direct private origination.", "And as Ken noted in his opening remarks and you'll -- and you see in the exhibit to our deck, with regard to our structured investments and particularly CLOs, we are focused on the highest quality tranches with significant structural enhancement in those investments. I think the broader point is that portfolio management is one of our core strengths. The portfolio is defensively positioned as I just articulated. It's managed to the concentration limits that I spoke to. And we're also very disciplined around ALM, asset liability matching, which is sort of key to this as well.", "We've highlighted in the past different issues that have come up. So, we talked about asset leverage during our guidance call and we provided an exhibit on that, and what we showed is that properly adjusted our asset leverage is actually very comparable to our peers and more importantly our credit leverage is actually at the very low end of the range of our peers.", "In this deck, as I just noted, we've included something on CLOs and you can see that our exposure is entirely comprised of not just of NAIC 1, but of AAA tranches. So even more high quality within the range of NAIC 1, that are well underwritten and benefited from significant subordination levels. And then I guess the thing has come up more recently that we haven't actually spoken to. So I'll take the opportunity to do it. We are seeing some research around credit impairment history. Our own experience on that has been well below our benchmarks. It's below what we've been embedding in our pricing. And all that includes our experience with the financial crisis, including the experience that we and others went through with subprime. If we replicate our portfolio for the calculation that's being produced out there and that calculation is looking at after-tax impairments and we've assumed that those impairments also include credit loss sales, and comparing that to average total investment assets for the period from, I think, the statistics that are out there from January of 2008 through September of 2018, our actual losses excluding the closed block are 0.73%, so 73 basis points in aggregate across that period. If we roll that forward to the end of the year. It only moves by 2 or 3 basis points. So again, I think what you would find is that's at the very low end of the performance of our peers, or very high end from a performance standpoint, low end from a loss stand point.", "None of this is to imply that we will be immune to a credit cycle, but we would expect consistent with our historical experience through prior cycles to weather it well. That's due to the defensive posturing of the portfolio as I've gone through and the investment advantages we derived from PGIM that Charlie spoke about in his opening remarks. Specifically, its ability to directly originate privates, which are now 11% of the general accounts and actually almost a third of our corporates, and its ability to originate mortgages that I spoke to before, as well as its strong track record of investment performance in publics and that's evidenced by the size of our operation and by the 16 consecutive years of positive third-party institutional flows coming into it.", "And due to the broader financial strength we have as in the last cycle, we would expect to have the flexibility to be opportunistic in taking advantage of the more attractive investment environment and the more attractive acquisition environment that typically accompanies those sorts of downturns. And with that, I hopefully have fully answered your question." ] }, { "name": "Nigel Dally", "speech": [ "Absolutely. Thank you. My second question was just on the escalation of competition in the bank channel in Japan. Just wondering whether that's new entrants or is that existing players in the marketplace? Just a little more color as to what's going on there." ] }, { "name": "Scott Sleyster", "speech": [ "Hi, this is Scott, Nigel. I would say a couple of things about that. No, I don't think it's necessarily new entrants to the market, but it is new product offerings that they may be bringing to market, in particular a number of people have been bringing yen single premium, yen recurring premium to that marketplace. I think perhaps on a broader basis, I should say -- talk about our approach to the bank channel. Out of all the channels that we have in Japan, it really is the more opportunistic.", "Our core life planner and life consultant models are really needs-based selling channels. They very much focus on protection-based life insurance. When you move into the bank channel, that's traditionally the most competitive. Various participants will come in throughout the cycle with aggressive pricing for one reason or another for various objectives that they might be achieving. Our model, I think, is highly disciplined. We're traditionally still selling protection insurance. We've got a lot of pricing discipline, and as we stick to that, we would expect to see quarter-to-quarter volatility in that channel." ] }, { "name": "Nigel Dally", "speech": [ "That's great. Thank you." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of John Nadel with UBS. Please go ahead." ] }, { "name": "John Nadel", "speech": [ "Hey, good morning. Just a question on pension risk transfer for the year. Could you just tell us what the net flows specifically for PRT were. I think you mentioned $16 billion of gross sales." ] }, { "name": "Stephen Pelletier", "speech": [ "John, this is Steve. Our annual run-off on PRT is consistent with what we've communicated before, which is about $4 billion total, $3 billion on the funded side and $1 billion on the longevity risk transfer side. So, that gets you to the flows. I would say that in terms of looking at the year that we're in now, we still see a very, very robust pipeline. I'm sure that some people may be thinking that the market volatility in the fourth quarter and what that did to funding levels in the aggregate across all pension funds may have an impact.", "And I would just point out that while that observation about some pullback in funding levels in the aggregate is true, virtually all the companies in the visible pipeline, first of all, are fully funded, and second of all, have taken steps to hedge their risk and to mitigate any capital market's impact. So we still see a very robust pipeline. We are still very confident in our ability to transact within the pipeline. I think that's borne out by our fourth quarter experience, where we had very strong flows of $7.5 billion in PRT total, $5.5 billion funded in the other longevity risk transfer. And I would also say that we see an opportunity given the strength and given the kind of configuration of the pipeline for this year's experience to possibly be less back-loaded than the past several years have been." ] }, { "name": "John Nadel", "speech": [ "Interesting. Okay. Thank you. And then just a question for, I guess, Robert. And just specific to the fourth quarter results, could you just quantify for us to how much was the seasonally higher expenses up relative to the average of the first three quarters? And then how much was offsetting that in the form of lower compensation-related expenses driven by your share price and the market decline, I think, that runs through corporate?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, John, it's Ken. Yeah, we had given guidance that typically our fourth quarter expenses are seasonally higher and range from about $125 million to $175 million and we thought they would come in at the high end of that range and they did and about half of that occurred in corporate. And then in terms of the impact of our compensation expense from our long term and deferred comp plans that are either linked to our share price or other market indexes, that had a benefit of about $90 million in the quarter and about $70 million of that was in corporate and other." ] }, { "name": "John Nadel", "speech": [ "Terrific. Very helpful. Thanks." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of Ryan Krueger with KBW. Please go ahead." ] }, { "name": "Ryan Krueger", "speech": [ "Hi. Thanks. Good morning. I guess, ahead of the statutory statements being filed, wanted to get your perspective on what your target RBC ratio will be, I guess, going forward versus the historical 400% post tax reform." ] }, { "name": "Ken Tanji", "speech": [ "Yeah, so, Ryan, it's Ken. We did adjust our RBC target and we provided that with our guidance for 2019. And just a little bit of reminder that with tax reform, we have a lower tax rate and that improves our earnings today and in the future and strengthens the value of our deferred profits that reside in our reserves. So, overall, the impact of tax reform is positive for us. It does lead to higher regulatory capital requirements. And so when we put that all together, our improved financial strength along with higher regulatory capital requirements, we did think an adjustment to our RBC ratio to 375% was -- made a lot of sense and we've done that. And we would expect to end -- we will file our our statutory financials at the end of the month and we would expect our RBC ratio (inaudible) above our objective." ] }, { "name": "Ryan Krueger", "speech": [ "And then on PGIM, I don't know if you can give us any perspective on January flows if you've seen a rebound relative to the fourth quarter." ] }, { "name": "Stephen Pelletier", "speech": [ "Ryan, this is Steve. Without commenting on results in a given month, I would just say that we entered the year with a strong sense of confidence about our ability to continue to generate flows, as Rob touched upon. We operate across a range of asset classes, equity, public and private fixed income, real estate and the mortgages and other sources of alternatives. So, we feel -- and through our -- also based on our strong investment performance, we feel very confident in our ability to generate flows this year." ] }, { "name": "Ryan Krueger", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of Alex Scott with Goldman Sachs. Please go ahead." ] }, { "name": "Alex Scott", "speech": [ "Hi. Thanks for taking the question. The first one I had was just on the comments made earlier on the call around being well positioned for potential M&A opportunities, I mean, the holding company cash is quite strong, sounds like you're probably above your RBC target, so that all makes sense. I'd just be interested on any color you'd have on what kind of M&A opportunities you'd be interested in. I mean, is it things you would target building our distribution and increasing volume growth? Would it be about expanding geographically further or maybe some of them are cost synergies. I mean is it -- where would your focus be?" ] }, { "name": "Charles F. Lowrey", "speech": [ "Sure. This is Charlie. Let me take a step back if I may and just talk about the stages of development of the Company and this will put your question into perspective and we will answer it along the way. But I'd characterize our development over the course of the past 20 years as having kind of four stages. And the first is the elimination of the financial supermarket and we spent a couple of decades clearing out the underbrush if you will, and during that process, we sold about 40 businesses for about $10 billion and we discontinued several others. And we still are critically examining our businesses. So, in the past number of years, we've sold the Wealth Management Services business, retail, real estate, global commodities and most recently our insurance business in Poland. So we've honed our business lines down to three specific areas, right, protection, asset management and retirement. That's what we're focused on, which brings us to the second stage, which is in each of those businesses, we wanted to build world-class businesses, right. So, we focused on the performance of each of those individual businesses and increased over time the ROE significantly of each business. We made about $16 billion of acquisitions to augment the businesses we had both domestically and internationally, and we'll continue to look for acquisitions as we go forward to augment these three lines of businesses whether that's internationally or domestically.", "We were also opportunistic in acquiring talent during this period, especially during the great recession both in terms of individuals and lift-outs of teams and we continue to do that as we go forward. So then the third stage is, once we had developed those businesses and they were at scale, we consider the diversification benefits of and operation -- of operational efficiencies between the different businesses. This can be capital diversification of which there is a great deal. It can be mortality or longevity balance, and as Steve talked about, we have a very, very good pipeline of longevity business. We're glad to have our insurance businesses, because that can balance the longevity, which allows us to do the PRT business we do. And then we focus on efficiency such as shared services between the businesses that create better customer experience and also cost savings. So, we consider ideas that make us far more efficient in terms of operations and in terms of the use of capital by our businesses and the deployment of our capital to our stakeholders. And you've seen that through the increase in buybacks and dividend increases. And that really leads to the fourth stage and that's the one we're in now, where we are fully integrating the entire business system to expand significantly our addressable market by completely focusing on our customer needs and reaching more of those customers through fully integrated workplace and digital channels. Hence, our focus on an increased discussion about financial wellness, which stems from our belief that we are uniquely positioned with our sets of complementary businesses to solve the changing needs of our clients as they consider Insurance, savings and retirement. But to integrate the services we provide by combining elements from different businesses requires, what I call, real and selfless team work, which gets to the core of the success of this Company, which is its culture. And it's our culture that enables us to work across businesses to provide relevant and timely solutions to our clients' most pressing financial needs and also to the communities in which we work, which is such an important part of who we are, in other words giving back. So it's the fourth stage that we're in and beginning to communicate to you about. And given that this is -- we are in this fourth stage, the kind of acquisitions we look at would be ones that would augment these three lines of business either by bringing additional capabilities to those businesses or additional distribution over time. Internationally, you've seen us grow in Southeast Asia, in Latin America, in Africa, higher-growth markets to balance off the -- our presence in Northern Asia. And in the US, you would see us continue to consider transactions that would either, again, increase distribution or increase our capabilities in certain areas related to the US Financial Wellness program." ] }, { "name": "Alex Scott", "speech": [ "All right. Thanks for that." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of John Barnidge with Sandler O'Neill. Please go ahead." ] }, { "name": "John Barnidge", "speech": [ "Thanks. Most of my questions have been answered, but maybe how has market volatility and the government shutdown changed the nature of conversations for your Workplace Solutions business over the last, call it, six weeks to a quarter? Thank you." ] }, { "name": "Stephen Pelletier", "speech": [ "John, it's Steve. I'll answer your question. We do not see a significant impact of market volatility and the government shutdown, as you mentioned, in the group benefits business. Our engagement with corporate clients on that front continues to be very much around the strength of our value proposition and in particular the financial wellness value of proposition. On the retirement side, the other part of Workplace Solutions, I would not say there is a -- there's been a particular impact either, except to say that for those companies that are well-funded and that are well-positioned from an ALM standpoint and hedging their risk, as it relates to capital markets movements, those -- frankly the movements are a reminder that the time to transact may be here and to take risk off the table in terms of any further capital markets movements. I would say that overall, though, the real engagement on the Full Service retirement front and on the Group Insurance front has been around the strength of our financial wellness proposition. Rob mentioned some of the numbers, $100 million of annualized group premium, that stems directly from our financial wellness proposition. And now $9 billion, previously the number we were citing to you last year was $6 billion, now $9 billion of Full Service sales directly attributed to the strength of that proposition. This is very much as we anticipated. As we developed this financial wellness strategy, we anticipated that the impact of it would -- in terms of our results, would first be visible at the top of the funnel, if you will, at our work at the employer level with companies in their provision of retirement plans and benefit packages. As we continue to develop the customer engagement funnel, we are seeing very, very strong levels of engagement with that value proposition. It's interesting if you compare our experience, for example, to a lot of the start-ups that have entered this space. Our customer engagement levels and our client acquisition costs are a fraction of some of those start-ups and frankly client acquisition costs are the issue that a lot of those start-ups run into. And the reason is that the people who are seeking to engage know that they're already doing business with Prudential. They're already part of a retirement plan or a group benefits plan that is administered by Prudential. So, we're confident that the engagement levels that we're seeing will lead to greater revenues from our engagement with individuals and are providing them the solutions that address their financial needs. In fact, we're already seeing some flow of retail revenues. It's just the beginning of that process, but we're already somewhat ahead of where we thought we'd be at this point. So all in all, we are feeling very, very strong about the ability to advance the financial wellness proposition and to differentiate ourselves in the market based on that proposition." ] }, { "name": "John Barnidge", "speech": [ "Thanks a lot for the answer." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of Erik Bass with Autonomous Research. Please go ahead." ] }, { "name": "Erik Bass", "speech": [ "Hi, thank you. Can you provide some more detail on your variable annuity hedging performance this quarter, and in particular in December?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hi, Erik, it's Ken. We're -- we were quite happy with our hedging programs particularly and overall. They performed very well. Our variable annuity living benefit hedge program gained $3 billion in value during the quarter, most of that in December with a hedge effectiveness of 98%. And we also have a capital hedge program that was also very effective at offsetting the overall increase in our net GAAP liabilities due to equity markets and that's reported in our non-operating earnings and that gained over $600 million in value and more than offset the overall increase in our net GAAP liabilities due to equity markets. So, we thought our hedge programs did a solid job at protecting our balance sheet and capital position and we think it demonstrates the resilience of our financial profile amid difficult markets." ] }, { "name": "Erik Bass", "speech": [ "Thank you. And you've highlighted the consistent cash flows from your annuity business which, I think, for the year are above 60% of operating earnings. As your sales growth picks up there, will that cash flow ratio come down or is the bigger impact the run-off of the older block of policies that you're seeing?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. So, our capital position in annuities is very solid. We've designed our hedging program and our capital framework to withstand market moves. And as I mentioned, the hedging program performed quite well. We hold the capital in excess of our own standard and regulatory standards and that enables cash flow to continue. You cited 60% that would, I think, be more on a pre-tax basis. We think of it more on an after-tax basis and it would be more like 80% and it was $1.2 billion for the year. That's reflective of the solid fee stream that we have coming from that business that is both well hedged and well capitalized and profitable, and we find that attractive. If we are able to pick up sales in more profitable business and earn the returns that we've -- that we target that we would think that would be a good use of capital and we would deploy capital toward that." ] }, { "name": "Erik Bass", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "And now for closing remarks. I'll turn it back over to Charlie Lowrey. Please go ahead." ] }, { "name": "Charles F. Lowrey", "speech": [ "Thank you. Let me add just a few final thoughts. We feel really positive about how we can continue to make a meaningful difference in our customers' financial lives and deliver long-term value. By leveraging our capabilities across businesses, deploying technology and continuing to innovate, we can grow and expand our market, meaning that there are a variety of ways in which we can reach more customers and do more to help them achieve financial security and peace of mind. We have the scale to invest for the long term and a rock solid balance sheet to provide our customers with comfort and knowledge of and confidence in our stability throughout the market cycles. With thoughtful strategies and high-quality execution by our talented employees, we deliver sustainable value for our customers for the communities in which we operate and for our stakeholders.", "Thank you for your interest in Prudential and for joining the call today. Have a good day." ] }, { "name": "Operator", "speech": [ "And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect." ] } ]
PRU	2019-05-02	[ { "description": "Head of IR", "name": "Darin C. Arita", "position": "Other" }, { "description": "Chief Executive Officer & Director", "name": "Charles Frederick Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Robert Michael Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Kenneth Tanji", "position": "Executive" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Head of Domestic Businesses", "name": "Steve Pelletier", "position": "Other" }, { "description": "JPMorgan Securities -- Analyst", "name": "Jamminder Singh Bhullar", "position": "Analyst" }, { "description": "Chief Operating Officer-International Businesses", "name": "Scott Sleyster", "position": "Executive" }, { "description": "Evercore -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "UBS Investment Bank -- Analyst", "name": "John Matthew Nadel", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Dowling and Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Sandler O'Neill -- Analyst", "name": "John Bakewell Barnidge", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by. Welcome to the Prudential Financial Quarterly Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions) As a reminder, today's conference is being recorded.", "And I would now like to turn the conference over to the Head of Investor Relations, Darin Arita. Please go ahead, sir." ] }, { "name": "Darin C. Arita", "speech": [ "Thank you, Brad. Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, Chairman and CEO; Rob Falzon, Vice Chairman; Steve Pelletier, Head of Domestic Businesses; Scott Sleyster, Head of International Businesses; Ken Tanji, Chief Financial Officer; and Rob Axel, Controller and Principal Accounting Officer. We will start with prepared remarks by Charlie, Rob and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to comparable non-GAAP -- comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-Looking Statements and Non-GAAP Measures in the appendix to today's presentation, which can be found on our website at investor.prudential.com.", "Also, as a reminder, we will be hosting an Investor Day here in Newark, New Jersey, starting at mid-day on June 5. The focus will be on our business strategy, with plenty of time to interact with our executives. We will also feature a Financial Wellness experience exhibit at the start of the events. We hope that you will be able to join us.", "With that, I will hand it over to Charlie." ] }, { "name": "Charles Frederick Lowrey", "speech": [ "Thank you, Darin. Good morning and thank you for joining us today. The first quarter of 2019 marked a solid start to the year for Prudential. We accelerated our strategy to bring greater financial opportunity to more customers. We produced a 12.6% adjusted operating return on equity, increased our book value per share and generated good business fundamentals. With a foundation of a rock-solid balance sheet, we continued to return capital to shareholders totaling $915 million this quarter via share repurchases and dividends.", "Our three interconnected businesses are the drivers of our financial results. They are the U.S. Financial Wellness business: PGIM, our global asset manager; and International, which has our life insurance business in Japan and smaller businesses in growth markets around the world.", "In our U.S. Financial Wellness businesses, we continue to grow our suite of solutions to help the employees of our workforce -- of our workplace clients learn, adopt and practice positive financial behaviors. Rob will provide more color on these solutions in a moment.", "Our workplace clients employ millions of people, giving us a distinct advantage in our ability to connect with a large population via a trusted environment. These workers can engage with us how, when and where they prefer in an in-person, phone or digital way. We see a significant opportunity to expand our total addressable market and to grow as we holistically serve people's needs including investment, retirement income, protection as well as savings and debt management.", "PGIM is a top 10 global asset manager, with leading positions in alternatives including real estate and private credit. The business continues to generate consistently strong investment performance, third-party flows and core earnings growth. PGIM provides a competitive advantage for our other businesses by helping to innovate new solutions and by generating differentiated investment returns.", "PGIM in turn benefits from Prudential's significant pool of assets and large balance sheet. Finally, our international operations further distinguish our business model from that of our peers as they provide sustained growth, strong returns, and steady capital generation. We continue to grow our Japan business, maintaining a leadership position in the Japan life insurance market and also have businesses in highly populated growth markets, including Brazil, Chile, Indonesia, India, China and Africa.", "Turning to slide 3. I'll provide four additional financial highlights on the first quarter. First, first quarter adjusted operating earnings declined from the year ago period primarily due to two factors, one, higher cost for compensation plans tied to Prudential's stock and overall equity market returns; and two, lower fee income reflecting lower average variable annuity assets under management. These two items are partially offset by continued underlining growth across a number of our businesses. Second, our adjusted book value per share grew to more than $96. Third, we deployed our capital into growth -- into growing the business, repurchasing shares and paying dividends. And fourth, we achieved all of this while maintaining a robust capital position consistent with our AA standard.", "We also saw solid drivers across many of the businesses. Our Retirement business account values increased to a record level. Individual Annuities sales continue to increase and the business maintained its regular quarterly capital generation with $285 million paid to the holding company, and our Life Planner business also delivered a strong sales quarter driven by a record level of life planners. While we are encouraged by the momentum of our businesses, it is important to highlight that we remain disciplined on pricing to ensure that we continue to generate returns at or above our target levels given the recent decline in long-term interest rates, which has had an effect on the level of sales in some of our businesses.", "Before I turn it over to Rob for more on how our businesses are executing on our strategic priorities, I'd like to say a few words about our commitment to solving the financial challenges of our changing world.", "So let's turn to slide 4. Underlying our purpose is a commitment to fostering sustainable business that produces attractive returns for our long-term shareholders, along with an integrated environmental, social and governance framework. We've been recognized by a number of third parties specializing in ESG with high marks from Sustainalytics, institutional shareholder services, MSCI and CDP. As an example of our actions, just last month, we announced a $180 million investment in Opportunity Youth. This funds partnerships, grants, corporate contributions and impact investments through 2025 to improve the financial security of young people around the world.", "We care about ensuring that future generations are prepared for a successful professional and financial life and we are proud of our commitment to their success. This is a great example of who we are as a company and the purpose for which we exist.", "Thank you all for your time this morning, and with that, I'll turn it over to Rob." ] }, { "name": "Robert Michael Falzon", "speech": [ "Thanks, Charlie. I'll provide more color on how we are growing our three businesses: U.S. Financial Wellness, PGIM and International. As shown on slide 5, U.S. Financial Wellness represents our workplace and individual solutions businesses that produce a diversified source for earnings from fees, investment spread and underwriting income.", "Our broad capabilities including advice, investment, retirement income and protection solutions continue to help clients with their financial wellness needs. We have three key growth priorities for financial wellness. First, we are continuing to help employers understand our differentiated value proposition. Since the launch of our Financial Wellness capabilities in 2015, we have generated about $11 billion of full service retirement plan sales and over $130 million in Group Insurance case wins that we contribute to the competitiveness of our platform. In addition to helping us win new clients, we expect to retain more of our existing clients that are aligned with our value proposition.", "Second, we are engaging and educating workers to better understand and utilize their existing workplace solutions. We activate these relationships through our financial pathways program and our digital Financial Wellness platform. Our financial pathways program has been adopted by nearly 600 of our workplace clients. In this program, employees of our workplace clients participate in worksite financial seminars delivered by Prudential's financial advisors. Our digital Financial Wellness platform has been adopted by nearly 3,100 clients, reaching nearly 8 million employees. This platform provides a digital venue to address a variety of individuals' needs including education on financial wellness topics, assessment of financial needs and tools that allow individuals to take action.", "And third, we are addressing the holistic financial needs of individuals. One way we deliver that is via LINK by Prudential which we launched in the second half of 2018. This is a highly personalized online experience that helps employees customize financial goals, connect with advisors digitally or via phone and obtain investment, income and protection solutions. We recently released LINK to our workplace clients and are already beginning to experience good traction on engagement at the individual level.", "What we do is making a tangible difference. Based on case studies we have conducted, employers are experiencing a significant increase in the productivity and satisfaction of their employees. This includes substantial increases in retirement plan participation, employees increasing their retirement plan contributions to their company's match level or above, and more appropriate asset allocation by utilizing tools that help participants decide on a mix of investment options that meet their particular needs. Ultimately, we believe our solutions can change the behaviors for workers, produce better results for employers and significantly expand our addressable market, thereby enhancing our long-term growth potential.", "Turning to slide 6. We recently rolled out additional solutions for our workplace clients. As I previously mentioned, we extended the reach of LINK by Prudential to our workplace clients. In addition, we are piloting a financial coaching service available via phone and one-way screen share designed to help individuals learn about and adopt healthier financial behaviors. And we've deployed student loan assistance capabilities including helping individuals, evaluate student loan consolidation or repayment options to more than 350 employers during the first quarter of this year. Also employers can activate a feature that allows them to pay down the student loan debt of their employees.", "For individuals going through a job transition, we introduced PruPassages, which helps people maintain Financial Wellness and make more informed decisions to navigate changes during this time. And for those who have just lost a loved one, we're providing new beneficiary services, an easier claims process and resources to help guide their decisions during an emotionally challenging period. All these enhancements are aimed at meeting individual's needs at critical moments in their lives while improving productivity for employers and generating positive financial outcomes for our business.", "Turning to slide 7. PGIM, our global asset management business has over $1.2 trillion of assets under management. In the current quarter, we generated $1.4 billion of positive net third-party flows including $1 billion of institutional and about $400 million of retail net flows. These positive net flows include solid fixed income flows and are driven by our strong long-term investment performance. I would specifically highlight our five-year performance and note that 92% of the assets under management have outperformed their benchmarks over that period.", "Our strong investment performance and diversified product offering has allowed us to attract flows into high-return strategies such as emerging markets and alternatives. By way of example, we are the third largest global investor in alternative investments with our significant real estate and private credit platforms. This has contributed to keeping our overall asset management field stable at 22 basis points. We are encouraged by our pipeline and our ability to continue to grow. Our distinctive multi-manager model with broad asset class capabilities helps us to expand including globally with roughly 30% of assets under management currently sourced from outside the U.S.", "Now turning to slide 8. Our International business includes our world-class Japanese life insurance operation as well as other businesses including those in high-growth markets with attractive demographics. Our differentiated business models and proven ability to execute our strategy, combined with seasonally higher earnings from annual premiums, led to a record level of earnings in the quarter. Life Planner sales, which were about half of the total international sales in the current quarter, increased by 19% compared to the year ago quarter. This was driven by higher U.S. dollar sales and the number of Life Planners in Japan increasing by 6% to a record level of more than 4,300.", "Sales for Gibraltar, which represents the other half of international, were lower than a year ago. This primarily reflects continued competitive conditions in the bank channel.", "In summary, our momentum remains positive across our businesses: U.S. Financial Wellness, PGIM and International. We have thoughtful strategies and quality execution that continue to build strong fundamentals as we serve our customers well, and we are monetizing those fundamentals to generate profitable growth at attractive returns.", "With that, I'll hand it over to Ken." ] }, { "name": "Kenneth Tanji", "speech": [ "Thanks, Rob. Slide 9 includes the notable items which had an impact on adjusted operating results in the current quarter. We highlight these items because they may not be indicative of future performance. In total, these 3 items reduced pre-tax earnings by $10 million or $0.02 per share. Excluding the notable items, earnings per share would be $3.02, relatively consistent with the year ago quarter.", "First, variable investment income, which includes non-coupon and prepayment income was about $100 million below long-term expectations. This reflects the 1 quarter lag effect of private equity returns and lower-than-expected prepayment fee income partially offset by higher-than-expected hedge fund returns.", "Second, equity market appreciation in the current quarter resulted in a $70 million of favorable adjustment to certain -- to the recognition of certain benefits and costs primarily associated with variable annuities and variable life policies.", "And third, underwriting experience was inline with our seasonal expectations and reflects the benefit of our complementary mortality and longevity profile as highlighted on Page 22 in the appendix.", "Regarding our quarterly earnings pattern, I would also like to highlight a couple of additional items also included in the appendix that impacted current quarter results. Long-term compensation expense for retiree eligible employees is recognized when awards are granted, which is primarily in the first quarter of each year. This resulted in about $30 million of expense in corporate and other and $30 million -- $35 million of expense in PGIM.", "In addition, certain deferred compensation and long-term employee compensation plans are based on Prudential's stock and equity market performance. Market appreciation in the current quarter exceeded our expectations and resulted in an incremental expense of $50 million primarily in corporate and other.", "In total, these 2 items reduced pre-tax earnings by $120 million or $0.22 per share. I would also like to highlight a concentration of annual premiums in our International Insurance operation results in an earnings pattern that favors the first quarter. We estimate that this benefited the current quarter results by about $55 million.", "Turning to slide 10. I'll provide an update on capital deployment, liquidity and leverage. We returned $915 million to shareholders during the current quarter through dividends and share repurchases. We repurchased $500 million of shares through our $2 billion share repurchase authorization for 2019. In addition, we increased our quarterly common stock dividend per share by 11%.", "Our cash and liquid assets at the parent company amounted to $5.5 billion at the end of the quarter, consistent with year-end 2018 and higher than our $3 billion to $5 billion liquidity target range. We also maintained a strong balance sheet. Our regulatory capital ratios continue to be above our AA financial strength targeted levels and our financial leverage ratio remains better than our target.", "Turning to slide 11 and in summary, our market-leading global businesses with complementary capabilities are providing integrated financial wellness solutions to more customers. We generated a strong adjusted operating return on equity along with a record adjusted book value per share and continued underlying growth across a number of our businesses, and we distributed $915 million to shareholders and maintained a robust capital and liquidity position with financial flexibility.", "Now I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "(Operator Instructions) Our first question today comes from the line of Erik Bass from Autonomous Research. Please go ahead." ] }, { "name": "Erik Bass", "speech": [ "I was hoping you could comment on the pension risk transfer pipeline given the strong momentum you've seen to start the year. And is this pulling forward activity, or do you expect it to remain very active here?" ] }, { "name": "Steve Pelletier", "speech": [ "Erik, it's Steve. I'll address your question. We look at the pension risk transfer pipeline for the -- for this year as still quite solid. The decline in interest rates has impacted funding levels in plans on an aggregate basis. However, we still see the need for the solution as being quite strong and we still see a very solid opportunity set before us in regard to companies that have already taken steps to hedge or mitigate their exposure to capital markets movements.", "So we still see a pretty solid pipeline. This is on the U.S. funded side that I'm speaking about, and we feel very good about our opportunities to compete with the net opportunity set.", "On the unfunded side, the longevity reinsurance side, the U.K. business, we actually see a very strong pipeline. We reported in the aggregate $1.1 billion in PRT flows this quarter. That was $400 million in funded business and $700 million in longevity reinsurance.", "Also, since the beginning of the second quarter, we publicly announced another couple of billion dollars in longevity reinsurance, and we expect the demand to stay pretty strong on that front for the balance of the year as companies look to manage their risk in this area ahead of Brexit considerations." ] }, { "name": "Erik Bass", "speech": [ "Thank you. And then can you talk about the returns you're able to generate on new PRT business? I think historically, you talked about it being in line or higher than the corporate objective of 12% to 13%. Is that still the case?" ] }, { "name": "Steve Pelletier", "speech": [ "Yes. That would still be the case, Erik. For quite some time, we've been able to write this business at a return level that is consistent with our corporate objectives, actually in the low-double-digits on an unlevered basis, so quite consistent with our corporate objectives.", "There are certain instances in which we might choose due to the risk characteristics of a certain piece of business to make that into the very high-single-digits. But by-and-large, we do this business at our target levels that are quite consistent with our corporate return objectives." ] }, { "name": "Erik Bass", "speech": [ "Great, thank you." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of Jimmy Bhullar with JPMorgan. Please go ahead." ] }, { "name": "Jamminder Singh Bhullar", "speech": [ "I had a couple of questions. First, could you just give us some color on what's going on in the Japanese business in terms of competitive conditions, and just your expectations for sales? Obviously, you had a pretty good quarter on the Life Planners side, but a very weak result at Gibraltar." ] }, { "name": "Scott Sleyster", "speech": [ "Thanks Jimmy. This is Scott. I think I'll answer that in two ways. For the traditional Life Planner business, we feel like our model is fairly differentiated. It's well trained Life Planners. It's a needs based selling model, and the benefit you're seeing now is that our Life Planner account in Japan is continuing to increase. I think we were up over 250 Life Planners in Japan or 6% this year. So I think that's fairly straightforward, if you will.", "If you look over at the Gibraltar businesses, you do end up with a different set of activity there, and that we are in the bank market there, and that market is a little more -- it's a little more opportunistic. First of all, the competitors there have different drivers than we do in some cases, and we also compete against the mutual fund market and other things that customers might be looking to do on the margin.", "For the most part, our business there, we're very focused on recurring premium. You may recall from our Japan Investor Day that what we like to do is take former Life Planners that are well schooled in needs-based planning and move them into the bank channel.", "And therefore, their focus I think is substantially different than the average player in the market. Market has been pretty competitive. You've seen a decline year-over-year, although not so much quarter-to-quarter, and that will just vary. And if we're going to maintain our pricing discipline, it's really a little bit hard to forecast from that perspective. But I would say there's a stable core of what we do that customers need in the banks, and we're going to stick to our knitting there." ] }, { "name": "Jamminder Singh Bhullar", "speech": [ "And for Ken, how much insight do you have on just the book value impact over earnings, increase in earnings volatility you might experience from just changes in accounting for long duration product?" ] }, { "name": "Kenneth Tanji", "speech": [ "Yeah. So Jimmy, this is Ken. We're in the early days of adopting those new accounting methods, and it's too early to provide any guidance. Overall, we're working our way through it, and our objective is to, in the end, be able to provide clear measures of our fundamental business performance that's in line with the economics that are appropriate for our business mix. So, it's still very early days, too early for us to comment on directional impact." ] }, { "name": "Jamminder Singh Bhullar", "speech": [ "Okay. And then just lastly, on the $55 million tailwind to 1Q earnings that you don't expect to repeat in 2Q, that's an after-tax number?" ] }, { "name": "Kenneth Tanji", "speech": [ "No. It's a pre-tax." ] }, { "name": "Jamminder Singh Bhullar", "speech": [ "Pre-tax number, so it's going to like $0.08, $0.09 to EPS, right?" ] }, { "name": "Kenneth Tanji", "speech": [ "I think that's about right, yes." ] }, { "name": "Jamminder Singh Bhullar", "speech": [ "Okay. Thank you." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of Tom Gallagher with Evercore. Please go ahead." ] }, { "name": "Tom Gallagher", "speech": [ "Hi. So, it looks like your Holdco debt went up by about $1 billion versus 4Q, but Holdco cash stayed flat. Can you comment on what's happening there? Was that just timing of dividends out of the subs, or are you planning on using leverage to fund part of your buybacks and dividends this year? That's my first question." ] }, { "name": "Kenneth Tanji", "speech": [ "Yeah. So overall, we feel very good about our position in terms of capital and highly liquid assets at the holding company. The liquid assets were flat from year-end. We did issue $1 billion of debt, and that is really to position us well for a pre-funding of debt that matures in the second quarter.", "We did have cash flow come into the holding company from our businesses that pay dividends quarterly and regularly, and that was from annuities and PGIM, which are nice, stable fee businesses that we have on -- providing dividends on a quarterly and regular basis.", "And then we tend to have the dividends from our insurance operations in the second half of the year. So our businesses are generating solid cash flow, and support -- will support our plans for shareholder distributions as we go through the year." ] }, { "name": "Tom Gallagher", "speech": [ "So Ken, I guess, yes. So bottom line there, you expect to fund your dividends and buybacks with all dividends from subs throughout the course of the year, not to releverage? Is that a fair conclusion?" ] }, { "name": "Kenneth Tanji", "speech": [ "That's right. And over time actually, you've seen our leverage trending down, and that's reflective of the strong cash flow nature of our business." ] }, { "name": "Tom Gallagher", "speech": [ "Got you. And then just my follow-up is just on PGIM. Now I know you don't disclose it this way on asset flows, but from the ending balances between equity and fixed income, it looks like you're seeing pretty big inflows in the fixed income and outflows in equities. Just want to know is that what's happening underneath? And also, with that -- are there implications for revenue yields that you see there because PGIM revenue yields have held up quite well, so just curious if you would expect that to remain the case." ] }, { "name": "Steve Pelletier", "speech": [ "Tom, it's Steve. I'll address your question. Thanks for it. You're right in making the observation that, by and large, we've seen flows into fixed income and outflows on the equity side. That's been the case for the past about several quarters, largely in the face of the active to passive trend, especially in equities.", "Although generally speaking, we've seen that -- we've seen the pressure on our equity flows moderate in the course of 2018, say. Our equity performance as well as our fixed income performance remains very strong. We see a good pipeline of mandates.", "So, based on the observation that at the end of the day investment performance really is the beginning of the virtuous cycle in the asset management business. We remain very confident in our ability to continue to generate flows in certainly fixed income and equities as well.", "In regard to revenue yield, I would say that our flows into fixed income have been into, relatively speaking, higher fee-yielding strategies. That's been especially true over the past, say, year and a half to two years.", "And so we have been able -- even in the face of some equity outflows and strong fixed income inflows, we've been able to maintain that 22 basis point fee level for some period now. That remains quite stable and we expect it to be so.", "I'd also just make the final observation that while all of our businesses are at scale with PGIM, the scale characteristics of our fixed income business are especially strong. So, when we attract flows into that business, it bodes well for our operating margin in the business." ] }, { "name": "Tom Gallagher", "speech": [ "Okay. Thanks. That's helpful." ] }, { "name": "Operator", "speech": [ "And we now have a question from the line of Suneet Kamath with Citi. Please go ahead." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. Just wanted to start with the wellness initiative. Can you give us a sense of how much you're spending on that on an annual basis? And what kind of the spend has been maybe over the past couple of years and where it's showing up?" ] }, { "name": "Steve Pelletier", "speech": [ "Suneet, I would address it. We've spoken before about our initiative spendings overall as a company. The Financial Wellness spend is a meaningful portion of that, but we have not broken that out as a separate matter.I would say that a fair amount of the spend is visible in our retirement and group businesses kind of concentrating on the top of the client engagement funnel, if you will.", "That's where people come into the Financial Wellness experience, through group and retirement. So, when you see some pick up in expenses -- in G&A expenses in those businesses, a significant portion of that is due to the Financial Wellness effort, In regard to the returns, we're realizing on it. We're actually very pleased in the areas that Rob outlined in his opening comments.", "We definitely see that momentum on the top -- at the top of the funnel. The very strong momentum in our full-service sales and in our group sales over the past couple of years is directly attributable to the Financial Wellness effort and Rob highlighted those numbers in his comments. And we see very strong beginnings of engagement of individuals with the Financial Wellness experience. Lots of different numbers I could cite from Rob's presentation, but in particular, I'd speak to the 8 million people who are now accessible -- who can now access the digital Financial Wellness portal through the 3,100 employers that have activated that portal. And we see the beginnings of very solid engagement, engagement with the digital properties that are in the portal, with the digital properties that are being introduced across the Financial Wellness platform, in particular LINK and some of the other capabilities that Rob mentioned.", "We see very solid engagement with those capabilities. We see people completing the kind of learning experiences and needs-based analysis that is embedded in that experience. And over time, we like the prospects for this resulting in individuals who come to us via the Financial Wellness portal engagement with our solutions, with our individual solutions as well, investment solutions, retirement solutions, and insurance solutions. I will emphasize that those individual-based revenues will emerge over an extended period of time, but all of the metrics that we're tracking and we'll talk more about this on Investor Day in June, all of the metrics we're tracking lead us to feel that this initiative is well on track in terms of achieving those outcomes for individuals and their employers." ] }, { "name": "Kenneth Tanji", "speech": [ "And I'll just add. This is Ken. Overall, we've been very disciplined and consistent in our approach to managing our operating expense resources and that reflects a combination of taking actions to gain significant efficiencies across the company by creating centers of excellence, pulling together functions to gain efficiency, and improving quality and improving systems and implementing automation.", "And those savings and efficiencies allowed us to, at the same time, increase resources to the initiatives that Steve just described to you in building data, digital customer service and customer engagement capabilities and expanding our PGIM business globally.So, if you looked across the surface at our operating expense, you'd see a pretty stable outlook modestly growing and growing at a rate below our earnings growth and expanding margins but, at the same time, being able to invest into the capabilities that Steve described." ] }, { "name": "Suneet Kamath", "speech": [ "Okay. Thank you. And then on the compensation plan, I guess that hit in the first quarter for the retirement eligible employees. Can you give us any kind of sensitivity around -- either sensitivity of the markets or your stock price just to help us model this? It seems like that was a decent portion of the shortfall relative to consensus?" ] }, { "name": "Kenneth Tanji", "speech": [ "Yes. There was really kind of two pieces to that and I think it's important to distinguish between them. The retiree-eligible piece means that if you're a retiree-eligible, the accounting requires that we expense that when it's granted even though it is paid out over a -- typically over a three-year period. And that was $70 million; $35 million in PGIM, $35 million in Corporate, but that's not market-sensitive.", "That's going to occur in the first quarter when their grants are typically made, and that occurred this quarter and it occurred in prior quarters as well. So it's more of a seasonal timing of expense than market-related.On the market-related piece which was $50 million and primarily in Corporate, you can think of that as having our compensation plans tied to the performance either of our stock and aligned -- aligning management's interest in that.", "Or to the extent people defer compensation and linking it to market indexes, it would experience fluctuation with those markets. In the first quarter, that was $50 million and our stock price improved by 13% and the S&P improved by 13%. So you can sort of calibrate $50 million to a 13% change in both of those components." ] }, { "name": "Suneet Kamath", "speech": [ "And will that happen every quarter? Meaning that, that second one, the $50 million, is that adjusted on a quarterly basis?" ] }, { "name": "Kenneth Tanji", "speech": [ "Yes. It will as market moves. And if you look to the fourth quarter, you saw it in the opposite direction actually to a more sizable degree." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. Okay. Thanks." ] }, { "name": "Robert Michael Falzon", "speech": [ "Suneet, it's Rob. The only thing I'd add is that, that is factored into the sensitivities that we've given you for full year earnings for the -- plus or minus 10% in equities. We talk about that being $0.30. That $0.30 is net of this. It's just the timing of it is such that we give you a full year number on sensitivity but the compensation piece hits in the current quarter, whereas the benefit is sort of spread throughout." ] }, { "name": "Suneet Kamath", "speech": [ "Okay. Thanks." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of John Nadel with UBS. Please go ahead." ] }, { "name": "John Matthew Nadel", "speech": [ "So Rob, I appreciate your comment there at the end in response to Suneet's question. It's a good segue to where I wanted to go. It seems to me at a high level that the strong market performance in the first quarter, actually on an aggregate basis for your company's earnings had a negative impact given we get the point-to-point impact through these compensation arrangements.", "But the average market performance impact was not that significant and we are to be getting that on more of a lagged basis as we work through the rest of the year. So I guess, just to confirm your comment, 10 or 10%-plus, I mean the market's up almost 17% at this point year-to-date performance. We ought to be seeing the first quarter pressures more than overcome by business segment earnings results, right?" ] }, { "name": "Kenneth Tanji", "speech": [ "Yes. This is Ken. That's exactly the way to think about it. It's the timing. So the $0.30 that we provided for a increase of 10% in the markets, that was over one year. And you saw the first component of that being the impact on costs of $50 million of the deferred and long-term comp expense hitting this quarter, and then in subsequent quarters, you would see the benefit which would be more than the $0.30 over one year's period. That make sense?" ] }, { "name": "John Matthew Nadel", "speech": [ "It does make sense to me, I guess. I guess when I think about the -- one of the slides in your deck shows a seasonal pattern and I know this isn't necessarily seasonal, but you highlight that -- and this has been the case forever, that your international operations benefit seasonally in the first quarter and then to some degree relative to the rest of the year. But you're not really highlighting for us the negative impact of this particular comp item relative to the positive impact that you ought to see in the rest of your businesses for the remainder of the year.", "And I guess I'd advise you guys if I could be so bold as to try to lay that out for us, even it's not on this call at your Investor Day coming up because you've missed earnings now, right, for four straight quarters. It's despite what's been a pretty good -- other than 4Q, a very good market backdrop, and I think there's some significant disconnect. I hear some really good commentary about growth around Financial Wellness, et cetera, et cetera. It seems to me there is more upfront cost and more lagged revenue effect. Maybe you could help flush that out as well. I just see you guys just performing so well from a strategic perspective and there's some miss between the connection of earnings to consensus expectations. That's all." ] }, { "name": "Kenneth Tanji", "speech": [ "Yes. There's a timing consideration. We do think it's important to align management's interest with the performance of the stock and that -- the accounting for that is appropriately recognized immediately and then the fees will occur over time. So over time, we think obviously, the equity markets are a very positive thing for our underlying earnings power and you should expect to see that in the subsequent quarters." ] }, { "name": "Charles Frederick Lowrey", "speech": [ "Hey, John, it's Charlie. First of all, let me say thank you for your comment. No, we really appreciate it. And to be candid, it's a source for frustration for us as well. We think our businesses are performing well. We are very pleased with the businesses we're in. We think they're high quality, they're at scale. The Financial Wellness initiative is bringing them all together in an integrated way. And this is -- we've been on a long journey and we're proud of where we come from in terms of the divesting of non-strategic businesses, acquiring businesses that we want to be in.", "And so we are also, quite frankly, frustrated by the noise that's out there that is created by some of the accounting regulation and other things. And so we will work on that and we'll try and see as we have and Rob and his crew over the years have tried to simplify our earnings. And you've seen us to be able to simplify them and bring net income more in line with AOI over time, but we have more work to do and we will commit to working on that to try and clarify and simplify our results to reflect what we think is a really good business system that we have and a good strategy." ] }, { "name": "John Matthew Nadel", "speech": [ "I appreciate that, Charlie. Thanks very much." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of Ryan Krueger with KBW. Please go ahead." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks, good morning. I had a question on holding company, liquidity above your targets. I think your buyback and dividends are relatively equal to your free cash flow generation. Just curious, how you're thinking about utilizing excess capital that's above your targets over time and if it's more dependent on opportunistic situations or if you look to manage that down?" ] }, { "name": "Kenneth Tanji", "speech": [ "Well, yeah, again, we feel really good about our capital position and our cash flow. It's been a pretty consistent picture of us generating good cash flow from our businesses, using that in a combination of ways. One, first, is to grow our businesses in attractive opportunities such as pension risk transfer. We have also had the opportunity to reduce leverage, and that also provides a source of financial flexibility for us. So overall, we feel real good about our capital position. It's been very consistent. We've been increasing our shareholder distributions in line with our earnings and as we generate cash flow. And we -- I think you should expect that to continue." ] }, { "name": "Ryan Krueger", "speech": [ "Okay, thanks. And can you give any perspective on how you're feeling about interest rate assumptions and policyholder behavioral trends and variable annuity, and the variable annuity business heading into the actuarial assumption review?" ] }, { "name": "Kenneth Tanji", "speech": [ "Yeah. We're still going through that. As you know, we do that in the second quarter. We're still doing our work, and we don't -- we prefer not to preview that on this call." ] }, { "name": "Ryan Krueger", "speech": [ "Okay, understood. Thank you." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of Humphrey Lee with Dowling & Partners. Please go ahead." ] }, { "name": "Humphrey Lee", "speech": [ "Hi, thank you for taking my questions. My first question is related to prepayment income. Obviously, you've lowered this in a quarter, and I think some of your peers talked about having lower prepayment income as well, which is surprising given yield came down in the quarter and spread tightened. I was just wondering, do you see that as a timing issue, or is there any structural change to the debt issuance market as refinancing activity slow down?" ] }, { "name": "Kenneth Tanji", "speech": [ "No. I think it's just -- the way to think about it is typical volatility, less tied to rate environments and more tied around the financing needs of the borrowers, and that's typically tied to some transactions or strategies that are underlying their businesses.", "So the change has been very typical, and if you looked at that -- as we look at that over time, it tends to be above and below our expectations on a fairly consistent basis, and so we see what happened this quarter is just typical." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. And then shifting gear to PGIM. Just looking at the gross sales, especially on the institutional side came down by a fair amount. I was just wondering, if you can talk a little bit about what you're seeing recently and then also in terms of your pipeline, in terms of on a gross sales perspective?" ] }, { "name": "Steve Pelletier", "speech": [ "Humphrey, it's Steve. I'll address your question and in doing so, I'll echo some of the comments I made earlier. We do see some solid pipeline in front of us across multiple asset classes, in particular in fixed income but also in equities as well.", "And with the performance -- investment performance that we're generating, with the build-out that we made in our global distribution platforms and with some of the mandates that we've -- that we're already seeing, some of which have yet to fund, but they've already been awarded. We do continue to feel very confident that our long, long string of positive net flows from the institutional market has every prospect for continuing." ] }, { "name": "Humphrey Lee", "speech": [ "So the low gross sales is just more of a timing issue as opposed to a change in client demand?" ] }, { "name": "Steve Pelletier", "speech": [ "Correct." ] }, { "name": "Humphrey Lee", "speech": [ "Okay. Thank you." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of John Barnidge with Sandler O'Neill. Please go ahead." ] }, { "name": "John Bakewell Barnidge", "speech": [ "Thanks. Both VA and FA sales did well. How much of this momentum have you seen carry over into 2Q? And then how much of this growth, do you think is coming from just the industry being hot versus Financial Wellness program driven demand?" ] }, { "name": "Steve Pelletier", "speech": [ "John, it's Steve. I'll address your question. We think that the sales that we saw in the first quarter really reflect the strong momentum that we have in the business. It's across multiple products and we see very strong diversification and growing diversification of our business with our Prudential defined income product having a major contribution and building momentum in our fixed index annuity.", "And that, in particular, was a product, which basically got off the ground a year ago when we saw $200 million in sales in it this quarter. We see this strength across multiple distribution channels within the industry, and we think we have every prospect of continuing the momentum.", "In saying that, we always run all of our businesses for sustainable profitable growth, and we will continue to manage them accordingly and to take a look at our pricing dynamics in relation to the market environment in which we're operating.", "But I think what we're really seeing is growing demand among financial advisors for their clients to be able to access this type of solution. There has been a pickup in industry sales, but I will say that we're pleased to see that both in 2018 and in the first quarter of 2019 our growth has been above industry levels. So we've been gaining share in this market." ] }, { "name": "John Bakewell Barnidge", "speech": [ "Okay. And my follow-up, with this being the first tax season since reform was finalized, have you noticed any changes in behavior on the part of the consumer, business owners? And this may also be more relevant for 2Q than 1Q? Thanks for the answers." ] }, { "name": "Steve Pelletier", "speech": [ "I've not seen any particular dynamics from the -- any behaviors in regard to tax season, that would be unusual compared to previous years." ] }, { "name": "Operator", "speech": [ "And we do have a question from the line of Alex Scott with Goldman Sachs. Please go ahead." ] }, { "name": "Alex Scott", "speech": [ "Hi. Good morning. First question I had was just on dividend capacity. I think you commented some on it already, but I guess just in light of sort of the mix of dividends this last year and it kind of being, I think, a bit more weighted toward international versus your biggest U.S. opco, could you talk about how dividend capacity looks this year? When you do expect to have access to dividends?" ] }, { "name": "Kenneth Tanji", "speech": [ "Yes. This is Ken. Last year, I'll remind you that we did have the impact of tax reform and that led to a strengthening of our capital position in Prudential Insurance Company of America, our flagship U.S. insurance company. And so we didn't take a dividend from that business last year, but we would expect to this year in ordinary course, as well as having the diversity of our cash flows from our other businesses with PGIM generating cash flow, quarterly annuities generating cash flow quarterly and our international businesses, particularly in Japan, also with a source of cash flow at the typical levels, which will vary over time and certainly quarter-to-quarter, but it's about 65% of after-tax earnings." ] }, { "name": "Alex Scott", "speech": [ "Got it. Okay. And my follow-up question was just on PGIM. When I look at earnings and maybe a margin, sort of, adjusted for the other related revenues and earnings that you receive there, I mean the core margins and I appreciate that there was, sort of, these first quarter seasonal deferred comp expense, but even just looking relative to other 1Qs. I mean the margin I think was down around 4 or 5 points from where it's been.", "So I would just be interested if there was anything else that's already going on there. I mean, should we expect margins to sort of remain at this lower level, or do we -- or should we expect them to go back up to a higher level? And if you could remind us, I think you guys have talked about a core margin target there before that maybe was closer to the 30%?" ] }, { "name": "Steve Pelletier", "speech": [ "Alex, it's Steve. I'll address your question. We do not -- the numbers that we look at, we're not seeing the same type of margin erosion to which you refer. Maybe we can follow-up in due course. But we do see that, as we attract flows into businesses at scale and maintain our average fee rate, which we've been quite successful in doing, we see the ability to continue to gradually and all of the things being equal, expand our margins in the business.", "In the range of the 30%-plus is how we see our margin objectives in the business. We can talk more about this again at Investor Day, but we do see the opportunity and the reality of continued margin expansion in the business." ] }, { "name": "Alex Scott", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "And at this time, for closing remarks, I'll turn the conference back over to Charlie Lowrey. Please go ahead, sir." ] }, { "name": "Charles Frederick Lowrey", "speech": [ "Sure. Thank you. Let me close with a few final thoughts. We feel confident about our strategy, the scale of our businesses and the strength of our balance sheet. As we continue to focus on our businesses and deploy new technology to grow and expand our markets, we will make an even greater impact on the financial lives of our customers and in the global community.", "This should lead to growth in our businesses and greater value for our shareholders. We look forward to providing you with more details at our Investor Day here in Newark on June 5. Thank you for joining the call, and have a nice day." ] }, { "name": "Operator", "speech": [ "And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect." ] } ]
PRU	2020-02-05	[ { "description": "Senior Vice President of Investor Relations", "name": "Darin C. Arita", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charles F. Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Robert M. Falzon", "position": "Other" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Executive Vice President and Head of U.S. Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Executive Vice President and Head of International Businesses", "name": "Scott Sleyster", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Nigel Dally", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Andrew Kligerman", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Sandler O'Neill -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Dowling and Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by. Welcome to Prudential Quarterly Earnings Conference Call. [Operator Instructions]", "I would now like to turn the conference over to your host, Darin Arita. Please go ahead." ] }, { "name": "Darin C. Arita", "speech": [ "Thank you, Greg. Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, Chairman and CEO; Rob Falzon, Vice Chairman; Andy Sullivan, Head of U.S. Businesses; Scott Sleyster, Head of International Businesses; Ken Tanji, Chief Financial Officer; and Rob Axel, Controller and Principal Accounting Officer. We will start with prepared comments by Charlie, Rob and Ken, and then we will take your questions.", "Today's presentation may include forward looking statements, it is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non GAAP measures. For reconciliation of such measures to the comparable GAAP measures, and the discussion of factors that could cause actual results to differ materially from those into forward looking statements, please see the slide titled forward looking statements and non GAAP measures in the appendix to today's presentation, which can be found on our website at investor.prudential.com.", "With that, I'll hand it over to Charlie." ] }, { "name": "Charles F. Lowrey", "speech": [ "Thank you, Darin. Good morning, everyone, and thank you for joining us today. Yesterday, we reported fourth quarter earnings per share of $2.33. We also reported an adjusted operating return on equity of 12.1% for the full year. Looking back on 2019, we implemented a number of important actions to enhance our business and financial performance for the long term. As a result, we have begun 2020 with a clear set of initiatives, against which we will execute with the renewed confidence that our businesses can deliver increased earnings performance. I'll begin this morning by sharing a few accomplishments from 2019. First, we launched a process, talent and technology transformation initiative, which is on track to realize $500 million in run rate cost savings by 2022. As part of this program, we initiated a voluntary separation program for segments of our U.S. workforce during the fourth quarter, which is reducing our cost base over the course of 2020 and creating a more agile and competitive workforce.", "Second, we returned approximately $4 billion to shareholders via dividends and share repurchases. The 10% increase in our dividend represents the 12th consecutive year of dividend increases and produces a yield on booked value in excess of 4%. Third, we completed our acquisition of Assurance IQ in October, adding a leading direct to consumer financial wellness solutions platform. We're encouraged by the growth and customer demand, the interest from carriers wanting to put their products on the platform and the level of talent we are attracting from well-known technology companies. Finally, we may progress in our ongoing efforts to reduce the variability of our quarterly earnings pattern. And we added transparency to our quarterly financial performance.", "In 2019, our financial performance was impacted by a low interest rate environment, the annual assumption update in our Individual Life business and higher-than-typical expenses in our International Businesses. In 2020, we are implementing a number of initiatives to drive improved financial performance in the years ahead. We're focused on executing three key initiatives. First, we remain focused on enhancing the customer experience to produce long-term sustainable growth while generating $140 million in cost savings this year. Second, in our International Businesses, we continue to focus on increasing the percentage of earnings coming from growth markets. Supporting this objective, this quarter, we closed on the acquisition of a Colombian pension fund manager with Habitat, expanding our presence in Latin America.", "We also completed the sale of our Italian insurance business and are exploring strategic options for operations in other markets, including Korea. We'll share further details at the appropriate time. And third, we're continuing to take steps to mitigate the effects of the low interest rate environment, such as adjusting the mix and pricing of our products. Turning to slide three, I'll briefly touch upon some of the key drivers of our fourth quarter results, which Rob will cover in more detail. Our U.S. Businesses benefited from record account values in Retirement and Individual Annuities. Earnings increased from the prior year quarter, reflecting higher net investment spread results partly offset by lower fees in our annuities business. PGIM, our global asset manager, reported record assets under management of $1.3 trillion, as well as higher net asset management fees and Other Related Revenues.", "Our International Businesses increased earnings, driven by higher net investment spread results and business growth, partly offset by higher-than-typical expenses. Turning to slide four, I'd like to touch briefly on four ways we generate value to our stakeholders in a sustainable way. First, we are a purpose-driven company. We strive to make lives better by solving the financial challenges of our changing world and do so for a broad array of stakeholders. Second, in December, our Board introduced a multi-stakeholder framework that extends the Board's accountability to investors, employees, customers and society at large, reinforcing the Board's commitment and ours to enabling positive change as well as strong financial returns. Third, this multi-stakeholder framework is reflected in our continued pursuit of exemplary environmental, social and governance practices. Finally, we provide transparency so investors can measure our progress.", "We disclose metrics and targets related to the financial stability board's task force on climate-related financial disclosures. This includes quantifying greenhouse gas emissions, recycling and water usage. In addition, we publish metrics in accordance with the Sustainability Accounting Standards Board. We continue to be recognized for our commitment and standards we uphold. Just last month, Fortune included us on its list of World's Most Admired Companies for the fifth consecutive year. We are proud to have earned the first place distinction in the life and health insurance category each year. In closing, we continue to move quickly and with conviction to execute on our strategy that we put into place, including the three initiatives I have outlined for 2020.", "With that, I'll turn it over to Rob for a closer look at our business performance for the quarter and our earnings outlook." ] }, { "name": "Robert M. Falzon", "speech": [ "Thank you, Charlie. I'll provide more color on how we are executing on our strategy within our U.S., PGIM and International Businesses and in our near-term earnings growth outlook. Turning to slide five. Our U.S. Businesses consist of the workplace solutions, individual solutions and Assurance IQ divisions that produce a diversified source of earnings from fees, investment spread and underwriting income. Our U.S. Businesses have three key priorities for growth. First, we are investing in transforming our capabilities and the way we work to deliver a better customer experience while realizing efficiencies that will improve our margins. Second, we will continue to pursue targeted growth opportunities, including, by way of example, the non-jumbo corporate segment of the full-service retirement market and the premier segment of involuntary products offered by our Group Insurance business.", "And third, we remain committed to expanding our addressable market, including through workplace financial wellness, and assurance IQ. As a result of the continued thoughtful execution of these priorities, over time, we expect higher earnings growth and improved returns. In the near term, we expect underlying earnings in the US businesses to be relatively consistent with current levels as underlying business growth and retirement, group insurance and Assurance IQ offset the impact from low interest rates and the net outflows in our individual annuities business as we maintain pricing discipline. We have included a slide in the appendix that provides our expected underlying earnings outlook by business. Now turning to slide six.", "PGIM, our asset management business, continues to leverage its diversified multi-manager model, global distribution and affiliated flows to grow in higher value-added strategies that serve investors globally. With a record $1.3 trillion of assets under management as of year-end, PGIM is a top 10 global asset manager. It is the fifth largest investor in fixed income globally and one of the largest in alternative investments with significant real estate and private investment platforms. We continue to broaden and globalize our products and capabilities by developing and launching private and alternative investment strategies and expanding in both retail and international markets. And as the investment engine of Prudential, PGIM benefits from a symbiotic relationship with our U.S. and International Businesses. Our investment performance is a key driver of our business success.", "More than 80% of assets under management have outperformed their benchmarks over the last three-, five- and 10-year periods. This performance helped us to generate $1.9 billion of net third-party flows during the fourth quarter, including $1.2 billion of institutional and $700 million of retail net flows. In addition, PGIM rose to the seventh highest ranking mutual fund franchise based on 2019 net flows, up from 14th in 2018. PGIM's adjusted operating margin of 32% in the fourth quarter was 180 basis points higher than the year-ago quarter and has grown over the last three years as we balanced business reinvestment with margin expansion. For the full year 2019, PGIM had a record level of adjusted operating income that was 4% higher than 2018 and 6% higher after adjusting for business acquisition-related costs.", "Looking ahead, we believe PGIM is well positioned to deliver mid- to high single-digit earnings growth across the cycle driven by its deep asset class expertise while leveraging its scale and reach as a global asset manager. And we expect to grow earnings in 2020 despite the absence of the Wells Fargo fee arrangement that ended last year.", "Turning to slide seven. Our International Businesses continue to benefit from our world-class Japanese life insurance operation, where we have a differentiated business model with unique distribution as well as from our focus on other operations in high-growth markets. Life Planner sales increased by 17% compared to the year-ago quarter. This increase was driven by record Life Planner count and higher sales in Brazil, Korea and Taiwan. Sales for Gibraltar were 14% lower than the year-ago quarter.", "This primarily reflects lower single-pay U.S. dollar fixed annuity sales in our life consultant and independent agency channels as the recent decline in U.S. interest rates led us to lower crediting rates. In addition, we continue to focus on quality distribution. The number of life planners as a result has declined. The lower Life Consultant sales were partially offset by higher bank channel sales. We continue to innovate new products and implement pricing actions to maintain both sales and our targeted level of profitability. Total in force for international increased by 3% from the prior year, including a 5% increase in Life Planner and a 1% increase in Gibraltar. In the near term, we expect total in force to grow at a similar level. We expect underlying earnings to be relatively consistent with current levels as business growth will offset the impact of low interest rates.", "And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on slide eight, which provides insight into the earnings for first quarter 2020 relative to our fourth quarter 2019 results. We begin with pre-tax adjusted operating income in the fourth quarter, which was $1.2 billion and resulted in earnings per share of $2.33 on an after-tax basis, then we adjust for the following items. First, in the fourth quarter, we had favorable variable investment income driven by equity market performance and prepayment income, which was a benefit of $135 million. Second, the first quarter is expected to have lower seasonal expenses and implementation costs, which will result in a net benefit of $435 million or $0.85 per share and is comprised of two items. The fourth quarter included $160 million of seasonally higher expenses and $365 million of implementation costs, including the impact from the voluntary separation program.", "As indicated in the 8-K filing on December 17, we expect implementation costs of $175 million in 2020, with about $20 million of these costs in the first quarter. And long term compensation expense for retiree eligible employees is recognized when awards are granted, which is typically in the first quarter of each year. In the first quarter of 2020, we expect this expanse to be about $70 million split between PGIM and corporate and another. These items net to $0.85 per share. Third, there are other considerations that we -- we expect will have a $20 million more favorable impact in the first quarter relative to our -- to the fourth quarter. And fourth, we anticipate net investment income will be reduced by $10 million, assuming reinvestment rates are held flat with the fourth quarter. Combined, this gets us to a baseline of $2.95 per share for the first quarter of 2020 before including the impact of share repurchases, business growth and market impacts in 2020.", "The baseline also includes items specific to the first quarter that reduces EPS by approximately $0.15 per share. While we have provided these items to consider, there may be other factors that affect earnings per share in the first quarter of 2020. I'd also like to bring your attention to a few additional items that are included in the appendix. On slide 18, we have provided additional information that shows the adjusted operating income roll-forward by business. And on slide 19, we provided updated information regarding seasonal items by business. In addition, we have included some other considerations for 2020 on slide 21, regarding corporate and other net costs, the yen foreign exchange rate and the effective tax rate.", "Now turning to slide nine, I'll provide an update on capital deployment, liquidity and leverage. We feel very good about the overall strength of our capital position.", "We returned $900 million to shareholders during the fourth quarter through dividends and share repurchases, which were largely funded by the cash flows generated by our businesses. On December 19, we announced the Board's authorization to repurchase up to $2 billion of common stock in 2020. In addition, we increased the first quarter dividend to $1.10 per share, which represents a 10% increase from our dividend in the fourth quarter of 2019 and a 4.4% yield on our adjusted book value. We also continue to maintain a rock-solid balance sheet.", "Our regulatory capital ratios continue to be above our AA financial strength targets, and our financial leverage ratio remains better than our target. Our cash and liquid assets at the parent company were $4.1 billion at the end of the quarter and at the midpoint of our $3 billion to $5 billion liquidity target range. We will continue to invest in the growth of our businesses, assess acquisition opportunities to build scale or gain capabilities and return capital to shareholders. Turning to slide 10, and in summary, we had numerous accomplishments in 2019. We are focused on executing our key initiatives in 2020, leading to greater earnings in 2021.", "Now, I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator Instructions] Your first question comes from the line of Nigel Dally from Morgan Stanley. Please go ahead." ] }, { "name": "Nigel Dally", "speech": [ "Great. Thanks. And good morning. I had a question on annuities. It's one of the areas that you do expect a decline in earnings in 2020. So I just wanted to check, is that said just because of a modest decline in AUM, because of the anticipated outflows overwhelming market appreciation? Or is there also an underlying element of some deterioration in the return on assets? And if is the latter, what's driving that?" ] }, { "name": "Andy Sullivan", "speech": [ "So Nigel, thanks for your question. This is Andy. There's really two major impacts that we're seeing in the annuities business. One, as you pointed out, is the outflow. That really is coming from -- we are being very disciplined in our pricing of product and in our return on new sales. And if you look backward, we had some pretty sizable blocks back in the 2010 to 2012 range. So that's creating that outflow. And the other thing I would point to, though, is as that business is rolling across its surrender period, we are seeing business go to lower fee tiers and getting fee pressure from that effect." ] }, { "name": "Ken Tanji", "speech": [ "Yes. Nigel, this is Ken. I'd just add -- I know there's been some questions about the ROA. Our primary objective with the profitability of our annuity business is to achieve a high ROE, and our variable annuity business is very profitable, and that is evident by the higher ROE that's in the high teens. And that high ROE reflects our unique product design, our robust risk management and disciplined pricing. And our hedging program is highly effective and it results in very stable earnings, capital and cash flow even with significant market moves. So as a result, our earnings, capital and cash flow will be less sensitive to markets than the account values. And the ROA may move as market moves, but again, our earnings, capital and cash flow will be stable and ROA is simply an outcome. So the decline in rates and the increase in the equity markets, while it had an increase in account values, had a less meaningful impact on our earnings, again, due to our robust risk management." ] }, { "name": "Nigel Dally", "speech": [ "Okay. Got it. Second question was just on dividends. Good to see the incremental dividends again this quarter. I think that brings your payout ratio to around 35%. Is there a limit to how high you'd like to go? Or is there incremental upside there?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Sure. So maybe just a little bit of reflection of our capital management and shareholder distribution philosophy that's been very consistent over time, and it starts with our free cash flow, which is about 65% of after-tax earnings. This year, a little bit better than that. And this should -- we then distribute in both the forms of dividends and share repurchases. Our dividends have increased actually 12 years in a row now. And if you looked at the average increase over the last five years, it's been 11%. And now that dividend represents, as I mentioned in my opening comments, a 4.4% yield on book value. Our Board has also authorized $2 billion of share repurchases for 2020. So generally, a very consistent approach to our shareholder distributions, which balances both dividends and returns of excess capital through share repurchases." ] }, { "name": "Nigel Dally", "speech": [ "Very helpful. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Andrew Kligerman from Credit Suisse. Please go ahead." ] }, { "name": "Andrew Kligerman", "speech": [ "Hey, good morning. So maybe a question on interest rates. On last quarter's call, you increased your guided interest rate sensitivity to $0.30 of EPS impact for a 50 basis point drop in rates. And now we've seen in 2020 -- well, maybe not today, but I was estimating 30 basis points so far in 2020. So I just want to make sure there are no changes. Should we expect a $0.15 to $0.20 negative impact on 2020 EPS based on that? Or are there some other factors at work? And with that, maybe you could tell us what your new money yields are too on the portfolio." ] }, { "name": "Ken Tanji", "speech": [ "Yes. Sure. So the sensitivity that we gave to interest rates of 50 basis points at $0.30, that's still good. So that rough rule of thumb and how you applied it, I think that still is appropriate. Our new money yields in the second half of the year were about 3.65%, and you can think of that relative to our -- and that's in the U.S. relative to our U.S. portfolio yield of about 4.2%." ] }, { "name": "Andrew Kligerman", "speech": [ "Okay. Thank you. And then just shifting over to the Individual Life segment and kind of thinking back, second quarter, you had that $200-plus million charge. Third quarter, there was about $30 million of underwriting income below expectations. And in 4Q, it was about $15 million now below expectations. So I'm wondering if -- as we look forward, are you comfortable with underwriting assumptions into the year? And your sales were really robust at $209 million. You cited it as a record since 2013. So what are you selling that you're excited about?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. So Andrew, it's Andy. Thanks for your question. So we would consider our actual to expected in the fourth quarter as in line with our expectations. The result was 103%, and I would encourage you to think of there's a quarter around that $100 million plus or minus a couple of percent so that -- we really think that's in line. As far as you referenced the assumption updates, we're seeing that our business performance has been consistent with the updates that we made in the second quarter. Shifting over to the new business sales, we are very, very pleased with the performance of sales in the Individual Life business, as you cited, it's best quarter in five years.", "We're probably even more pleased that versus the absolute level in the mix of sales. The mix has shifted pretty meaningfully away from Guaranteed Universal Life, which obviously is highly interest rate sensitive and over to where almost half of the sales are variable life, which has much, much less sensitivity to interest rates. So pleased with what we're seeing. The success is really coming from we have a very, very strong brand name. We believe our product portfolio is very strong and our distribution system is top-notch." ] }, { "name": "Andrew Kligerman", "speech": [ "In term life, is that the balance of the sales largely?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Awesome. Thanks so much." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Tom Gallagher from Evercore ISI. Please go ahead." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. Just a first question on the assurance IQ deal in terms of how are you thinking about the results so far. It looks to me based on the disclosure that the revenues are coming in below what was projected initially. I think it was $500 million, was the 2019 guide and looks closer to maybe $300 million on a full year basis. I guess first question is that right? And secondly, does that cause you to rethink revenue and earnings projections, 2020, 2021?" ] }, { "name": "Andy Sullivan", "speech": [ "So maybe -- Tom, this is Andy. I'll start, and then I'll hand it off to Ken. So as you'd imagine, these are early days. We just closed the acquisition in October, but I'll tell you, there's a lot of things that we're excited about. We're, as we sit here today, even more excited about the strategic growth potential of this business. In fourth quarter, we saw very, very strong consumer demand flow across the platform. We saw 6.5 million shoppers. And just to define that for you, we define a shopper as an individual that has an absolute intention to buy a financial service product and that's willing to share their contact information with us. So we saw 6.5 million shoppers across the platform in 4Q. That's compared against $3.5 million in the year-ago quarter. So we're very pleased with the level of consumer flow and consumer demand.", "A very positive for us on that is we have product providers, literally lining up of every shape and size that want to go ahead and get on the platform. So from a revenue potential perspective, we're every bit as strong as we were. We are in -- kind of where we're focused right now is getting those additional products on to the platform. As far as your numbers around revenue, yes, our revenue for the year came in just north of $300 million. And really, what I would tell you there is we had a lot more consumer demand than we had appointed agents, we'll call it, capacity on the platform. We learned some lessons in the quarter around the effort and energy and time line it takes to get the Medicare Advantage and under 65 healthcare agents onto the platform. I will tell you that we're already well underway in getting those agents appointed for 4Q of 2020. So it's a completely rectifiable situation and we're well out in front of it." ] }, { "name": "Ken Tanji", "speech": [ "Yes. The only thing I'd add there is, as you had heard from Andy describe, this business is in a very high-growth phase and we were not expecting meaningful earnings in the near term or in 2020 as a result. And so it's early days and we'll report this information to you each quarter. And just as Andy indicated, just a reminder, that is a seasonal business, primarily fourth quarter loaded." ] }, { "name": "Tom Gallagher", "speech": [ "Got it. And Ken, would you say you're sticking to the $700 million revenue projection for 2020 still? Or is that sort of TBD?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Given the high-growth nature of this business, we don't want to get into the practice of updating each and every quarter. So again, we're going to -- you're going to see the results as they occur in a separate segment." ] }, { "name": "Tom Gallagher", "speech": [ "Okay. Thanks. And then just my follow-up is, is PRU planning on early adopting variable annuity reform at year-end 2019? And if not, is the plan to do full implementation in 2020 or a three-year phase-in?" ] }, { "name": "Ken Tanji", "speech": [ "We're going to adopt on the effective date, which is January 1, 2020, but remind you that we made big structural changes that were very much aligned with the new reform many years ago. So we're well positioned, and we expect to be very well capitalized before the reform and after the reform." ] }, { "name": "Tom Gallagher", "speech": [ "Okay. And Ken, no three-year phasing, you'd fully adopt in 2020?" ] }, { "name": "Ken Tanji", "speech": [ "Fully adopt, January 1." ] }, { "name": "Tom Gallagher", "speech": [ "Okay, thanks." ] }, { "name": "Operator", "speech": [ "[Operator Instructions] Next, we'll go to the line of Erik Bass from Autonomous Research. Please go ahead." ] }, { "name": "Erik Bass", "speech": [ "Hi, thank you. Um, So you've clearly taken some big steps to accelerate the timing of realizing the expense savings you've talked about. Can you just help us think about when we'll start to see these in results and where they'll come through, I guess, whether in terms of the business segments or through in corporate?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Sure. In our 8-K that we filed, we gave some information of our belief of the progression of the saves. They were modest in 2019 and we provided an estimate for 2020, that $140 million would be realized in the P&L in the year. Those results, you can expect to build as we go through the year and you can expect to see them emerge with -- primarily in the U.S. Businesses and in corporate but throughout those businesses but, again, because it's a company -- it's a U.S. Business-wide program." ] }, { "name": "Erik Bass", "speech": [ "Got it. And when you're giving sort of your walk-through in the slides of kind of future earnings trajectory, am I right that there's nothing really explicitly contemplated there from savings in the businesses?" ] }, { "name": "Ken Tanji", "speech": [ "Only what was accomplished in the -- through 2019 or the first and the fourth quarter. And then any future improvement, whether it's from business growth or share repurchases or additional expense saves, incremental expense saves would not be included in that baseline. That's all in the future." ] }, { "name": "Erik Bass", "speech": [ "Got it. And then you mentioned in the remarks, potential actions to continue streamlining your business portfolio and realize that it's premature to say much specific. But how would you think of redeploying any proceeds you potentially generate? Would you look to reinvest these in the businesses? Or potentially, would they be available to return to shareholders?" ] }, { "name": "Charles F. Lowrey", "speech": [ "The answer is yes. So what we mean is, we'll cross that bridge when we come to it. But let me take a step back for a moment and make a more general comment on how we think about capital, in particular, the optimization of our capital, which I think we've been doing for years. So we always look across our businesses, both domestically and internationally, to ensure that we're optimizing capital deployment; and when we see attractive opportunities, you've seen us invest in growth and make acquisitions. And you've also seen us scale back or look for divestitures over the years when there are better uses of capital and then put that capital to use either in growing the franchise or, if there aren't opportunities, returning it to shareholders. So we'll continue to look for ways to optimize capital deployment and to maximize outcomes for our shareholders, whether that be in investing in new business opportunities, which, again, you've seen us do or return capital to shareholders." ] }, { "name": "Erik Bass", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Ryan Krueger from KBW. Please go ahead." ] }, { "name": "Ryan Krueger", "speech": [ "Hi, good morning. I guess first, have you completed the year-end cash flow testing analysis? And if so, can you give us any indication of the impact?" ] }, { "name": "Ken Tanji", "speech": [ "The statutory filings will come out at the end of the month, and so yes, that will include our updated cash flow testing or asset adequacy testing. You'll see those results when we report them. What I'd offer you now is, given lower rates, we would expect some strengthening in our AAT reserves or cash flow testing, but we have derivative gains or interest rate hedges that offset that and we expect to have RBC ratios that are above our AA financial strength objectives." ] }, { "name": "Ryan Krueger", "speech": [ "Got it. Thanks. And then when you did the second quarter assumption review and had some impacts to the Individual Life business, at the time, you talked about reinsurance as being a potential option to improve returns in that business. So that’s something that you're still contemplating? And can you give us any update there?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Ryan, this is Andy. So I would broaden your question and say we're taking a number of actions to strengthen the performance of our life business. First and foremost, we are working diligently on expense efficiencies and you can think about that in the context of the broader work going on at the company and the $500 million in outcomes we expect over the next couple of years. We already talked about the sales, which we think is a meaningful -- will be a meaningful contributor to giving earnings lift over time in the business. And then, yes, you are correct. We have been looking at options and we'll continue to look at options from a reinsurance perspective on -- with the block. And what we're looking for there, obviously, is the right partner and the right terms that make economic sense for us. There's nothing currently that we want to report, but we'll keep you posted as we go forward." ] }, { "name": "Ryan Krueger", "speech": [ "All right. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Suneet Kamath from Citi. Please go ahead." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. Just focusing on slide 20 of your deck in the International Businesses, it looks like, at least over the next 12 months, Life Planner and Gibraltar are expected to be flat, which is lower than that intermediate earnings growth guidance you gave at Investor Day of mid-single digits. So just want to get a sense of if we stay in this interest rate environment, what kind of gets us from flat back up to the mid-single digits and sort of over what time frame?" ] }, { "name": "Scott Sleyster", "speech": [ "Hi, Suneet. This is Scott. Let me take that. So as you pointed out, the underlying business fundamentals for our International Businesses actually look quite strong. As Rob pointed out, our in-force block is growing at about 4%, 4% to 5% in LP and about 1% in Gibraltar. Unfortunately, given the low-rate environment, for the most part, we're giving back a lot of the earnings growth associated in the block, and we're continuing to make some portfolio investments on technology and the like. So right now, I would say, over the -- certainly, looking out to this year, we think we're going to be closer to flat. We hope, over time, as we make adjustments, that'll start to build. But I would say, even right now, looking at the intermediate term, we'd say we're looking at low single-digit growth." ] }, { "name": "Suneet Kamath", "speech": [ "Okay. Thanks. And then a follow-up is just on Assurance IQ. I think it was mentioned that there are about 6.5 million shoppers in the fourth quarter. What should we expect to be the conversion rate of the -- of that balance, in other words, of the $6.5 million? How many would you expect to actually buy a product?" ] }, { "name": "Andy Sullivan", "speech": [ "So Suneet, it's Andy. I'll take your question. Conversion rate is a very complex topic. So it very much depends on the product mix that's on the platform. And as we talked about, we are in a phase of rapidly looking out -- looking to roll new products onto the platform. So the conversion rates that we're currently experiencing are going to change quite a bit with that product mix shift as well as, as you can imagine, with the shopper demand we had, but the mismatch with our agent capacity, our conversion was lower than we would expect going forward. At this point, we're not going to put out explicit numbers, but hopefully, that gives you a way to think about it." ] }, { "name": "Suneet Kamath", "speech": [ "And have you put any PRU products on that platform yet? I know that was one of your objectives when you announced the deal." ] }, { "name": "Andy Sullivan", "speech": [ "Yes. So it absolutely is one of our primary objectives. We have been working diligently to get our simply term life product onto the platform. We are ahead of schedule on those plans, and we will get that product on the platform in the second quarter of this year. And we're very encouraged with our brand name and the quality of our products that will give both assurance and, obviously, other Prudential some lift." ] }, { "name": "Suneet Kamath", "speech": [ "Okay, thanks." ] }, { "name": "Operator", "speech": [ "[Operator Instructions] Next, we'll go to the line of John Barnidge from Sandler O'Neill. Please go ahead." ] }, { "name": "John Barnidge", "speech": [ "Thank you. Have you seen any meaningful acceleration in PGIM's U.K. business post election or demand for product from that market in Continental Europe?" ] }, { "name": "Andy Sullivan", "speech": [ "So John, this is Andy. I'll take that question. So what I would tell you is in the short term, with all the flux that's been going on, we haven't seen any meaningful change or lift. I would kind of frame it as, in many ways, the marketplace is a bit hunkered down. So as an example, on the real estate side, we haven't seen a whole lot of capital fundraising and deployment. We are absolutely ready no matter how that plays out. We have licenses in all the right places and people in all the right places to continue not only serving our current clients but to capitalize on potential opportunities if and when the dust settles." ] }, { "name": "John Barnidge", "speech": [ "Okay. And then my follow-up. As we look back to SARS over 15 years ago in light of the coronavirus, do you see any increased demand for your products on the benefits side to note?" ] }, { "name": "Scott Sleyster", "speech": [ "This is Scott, again. On the specific question, I would say, history would show that any time there's a widespread illness, it creates a greater sensitivity among the customer base about the kinds of products that we sell. In particular, as you know, on the international side especially, we're very focused on death protection products. And so anytime you have something like this that goes on, you're very concerned about your employees and your customers and you're taking lots of actions there, but I do think there is a follow-on effect of greater sensitivity to the products that we offer." ] }, { "name": "John Barnidge", "speech": [ "Great, thank you." ] }, { "name": "Operator", "speech": [ "Your next question comes from the line of Humphrey Lee from Dowling & Partners. Please go ahead." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning, and thank you for taking my questions. A question related to PGIM. So looking at your retail flows, it looks very strong from an inflows perspective. I think it may be even a record number, but then at the same time, it seems like you have record withdrawals as well. I was just wondering if you can provide some color in terms of where you see the inflows and what happened in the outflows and how do you think about it in 2020." ] }, { "name": "Andy Sullivan", "speech": [ "So yes. This is Andy, Humphrey. So we are very pleased and proud of the retail flows that we saw. As I think Rob mentioned in his opening, we moved up to number seven in the quarter. The retail flows are really coming from an expansion of our product portfolio on that platform as well as the work that we've done around usage. From an outflow perspective, what I'd say is that will tend to be episodic, and I think over the long term, we feel very, very good that due to our investment performance and our range of strategies, that we will see a continued upward trend over time." ] }, { "name": "Charles F. Lowrey", "speech": [ "And Humphrey, I would just add on the institutional side, that those flows can be a little bit lumpy. And we saw a couple of clients who want to consolidate this year. And sometimes, we're the beneficiary of consolidation. Sometimes we're not and a couple of dominoes tilted against us this year, but that doesn't affect how we think about our institutional capability or the quality of flows that we can have going forward." ] }, { "name": "Humphrey Lee", "speech": [ "That makes sense. And then just a clarification of regarding Assurance IQ. So I think Ken was talking about the -- given the growth that you're expecting and then you're not necessarily expecting any earnings from Assurance IQ in 2020. I just want to make sure that I heard that correctly because I think originally, at the time of the announcement, you were expecting maybe a $0.10 EPS accretion for 2020. So I just wanted to kind of bridge the differences." ] }, { "name": "Ken Tanji", "speech": [ "Yes. No, I didn't mean to say no earnings. I said not meaningful earnings, again, because of the high-growth nature of the phase that they're going through." ] }, { "name": "Humphrey Lee", "speech": [ "So the $0.10 still kind of -- I understand you're not going to update guidance or anything like that, but is $0.10 still a reasonable expectation?" ] }, { "name": "Ken Tanji", "speech": [ "Again, we don't want to get in the practice of having to update this every quarter." ] }, { "name": "Humphrey Lee", "speech": [ "Okay. All right. Thank you." ] }, { "name": "Operator", "speech": [ "And I'd now like to turn the call back to Charlie Lowrey for any closing comments." ] }, { "name": "Charles F. Lowrey", "speech": [ "Okay. Thank you very much. So in closing, I hope you all walk away from this call with a clear picture of our progress and priorities, our continued sense of conviction and urgency and our path forward to deliver meaningful outcomes for all of our stakeholders, including investors. So thanks again for joining us today, and have a nice day." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
PRU	2020-05-06	[ { "description": "Head of Investor Relations, Senior Vice President", "name": "Darin Arita", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charles F. Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Robert M. Falzon", "position": "Other" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Executive Vice President and Head of U.S. Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Nigel Dally", "position": "Analyst" }, { "description": "Dowling & Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Piper Sander -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "[Abrupt Start] Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the conference over to your host, Mr. Darin Arita. Please go ahead." ] }, { "name": "Darin Arita", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, Chairman and CEO; Rob Falzon, Vice Chairman; Andy Sullivan, Head of U.S. Businesses; Scott Sleyster, Head of International Businesses; Ken Tanji, Chief Financial Officer; and Rob Axel, Controller and Principal Accounting Officer. We will start with prepared remarks by Charlie, Rob and Ken, and then we will take your questions. Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled forward-looking statements and non-GAAP measures in the appendix to today's presentation, which can be found on our website at investor.prudential.com. Also, due to circumstances created by the COVID-19 pandemic, we have decided to cancel our Tokyo Investor Day that was scheduled for September.", "With that, I'll hand it over to Charlie." ] }, { "name": "Charles F. Lowrey", "speech": [ "Thank you, Darin. Good morning, everyone, and thank you for joining us today. I would like to start this morning by recognizing the extraordinary circumstances created by the COVID-19 pandemic and by expressing our gratitude to all of those on the front lines who are fighting this crisis around the world. For those individuals and their families directly affected by the pandemic and particularly, those who have lost loved ones, we extend our deepest sympathies. At Prudential, we're guided by our purpose: to make lives better by solving the financial challenges of our changing world. And that includes being there for our employees, our customers and our communities, especially in times like these. We are completely focused on ensuring that we take the right course of action for the business, mitigating the impact of COVID-19 while investing for the future in order to emerge from this crisis stronger than before. The strength of our balance sheet enables us to manage our business for the long-term growth while dealing with short-term business realities.", "Before we get into the first quarter performance, I'll cover some of the key steps we have taken as a company to support our employees, customers and communities in response to COVID-19. First, turning to slide three. Ensuring the health and well-being of our employees and their families is our top priority. As the pandemic emerged, we initiated new policies and actions to ensure their safety and security, including additional family care support. This included implementing a wide-scale remote work environment, with approximately 98% of our employees and most of our international employees now working remotely. I'm pleased to report that all our businesses and operational functions continue to run smoothly. Prioritizing the well-being of our employees enables us to address the evolving health and financial needs of our customers as the pandemic and its economic impact reverberate more broadly. We've also provided customers with assistance, such as premium deferrals and fee waivers as well as enhanced digital tools. I'm also incredibly proud of the work our employees have done to support our local communities, including in Newark, El Paso, Hartford and multiple international locations. These efforts include the donation of more than 150,000 face masks, including 75,095 respirators for healthcare workers in New Jersey.", "In addition, the American Nurses Association and Prudential recently entered into an agreement for Prudential to sponsor ANA event and outreach initiatives in 2020. This agreement will include offering Prudential's financial wellness services and solutions to ANA members and the broader nursing community. We're pleased to be of assistance to those serving on the front lines of this pandemic. Turning to our financial strength. On slide four, our rock-solid balance sheet provides the foundation for our employees to serve our customers and our communities. We're confident in our ability to successfully manage in this environment in large part due to the robust operational and financial risk framework that we put into place after the Great recession of 2008. This framework prepared us with a playbook to address multiple stress scenarios, including pandemics and economic conditions that are more severe than what we are currently experiencing.", "In addition, we benefit from our recurring revenue model and mix of complementary businesses, which offset risk and produce capital benefits, giving us confidence about Prudential's to navigate the current environment. We began 2020 with a strong capital and liquidity position, and our capital ended the quarter exceeding AA financial strength levels. As the pandemic unfolded and in light of uncertainty in the global markets, we executed our playbook. We successfully issued $1.5 billion of senior debt in early March, while spreads were still attractive. This included a $500 million green bond issuance, the first of its kind for a U.S. company in our sector. These actions prefunded our opportunities through the end of 2021 and enhance the liquidity of our businesses. As part of the playbook, we further enhanced liquidity of our businesses and also paused share repurchases at the end of the first quarter to see how the economic environment develops. During the quarter, our variable annuity hedging performed extremely well with a 99% effective rate. Our approach to hedging the economic risk resulted in significant gains on our equity market and interest rate hedges to offset the increased liability.", "We feel comfortable about our ability to manage equity market fluctuations and continued low interest rates over time. We're also highly confident about the quality of our investment portfolio, which Rob will cover in more detail shortly. The strength of our financial position means our dividends to shareholders remain well covered by our income and free cash flow. Turning to slide five. We are on track to accomplish our strategic initiatives for the year and, in fact, are accelerating their execution in some cases. First, we are repricing our products more quickly and pivoting toward lower risk and less capital-intensive products. Second, with respect to rotating our international earnings mix to higher-growth markets, in April, we reached an agreement to sell our Prudential of Korea business. We also continue to pursue strategic alternatives for our Taiwan business. Finally, we continue to make progress on achieving our goal of $500 million in cost savings, $140 million of which should be achieved this year. We realized $30 million in the first quarter through actions we completed before the start of 2020. Turning to slide six. Well it seems like a life time ago.", "I'd like to spend a moment on our first quarter performance. We reported pre-tax adjusted operating income of $1.2 billion or $2.32 per share. The GAAP net loss was $0.70 per share, driven largely by noneconomic factors. Our U.S. and International Business earned lower variable investment income in the quarter. We also generated lower underwriting income in our U.S. businesses. Higher asset management fees at PGIM were offset by lower other related revenues. While the severity and duration of the pandemic and related economic impact remains unknown, we are confident about the strength of our company. Prudential has survived pandemics, wars, recessions and depression, among other events in its 145-year history. We are resilient, we are strong and we will continue to move forward to deliver sustainable value for all our stakeholders.", "With that, I'll turn it over to Rob for a detailed look at our business performance for the quarter." ] }, { "name": "Robert M. Falzon", "speech": [ "Thank you, Charlie. As Charlie indicated, the results from our businesses in the first quarter were negatively impacted by two significant factors that we had not anticipated: adverse mortality and the impact of the pandemic, particularly on equity markets, interest rates and credit spreads. Adverse market conditions resulted in $150 million of lower variable investment income in our U.S. and International Businesses and also reduced other related revenues in PGIM by $55 million, and the Chilean and Kihei earnings in our International Business by $30 million. Overall mortality was $60 million above our seasonal expectation. We are continuing to work toward improving the profitability of our Individual Life business. We have strong life insurance marketing and distribution capabilities, which we've expanded with the acquisition of Assurance IQ. In aggregate, these factors reduced first quarter's adjusted operating income by about $295 or $0.58 a share. Lower interest rates and equity markets also challenged fundamentals across our businesses, and we are actively executing pricing and product actions to shift our business mix to less market-sensitive customer solutions.", "With that in mind, I'll turn now to providing more color on how we are executing on our strategy within our U.S., PGIM and International Businesses as well as on the outlook for these businesses considering current market conditions. I will also provide an overview of our investment portfolio, given the increased focus on the risks associated with the potential near-term credit cycle. Turning to slide seven. Our U.S. Businesses consist of the workplace solutions, individual solutions and Assurance IQ divisions that produce a diversified source of earnings from fees, investment spread and underwriting income. Our U.S. Businesses continue to execute on three key priorities: first and foremost, the financial strength of these businesses, which continues to be solid despite the impacts of COVID-19 and the broader economic conditions. Continue to take product actions, including steps to diversify our mix of business and maintain profitability. Second, as the needs of our customers rapidly evolve, including in response to COVID-19 and its economic impact, we are leveraging our ongoing technology transformation and digital capabilities to enhance customer engagement. For example, within a matter of days in March, we introduced our fast track automated underwriting process for COVID-19-related claims with expanded e-capabilities for proof of death.", "In just a weekend, we introduced new mobile apps and chat bots to help manage a surge in customer calls and inquiries. And we have expanded the use of electronic signatures across our businesses. We will continue to invest in transforming our capabilities by accelerating use of technology to deliver a better customer experience and enhance the speed at which we operate. And third, we remain committed to expanding our addressable market. The pandemic has amplified the financial wellness challenges that many U.S. households face. To support our clients in these challenging times, we continued to invest in and expand our range of capabilities to meet their needs. For example, we completely transformed our flagship financial wellness offering Pathways from an on-site to a virtual offering. In a matter of just weeks, we scheduled over 150 live web-based financial education seminars for our clients and we introduced a new solution to help customers manage debt and partnership with GreenPath. We're also shifting our focus to serving expanded addressable market with lower risk and less market-sensitive solutions, to address the changing market conditions. For example, in our Individual Annuities business we're pivoting to less interest rate sensitive products, including accelerating to May of this year, the launch of our FlexGuard indexed annuity.", "In our Individual Life business we're also making product and pricing changes that will result in the continued pivot to variable life and other less interest rate-sensitive products. As a result of pricing actions, product pivots and the disruptions to distribution from COVID-19, we expect sales to continue to decline for individual annuities in the near term, and we also expect reduced sales for Individual Life. In our Retirement business, while the longevity reinsurance market remains active, we expect that current market conditions will impact the funding levels of pension plans and, therefore, result in lower pension risk transfer transactions. Now turning to slide eight. PGIM is a top 10 global investment manager with $1.3 trillion of assets under management and continues to leverage its diversified multi-manager model to serve investors. Our robust infrastructure and investments in technology have allowed employees to seamlessly transition to working from home. This operational flexibility has allowed us to support clients with portfolio information and insights and address their questions, even as we work in a virtual environment. While significant market fluctuations in the month of March affected our three-year performance, PGIM's long-term track record remains strong. 79% of assets under management have outperformed their benchmarks over the last five years and 94% over the last 10 years, and we have seen some recovery of performance and our short-term track record in April.", "Despite clients temporarily rebalancing into cash, we generated $2.9 billion of net third-party flows during the first quarter. This reflects the resiliency of PGIM's diversified platform across asset classes, regions and client segments. Net flows included $4.2 billion of institutional inflows, partially offset by $1.3 billion of retail outflows. Public fixed income experienced both retail and institutional inflows. And of note, PGIM was the highest ranking U.S. mutual fund franchise across active and passive asset managers based on net sales in the quarter. PGIM's asset management fees were up 8% compared to the year ago quarter, driven by growth in average assets under management and a stable fee rate. Other related revenues declined primarily due to the effect of mark-to-market losses from credit spread widening in the first quarter. We expect near-term sales across the industry to be impacted by volatile public market conditions, reduced transaction volume in private asset classes and a slowdown in client activity. Despite this, we expect PGIM to emerge well positioned vis-a-vis our competitors, driven by its diversified global platform.", "Turning to slide nine. Our International Businesses include our Japanese Life Insurance operation, where we have a differentiated multichannel distribution model as well as other operations focused on high-growth markets. Life Planner sales decreased 5% compared to the year ago quarter, driven by lower corporate product sales, following the Japan tax law change, partially offset by replacement U.S. dollar protection products. Life Planner headcount, however, reached a record level, increasing 5% compared to a year ago. Sales for Gibraltar were also 5% lower, primarily reflecting the continued trend of lower single-pay U.S. dollar fixed annuity sales in our life consultant and independent agency channels. In addition, as we continue to focus on quality distribution, the number of life consultants has declined. In Chile, we are the leading pension provider via our joint venture with Habitat. We earn fees on assets and realized mark-to-market gains or losses on the capital that we are required to invest in the funds. Our investment performance has outperformed over time as well as in the fourth quarter in the first quarter. Returns in the quarter, however, were down across the industry, and that contributed to approximately $30 million of lower-than-expected operating income.", "As we look to the second quarter, we expect international sales to decrease significantly, reflecting the effect of social distancing protocols that limit in-person engagement with customers across our distribution channels. This will also affect recruiting of new life planners and life consultants. We're actively taking measures, including appropriate sales support to protect and care for our captive distribution during this difficult time. Over the longer term, we believe COVID-19 may result in heightened interest in protection products. Particularly the death protection products throughout the core of our needs-based selling approach. With respect to the current interest rate environment, we have successfully managed through decades of low interest rates and other market challenges in Japan. As you've seen in the past, we adjust to meet the needs and preferences of our customers, while also achieving our return on expectations. We have already taken actions and will continue to do so as needed, as we move forward. Also, as Charlie stated, in April, we announced that we have entered into a definitive agreement to sell Prudential of Korea.", "This business represented less than 10% of International Business sales. Now turning to our investment portfolio on slide 10. We have a conservative, quality focused approach to our investment portfolio of construction and management, reflects our robust asset liability management practices, commitment to broad diversification and a disciplined interest rate risk management framework. We also leverage PGIM's expertise across multiple asset classes, including its deep and long-standing experience in private placements and real estate. Back to our investment portfolio, here are a few key points. We have a high allocation to government securities, which is primarily comprised of U.S. treasuries and Japanese government bonds. About half of our BBB and below rated corporate securities are private placements, with financial covenants and structural protections that have consistently resulted in lower losses than comparable public securities. In past cycles, the loss experience of our BBB private placements has been comparable to single A public credits or about half the losses of similarly rated BBB public credits.", "Our commercial mortgage loans are well protected with a loan-to-value on the entire portfolio of 56% and debt service coverages in excess of 2.4 times. We are overweight in more defensive sectors, such as industrial and multifamily and underweight in both office and retail. We also have a low exposure in our investment portfolio to currently more vulnerable sectors like energy, retail and other at-risk corporates. Quality of our portfolio is demonstrated by its performance during the financial crisis in 2008 and 2009, where our credit loss experience compared favorably to peers. Since then, we have decreased our exposure to structured securities and BBB corporates and increased our holdings of government bonds and single A and above rated corporates. From 2008 through the first quarter of 2020, our annual fixed maturity credit losses averaged just 13 basis points of our portfolio. slide 23 in the appendix provides more details on our investment portfolio to exposures currently in focus. While we expect credit losses to emerge, the main takeaway is that we feel comfortable that our exposure is quite manageable and that we are well capitalized to absorb such losses.", "Turning to slide 11. To help you assess potential credit losses on our investment portfolio over a three- year recession cycle, we provide a framework using publicly available rating agency and other third-party data for the underlying assumptions. This framework provides potential impairments, defaults and ratings migration. The output suggests impact to PICA's RBC ratio and the solvency margin ratios in Japan would be very manageable and consistent with our expectations. Credit losses on an after-tax basis would total approximately $2.4 billion over a three-year period. To put that into perspective, that will be less than one-year of our free cash flow. Also, if we used experiences from the prior recession in 2008 as the underlying assumptions for this framework, the after-tax credit losses will be much smaller at about $1.6 billion.", "And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I will begin on slide 12, which provides insight into earnings for the second quarter of 2020 relative to our first quarter results. We began with pre-tax adjusted operating income in the first quarter, which was $1.2 billion and resulted in earnings per share of $2.32 on an after-tax basis. Then we adjust for the following items: first, we expect variable investment income in the second quarter to be $150 million lower than in the first quarter. This is primarily driven by lower returns from private equity investments resulting from the decline in values in the first quarter, reported on a one quarter lag in the second quarter. Second next, in the second quarter, we will have lower seasonal expenses, partially offset by higher implementation costs, which will result in a net benefit of $50 million. Third, there are other items that combined may be $45 million more favorable in the second quarter relative to the first quarter. This includes the normalization of PGIM's other related revenues in our Chilean joint venture income, which were lower in the first quarter due to the mark-to-market of assets for equity markets and credit spreads.", "This normalization is partially offset by classifying our Prudential of Korea business as a divested business. Fourth, we expect fees to be lower on a run rate basis in the second quarter. This reflects account values starting in the second quarter at a lower point than the average level in the first quarter. Next, we included a placeholder for Prudential potential COVID-19-related claims and expenses totaling $250 million. I will provide additional details of these items on the next slide. And last, we anticipate net investment income will be reduced by $15 million, reflecting the difference between new money rates and disposition yields on our investment portfolio. These items combined get us to a baseline of $792 million of operating earnings and $1.53 per share for the second quarter. Please note that this baseline includes items specific to the second quarter that reduce EPS by approximately $1.22 per share. While we have provided these items to consider, there may be other factors that affect earnings per share in the second quarter of 2020. Given the extraordinary circumstances created by COVID-19, on slide 13, we provide estimates for the potential operating earnings impact directly associated with the pandemic in 2020.", "As part of our risk management process, we model many potential stress scenarios, including a pandemic scenario. We have substantial reserves and highly liquid assets to ensure we are well positioned to readily satisfy all policyholder claims and continue to be well capitalized. We also benefit from the diversification of our businesses, and specifically, the complementary nature of our retirement longevity business and our mortality businesses. Although the extent and duration of the COVID-19 pandemic remains uncertain, we thought it would be helpful to provide estimates for the potential impact on net mortality and costs in 2020. The estimate for the impact on net mortality assumes 100,000 deaths across the total U.S. population and 40,000 deaths across the total population in Japan. After considering the profile of our insured policyholders, we estimate the impact on earnings from net mortality may be approximately $200 million in 2020. Also, assuming the spread of COVID-19 is substantially contained in the second quarter, we estimate approximately $135 million of earnings impact may occur in the second quarter with possibly lower impact in the second half of the year. Also, as we continue to support our employees and families during this difficult time, we expect to incur additional costs, primarily related to sales support, employee health protection, technology and other expenses.", "In 2020, we estimate these costs will be approximately $230 million with $115 million of these costs in the second quarter. Turning to slide 14. We continue to maintain a robust capital position and adequate sources of funding. Our capital position exceeds our AA financial strength targets. And we maintain liquid assets at the parent company that are greater than three times annual fixed charges. Our financial leverage ratio is at our target and our regulatory capital levels at our insurance companies remain higher than the targets. In addition, we have substantial sources of funding. Our cash and liquid assets at the parent company were $5.3 billion at the end of the quarter. As previously highlighted, we expect to receive net proceeds from of approximately $1.7 billion from the sale of Prudential of Korea business. Following the close of the transaction, which is expected in the second half of 2020. And another source of funding is free cash flow from our businesses, which represents approximately 65% of earnings over time.", "In addition, we have readily available off-balance sheet resources. This includes a $4 billion credit facility with 23 banks and a syndicate structure across the U.S., Europe and Asia. We also have access to $1.5 billion of funding from a contingent capital facility with the right to issue debt in exchange for U.S. treasury securities held by a trust. And we have a bank Japan Bank facility with JPY100 billion available to Prudential Holdings of Japan. Turning to slide 15 and in summary. We are committed to fulfilling our purpose, to make lives better by solving the financial challenges of our changing world. We maintain a rock-solid balance sheet with robust capital and liquidity position. And we remain on track with our objectives for the year as we accelerate the execution of our initiatives.", "Now I'll turn it over to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator Instructions] And it looks like our first question comes from the line of Erik Bass of Autonomous Research. Your line is open." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. Yes. First, can you provide a bit more color on how you're coming up with your estimated COVID impacts? And how you're thinking about the interplay between mortality and longevity exposures? And then also just to clarify on the expenses, is that just related to COVID? Or is that a net impact factoring and other things, such as lower T&E expense?" ] }, { "name": "Ken Tanji", "speech": [ "Yes, hi, Eric, it's Ken. I'll take your questions. On the COVID estimates. First, I want like to recognize that these are placeholders. These are based on an estimate of 100,000 tests in the U.S., and 40,000 deaths in Japan. Now what we have to see how things play out. And there's likely a range of outcomes around that for the U.S. and Japan. So I just want to recognize that we've done our best to give a placeholder, but it's predicated on a number of assumptions. What we do then is, we then make considerations for lower fatality rates for the insured population versus the general population. We certainly have take into consideration higher fatality rates for the older population. And then we took into consideration the geography of our insured population with that tend to have a little bit higher concentration in New Jersey and New York, California and Washington. So when we put that all together, we've applied those to our average profile and provided those estimates. And again, we'll likely have a good range around some of those assumptions. In terms of our retirement business, it does provide an offset to some of our life insurance as we've expected and designed.", "It offsets about 30% of our exposure, and that's just kind of how the modeling plays out. And then your second question was around the expenses. We've looked at the steps that we need to take in order to care for our employees, for crisis Care as well as compensation for sales professionals, particularly, in our international locations, if our sales were to decline. And we've estimated, that is the appropriate thing to do, given the situation. We will we haven't included in that estimate, potential offsets for the fact that travel and conferences and entertainment will be lower. We would expect if things return at some point to normal that some of that might come back, perhaps, you know they sort of rebound. But I would estimate if we're going to have savings here in the next quarter or so that you can think of that in the tens of millions. But that's not included in the estimate." ] }, { "name": "Operator", "speech": [ "[Operator Instructions] Next, we have the line of Suneet Kamath of Citi. Your line is open." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. I wanted to go to long-term care. Earlier this week, one of your competitors announced a regulatory review of long-term care reserves resulted in a pretty sizable increase to stat reserves. So just curious, if any of your regulators are contemplating or conducting similar reviews and maybe over what time frame would we expect any resolution, if there are such reviews in place?" ] }, { "name": "Ken Tanji", "speech": [ "This is Ken, Suneet. Just an ordinary course, we review our reserves with our regulators. And they have not indicated any concern about our level of reserves related to long-term care, and there's no special review under way." ] }, { "name": "Operator", "speech": [ "Next in queue, we have the line of Tom Gallagher of Evercore ISI. Your line is open." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. The $2 billion of debt that PRU issued in 1Q is, I think, being counted as operating debt. So just curious, what why that's counted as operating debt, I think, which is excluded from the leverage calculation? And what your plan is with those proceeds? And then, let's see, the other question I had is, just on the GAAP breakage you had, on the variable annuity side this quarter, was there also a similar statutory level of breakage? I realize it's uneconomic based on the accounting differences between the assets and the liabilities. But just curious, if you had a similar impact on statutory?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Hey, Tom, it's -- I'll take those. On the $2 billion of debt included the $1.5 billion that we issued at the holdco. You can think of that as, we would ordinarily have issued, say, $500 million earlier in the year and $500 million toward the end of the year. But we decided to do $1.5 billion in March, we were worried about how the conditions were developing and thought it would be prudent to do $1.5 billion, which essentially will take care of any maturities in 2020 and 2021. So it's about $1 billion more than we would ordinarily have done perhaps, but we thought it was an appropriate thing to do. In terms of why we call it operating debt, right now, those proceeds sit at the holding company in cash. And we follow sort of the way that our rating agencies think about classifications of debt. So and the planned proceeds, again, we have it available at the holding company.", "And it would it's used it's available for paying off the debt again for this year and next year. In terms of the non-AOI item for the quarter, our variable annuity business is very well hedged. And we like to align our outcomes for GAAP and stat in economics. And as Charlie mentioned in his comments, it was highly effective at 99%.The way we hedge interest risk, again, which was highly effective in the quarter, is with both derivatives that are mark-to-market and recorded in the P&L, but also by holding a 30-year U.S. treasuries, which had a $1.7 billion gain and would have offset the non-AOI item in the quarter. But the gain on the U.S. Treasuries is recorded to OCI and not to the income statement. So economically, and from a stat standpoint, we were very well aligned, just with a little bit of difference between where our gain is recorded for GAAP." ] }, { "name": "Operator", "speech": [ "Next we have the line of Ryan Krueger of KBW. Your line is open." ] }, { "name": "Ryan Krueger", "speech": [ "Hi. Thanks. Good morning. Can you help us think about, I guess, interest rate sensitivity within the balance sheet, both GAAP and stat? I think previously, you provided the sensitivity for 10-year rates in the 2% to 2.5% range. But given where they are today, was hoping for some additional sensitivity." ] }, { "name": "Ken Tanji", "speech": [ "Sure. Yes. Maybe I'll start with stat, Ryan. And the we have had sensitivity to our stat financials, primarily around asset adequate testing. Last year, given the decline in rates, we increased our asset adequacy testing reserve by about $500 million. Now we had derivatives that offset that. So we were with a gain. So we were had a stable RBC outcome. But it's also important to know that sort of at this level of very low interest rates, that the way the testing works is the when rates are so low, the shock is much lower. So we'll have less sensitivity to lower rates from this point forward. From a GAAP standpoint, our sensitivity really hasn't changed. And as you know, we have a process I'll remind people that we have a process where we look at our long-term rate assumption and that includes doing a survey of economist banks and other managers. And we also look at the implied forward curve, and we look to be at the median of all that. And that's the process that we're going through. I'd also note that the way our interest rate assumptions work for GAAP is, we start at current rates and we grade to a long-term assumption over 10 years. So as a result, our the 10-year treasury under the next seven years is less than 3%. So we're going through our process as we would typically would and that'll be finalized by our risk management committees in late June. So no change in our significant change in our GAAP sensitivity and we'll be doing our usual process in the second quarter." ] }, { "name": "Ryan Krueger", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "And next in queue, we have the line of Alex Scott of Goldman Sachs. Your line is open." ] }, { "name": "Alex Scott", "speech": [ "Hi. Thanks for taking the question. First one, I have is just a follow-up on the stat rate sensitivity comments that you made. I just want to make sure I interpreted it correctly. I guess as you go through your actuarial review and if the ultimate rate is set lower, does that reduce sensitivity sort of apply now? Like would we if it is sort of the 3% to 4% book value type impacts on GAAP, would that not necessarily all translate to statutory?" ] }, { "name": "Ken Tanji", "speech": [ "Again, the way asset adequacy testing works is, we don't set a long-term rate. Those are prescribed by GAAP. And we're going through our and so it's a little bit of a different framework. And we'll also so we're working through that." ] }, { "name": "Operator", "speech": [ "[Operator Instructions] Next in queue, we have the line of Nigel Dally from Morgan Stanley. Your line is open." ] }, { "name": "Nigel Dally", "speech": [ "Great. Thank you. So I had a question on the on buybacks. And you spend a few million at a time running through the strength of your current capital position, and also what appears to be quite a manageable stress scenario, and clearly a number of moving factors, but what are you looking for? What are sort of like some of the things that you're looking for to be comfortable in resuming buybacks? Should we assume that buybacks are suspended through the end of the year? Or potentially, could it be somewhat sooner than that? Any color there as to kind of how you're looking at that?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. The I think the primary thing we're looking at is the economic cycle. And we're seeing substantial impact, given the situation that we're in. We like the quality of our investment portfolio, and we think it's manageable, but we want to see how this credit cycle emerges. So I don't know if I can put a time frame on that. I think time will tell." ] }, { "name": "Operator", "speech": [ "Next in queue, we have the line of Humphrey Lee of Dowling & Partners. Your line is open." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning and thank you for taking my questions. My first question is related to Assurance IQ. The losses for the quarter looks a little bit larger than expected. Like how should we think about those losses would trend? Should we expect for the next couple of quarters will be recurring in the kind of $30 million range before seeing a recovery in the fourth quarter, when activity started to pick up due to enrollment period?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Humphrey, it's Andy. And thanks for your question, and I'll give kind of a little bit of a break here. So on Assurance IQ, I would characterize the results for quarter one as modestly worse than what we expected. We have started to lean in from an investment perspective to building out the platform more broadly. And to bringing new product solutions onto the platform as we think the first-mover advantage is very, very important. As we talked about last quarter as well, we learned some lessons from a Medicare Advantage perspective, and we are investing ahead of Q4 to make sure that we have the right number of agents and that they are fully and properly trained, and we're ready to go in the fourth quarter. So I think you could think about performance similar in the next couple of quarters. And obviously, the large opportunity is in Medicare Advantage in Q4." ] }, { "name": "Humphrey Lee", "speech": [ "Got it." ] }, { "name": "Operator", "speech": [ "[Operator Instructions] Next, we have the line of John Barnidge of Piper Sander. Your line is open." ] }, { "name": "John Barnidge", "speech": [ "Great. Thanks. If we were to assume the disease as seasonal nature and returns at the very least in 1Q 2021, could you help me demonstrate how many of these non-mortality, morbidity, CV19 costs would remain on a go-forward basis?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. I don't think we want to try to forecast that far, which given the situation. Eventually, I think we will operate differently, given the changes in environment and the way we're going to have to conduct business, but that's a bit out there. So I don't think we want to start to look through that far at the moment." ] }, { "name": "John Barnidge", "speech": [ "Okay. And then could you maybe provide average age on the products, where you have some CV19 exposure, please?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. So this is Andy. So obviously, the two predominant areas. There are really our Individual Life business and our Group Life business and then obviously offset in the longevity business that we have in retirement. So actually, in Individual Life and in Group Insurance, average age across the whole book is relatively similar in the about 55. In Group Insurance, in particular, though, 95% of that business is under the age of 65. As far as the longevity risk transfer business and the pension risk transfer business, our average age is in the 74 to 75 range." ] }, { "name": "John Barnidge", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Next in queue we have the line of Elyse Greenspan, Wells Fargo. Your line is open." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi, thanks. My first question is on the group business. Can you just discuss your outlook for the margins within that business for the rest of the year, just given that, I think COVID-19 could impact some of those businesses? Or do you think that we might not see an impact there maybe until 2021?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Elyse, this is Andy. So I'll take that question, and there are a number of impacts. So maybe I'll start more on the claims side of things. And we do expect, and it was in the estimates that Ken walked through. That we will see increased mortality in the book of business. Obviously, in the Group business, as I just referenced, that's somewhat mitigated by the average age. But we do think that, that will go up. We also believe and have seen evidence that we'll see an uptick in short-term disability incidents. So that will serve few compress margins throughout this year. We see a couple of other impacts I just mentioned from a sales and flows perspective. Most of our book of business is medium and large size employer. So actually, most of our sales for 2020 are already baked in that business. And any slowdown we're seeing is more of a 2021 impact. I guess the last thing I'd mention is, a lot of the impacts that Group Insurance will feel, we actually are mitigated against from the perspective that we're not in the under 100 Life segment business. So we don't have exposure to the small segment employers. And obviously, here, early days, that's where a number of the impacts have been." ] }, { "name": "Elyse Greenspan", "speech": [ "Okay. Great. And then my second question, you guys, in your prepared remarks went through kind of shifting the business to less interest rate-sensitive products. How do we think about the capital that you have to put forth to write, some of the new business, right, that's less interest rate-sensitive versus some products that may be required more capital, is there kind of a capital arbitrage there, as you kind of shift your writings in this low interest rate environment?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. I'll take that. The products that we are shifting toward do have less interest rate sensitivity, things like variable life, things like we're looking to release a structured variable annuity. And so they will be less capital-intensive and less interest rate sensitive. I don't think there's anything more to the dynamic than that." ] }, { "name": "Andy Sullivan", "speech": [ "And this is Andy. Maybe I'll just add some color, commentary. So in the Individual Life business, as Ken referenced, we've been shifting toward variable life. We're very pleased in Q1 that our sales were $187 million, which was up 15% quarter from Q1 of last year and 50% near 50% of those sales were variable life. We've also, in April, launched a product that is much less sensitive to interest rates and equity markets tuned to the RIA channel. And our buffered annuity, we're very excited about that launch, that has become a robust market. And 60% of the volumes in that marketplace are going through independent broker-dealers, and we have very, very strong relationships there. So we think that's going to be a very promising for us." ] }, { "name": "Operator", "speech": [ "Next in queue, we have a follow-up from the line of Suneet Kamath of Citi. Your line is open." ] }, { "name": "Suneet Kamath", "speech": [ "Yes, thanks for the follow-up. On the Individual Life business, in the past, you guys have talked about using reinsurance to either dampen down the earnings volatility or actually free capital. So I want to get an update on that? And is that strategy still effective or still possible given all the uncertainty around COVID-19?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Suneet, it's Andy. And maybe I'll take that question up a level first. As we talked about last quarter, we are leaned into performing the overall to improving the overall performance of that book of business in that business, with three levers. First, we are very much leaned into improving the expense profile of the business. A lot of our future of work, energy and effort is aimed in that regard. And we actually saw a reduction year-over-year in our expenses in the business. So we like the progress we're seeing there. The second lever was is leaning into and growing the business with profitable business that we're putting on the books. And as I mentioned, our sales are up year-over-year. And we are comfortable with the pricing and the profitability of the business that we're selling. As far as the third lever, and it's the lever that you referenced. It really is looking at the ability to reinsure the block of business. We continue to explore solutions. Obviously, we're looking very carefully about what is the right economic favorability for us. And if and when we take action on that, we will report out on it, but nothing to report as we sit here today." ] }, { "name": "Suneet Kamath", "speech": [ "I just have one quick follow-up for Ken, I guess, a follow-up to Elyse's question on capital. You cited in your prepared remarks pretty significant declines in sales, both in the U.S. as well as Japan. So any sense of how much capital or lower strain could you guys experience relative to a normal year based on that sales decline?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. So all things being equal, we would have less if we're selling when we sell business, we capitalize it well. And if we're selling less, that means it's requiring less capital to support it. And so we would expect all other things being equal, that would be the case. I think it's too hard to quantify that right now. We'll see how our sales plays out. If we have opportunities to make sales in attractive business, we'll do that. If the conditions are such that, either the returns are attractive or it's too difficult to conduct business that would lower sales and we would see some capital offset for that. So I just don't I think it's a little tricky to put a number on that right now." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. Thanks." ] }, { "name": "Operator", "speech": [ "[Operator Instructions] I think we do have a follow-up from the line of Alex Scott from Goldman Sachs. Your line is open." ] }, { "name": "Alex Scott", "speech": [ "Hi. Thanks for taking the call. I just wanted to see, if you could provide an update on the mortgage loan book. And I guess, specifically the commercial mortgage loans, would be interested if you can operate anything up around, like how much of it you've got forbearance requests on and what you'd expect there?" ] }, { "name": "Robert M. Falzon", "speech": [ "Alex, it's Rob. Let me handle that one. The we haven't received forbearance request. The vast majority of that actually would expect is coming from the hotel and mall tenants. Having said that, to date, through April in any event, we've had we've actually granted forbearance on a little less than 3% of the portfolio. And that, by and large, almost entirely has been just with respect to principal amortization. The loans continue to remain current with regard to interest payments. We do expect that will build over time to some greater amount. But having said that, we're actually quite comfortable. If you look at the loan-to-value that we have across the mortgage portfolio, it's at 56% based on our internal appraisals. And what we find is, if we actually use external appraisals that drops to around 46%. So being in a position to be able to provide forbearance on principal, we don't think actually puts at risk our ability to be repaid on those loans, given the relatively low amount of leverage that we have on our properties, and combined with the fact that our mortgage portfolio is very concentrated in higher quality, well located properties. So we're feeling quite good about the status of the mortgage portfolio, and we expect it to be resilient through this crisis, as it has been, in fact, through all prior of our recessions. If you look at the 2008 recession and you sort of take that and you roll that forward, we've had sort of a one basis point loss ratio on our mortgages from that period until now. So we actually feel pretty good about the way in which we've underwritten it, and we feel very good about the way we're positioned going forward." ] }, { "name": "Andy Sullivan", "speech": [ "And Alex, it's Andy. I was just going to add a point from our third-party managed fund business, very similar trends. We've to date seen low single-digit levels of forbearance. And clearly that will rise over time, but very similar trends to what Rob covered." ] }, { "name": "Operator", "speech": [ "[Operator Instructions] Next, we do have a follow-up from Humphrey Lee with Dowling & Partners. Your line is open." ] }, { "name": "Humphrey Lee", "speech": [ "Thank you for taking my follow-up. Looking at PGIM, so other related revenue has always been a source of variability for that segment. I think this quarter, you had some spread related kind of issue, hurting some of the private credit. But looking forward, like some of the strategies that you have in PGIM, whether it's real estate or private credit or some of the specialty products, they're likely to see lower activities. So how should we think about the other related revenue would trend for the balance of the year?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. So Humphrey, it's Andy. So you're correct. In first quarter, the predominant impact in other related revenue was from our strategic investing portfolio. That's where we have our seed strategies as well as where we co-invest alongside of our clients. The predominant impact was in from credit spread widening on the fixed income portion of that portfolio. In general, if you look back, we tend to have somewhere in the neighborhood of $50 million to $60 million coming from our ORR. We do think it is reasonable as you kind of look forward over the next couple of quarters. Obviously, we think flows will be lumpier in general, and then we do believe that there'll be some slowdown in client activity and then transactions. So there may be some near-term pressure on that. But over the long run, you could think of that in the $50 million to $60 million range." ] }, { "name": "Operator", "speech": [ "With no further questions here in queue, I'll be happy to turn it back to Charlie Lowrey for any closing remarks." ] }, { "name": "Charles F. Lowrey", "speech": [ "Great. Thank you very much. We'd just like to say in closing that we'd like to take a moment to thank all our employees for the extraordinary steps they've taken to support our businesses, our customers and our communities. Together, we remain financially strong. We remain resilient, and we remain committed to fulfilling our purpose of solving financial challenges of our changing world, including doing our part to contribute to an inclusive global recovery. Thank you all for joining the call. Please stay safe. And we look forward to talking to you soon." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
PRU	2020-11-04	[ { "description": "Senior Vice President, Investor Relations", "name": "Darin Arita", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Head of US businesses", "name": "Andy Sullivan", "position": "Other" }, { "description": "Dowling and Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Head of International Businesses", "name": "Scott Sleyster", "position": "Other" }, { "description": "Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Josh Shanker", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to the Prudential quarterly earnings call. [Operator instructions] And as a reminder, today's conference call is being recorded. I would now like to turn the conference over to Mr. Darin Arita.", "Please go ahead." ] }, { "name": "Darin Arita", "speech": [ "Good morning and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; and Rob Falzon, vice chairman; Andy Sullivan, head of US businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob and Ken, and then we will take your questions. Today's presentation may include forward-looking statements.", "It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-looking Statements and Non-GAAP Measures in the appendix to today's presentation, which can be found on our website at investor.prudential.com. With that, I'll hand it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Darin. Good morning, everyone, and thank you for joining us today. To begin, I hope that you, your families and colleagues remain safe and healthy. As the global health pandemic continues, we remain intently focused as a company on caring for our employees and the communities in which we live and work, as well as serving the evolving needs of our customers and other stakeholders in the current environment.", "We are also incredibly proud and grateful for the continued dedication and commitment that our employees have shown in fulfilling our company purpose-- of making lives better by solving the financial challenges of our changing world. I'd like to highlight a few of the ways in which we're serving the unique and evolving needs of our customers, who now more than ever are relying on Prudential to address their financial challenges. Since the beginning of the pandemic, PGIM has focused on providing clients with timely portfolio updates and asset allocation ideas. Our operational resilience, diversified global business model and strong performance has allowed us to support our clients.", "One example of the success is the growth of our US mutual funds, where we are one of the top-ranked companies based on net flows this year. In our US businesses, we continue to pivot within annuities through our FlexGuard buffered annuity product, which offers downside protection and upside opportunity at a time when customers face new challenges in protecting and growing their retirement assets. Following its accelerated launch to market in the second quarter, FlexGuard continues to gain momentum, accounting for 38% of our annuity sales this quarter. And in Japan, our life planner model with its highly personalized and customized approach to engaging customers, continues to be resilient, as demonstrated by our strong sales this quarter.", "During the third quarter, we continued to successfully execute on our strategic priorities for 2020, despite the challenging macroeconomic backdrop, including taking additional steps to expand our cost savings program. We also continued to benefit from the strength of our rock solid balance sheet, which places us on sound financial footing to navigate changes in the current environment. Turning now to 2020 priorities on Slide 3. On last quarter's call, we mentioned that we were exploring the potential to generate additional cost savings on top of our 2022 plan.", "Through the third quarter of this year, we have realized approximately 135 million of our $500 million cost savings program. Based on our progress of accelerating the savings realized and creating new ways of working, we now expect to generate an incremental $250 million in efficiencies by the end of 2023, bringing our total cost savings program to $750 million. With respect to rotating the international earnings mix, during the quarter we announced an agreement to sell Prudential of Taiwan to Taishin Financial Holding, and expect the transaction to close in 2021, subject to all regulatory approvals. And we also closed on our transaction to divest Prudential of Korea and receive proceeds of USD 1.6 billion.", "And finally, we continue to take additional steps across the company to reduce our exposure to changes in markets and rates by shifting sales momentum to less interest rate-sensitive solutions, while aggressively repricing certain existing products. As an example, in annuities we are focusing on our efforts on delivering protected outcome solutions like our FlexGuard product. And we're discontinuing all sales of our traditional variable annuities with guaranteed living benefits. We will also explore strategic opportunities for blocks of business, including reinsurance and other transactions.", "Turning to Slide 4. As we continue to execute against our strategic priorities, we remain grounded by our rock solid balance sheet, including highly liquid assets of $6.1 billion at the end of the third quarter. Prudential Financial and its subsidiaries continue to hold capital that exceeds AA financial strength level. The financial strength gives us the confidence and the flexibility to manage our business for long-term growth, while navigating the current and future market environment.", "We also continue to closely monitor conditions in the credit markets. While they have been developing better than previously expected, we don't intend to reinstate buybacks this year. We believe this is prudent as the duration and severity of the pandemic and its effect on the economy remain highly uncertain. We'll provide more details on our 2021 capital deployment plans once they have been finalized and approved by the board.", "Turning to Slide 5. I'll now take a moment to highlight our financial results for the third quarter. Pretax adjusted operating income was $1.6 billion in the quarter. And after tax adjusted earnings per share was $3.21, which benefited in part from strong variable investment income across our businesses.", "Our US businesses reported adjusted operating income of $873 million due to higher net investment spread, offset by lower net fee income in our individual annuities business and less favorable underwriting driven by COVID-19-related net mortality experience. PGIM reported record adjusted operating income of $370 million, driven by record assets under management of $1.4 trillion and higher other related revenues. The 11% growth in assets under management reflects strong flows, robust investment performance and market appreciation. Our international businesses reported adjusted operating income of $775 million as business growth, lower expenses and more favorable underwriting results were partially offset by lower earnings from joint venture investments and lower net investment spread.", "With that, I'll turn it over to Rob for more specific details on our business performance during the third quarter. Thank you all for your time this morning." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an update on how we're executing on our strategy within our US, PGIM and international businesses, the outlook for these businesses and a brief update on our investment portfolio. Turning to Slide 6. Our US businesses produced a diversified source of earnings from fees, net investment spread and underwriting income.", "We made progress in the quarter executing on three key priorities. First, we continued to implement pricing and product actions to simplify and de-risk our business mix while protecting profitability. For example, we are further pivoting to less interest rate-sensitive solutions in individual annuities by discontinuing sales of traditional variable annuities with guaranteed living benefits, including both our highest daily income and Prudential defined income products. In our individual life business, we are repricing products to mitigate the impact of low rates, in addition to suspending sales of our single life guaranteed universal life product in July.", "As a result of these actions, we expect individual annuities and individual life sales to continue to move lower in the near term. In addition, we continued to adjust crediting rates in our retirement business. Second, as the needs of our customers change, including in response to COVID and its economic impact, we're evolving the way we work. We continue to adapt and develop new ways of working effectively in remote locations and expect to recognize additional cost savings as we expand the use of technology, optimize our real estate footprint and benefit from a more efficient workforce.", "As Charlie mentioned, these and other opportunities to further efficiencies and improve our customer experience have resulted in a 50% increase in our originally planned $500 million earnings improvement target. And third, we remain committed to expanding our addressable market. For example, we continued to see strong interest in our Assurance IQ platform from customers in the healthcare, life and P&C lines of business. In preparation for the Medicare annual enrollment period in the fourth quarter, we accelerated our agent onboarding and training processes.", "While we are only three weeks into the annual enrollment period, we are pleased with the customer demand that we're seeing, which is driving considerable sales growth. Now, turning to Slide 7. PGIM is a top 10 global investment manager that continues to demonstrate the strength and resilience of its multi-manager model. PGIM's strong investment performance and diversified global investment capabilities across public and private asset classes, especially higher-returning and income-generating strategies across fixed income, alternatives, real estate and equities, position us favorably to continue to capture flows amid industrywide dislocation.", "Our assets under management reached a record level of over $1.4 trillion, up 11% from the year-ago quarter, driven by strong flows, robust investment performance, as well as market appreciation. PGIM's long-term investment performance remains strong, with more than 90% of assets under management outperforming their benchmarks. This strong investment performance, coupled with diversified investment capabilities across asset classes, regions and client segments, has led to continued growth. We generated over $7 billion of third party net flows during the quarter, including $5.3 billion of retail flows and $2 billion of institutional flows, driven by a continued appetite for fixed income strategies partially offset the moderating equity outflows.", "Our public fixed income platform generated flows of $11.6 billion as it continues to benefit from our broad suite of strategies and the leading position of our franchise. And the combination of customer demand, fund performance and investments in product development and distribution over the past several years has resulted in PGIM investments being ranked the second highest US mutual fund franchise based on year-to-date net flows. PGIM's asset management fees were up 11% compared to the year-ago quarter, driven by the growth in average assets under management. In addition, an increase in other related revenues was driven by an increase in co-investment and seed investment earnings, record-high agency loan production and higher incentive fees.", "PGIM's operating margin exceeded 37% for the quarter, aided by the strong other related revenues as we continue to focus on generating efficiencies to fund growth investments and on delivering margin increases from operating leverage. While PGIM's operating margin will vary with market conditions, we expect margins to remain in the 30% range across the cycle. Turning to Slide 8. Our international business includes our Japanese life insurance operation, where we have a differentiated multichannel distribution model, as well as other operations focused on high-growth markets.", "Our sales this quarter demonstrated the strength of our distribution channels and the continuing customer demand for the protection and retirement products we offer. Our distribution channels are also employing more virtual tools for non face-to-face sales and have benefited from the easing of pandemic related restrictions. Life planner sales increased 57% compared to the year-ago quarter, reflecting the resilience of the Life Planner model, the easing of COVID restrictions in Japan, and higher sales ahead of US dollar-denominated product repricing in August. Life planner head count increased 3% compared to a year ago due to stable recruitment and lower resignations.", "Similar to life planner, sales across Gibraltar's life consultant, independent agent and bank channels also increased in total by 30%. We believe a degree of sales were pulled forward into the current quarter due to repricing actions. And therefore we expect a lower level of sales in the fourth quarter, with sales returning to more normal levels over time beginning in 2021. Current order adjusted operating income continued to be impacted by low interest rates, and we anticipate this trend to continue given Gibraltar's higher exposure to US dollar products.", "We have taken pricing actions, and we'll continue to identify opportunities to become more efficient. In addition, we had $15 million of COVID response costs primarily to support our life consultants in Gibraltar, which we expect will moderate in future quarters. Now, turning to Slide 9. We have a conservative high-quality investment portfolio that reflects our robust asset liability management practices, commitment to broad diversification, and a disciplined interest rate risk management framework.", "We also leverage PGIM's expertise across multiple asset classes, including its deep and long-standing experience in private placements and real estate. There has been a slowdown in the pace of credit migration and impairments since the first quarter of this year, with year-to-date credit migration and losses below our expectations. For the third quarter, credit losses were just $12 million. We remain confident that we are well capitalized to weather whatever might emerge in the future.", "And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 10, which provides insight into earnings for the fourth quarter relative to our third-quarter results. Pretax adjusted operating income in the third quarter was $1.6 billion and resulted in earnings per share of $3.21 on an after-tax basis. We then adjust for the following items.", "First, variable investment income outperformed expectations in the third quarter, which is worth $215 million. Second, we adjust underwriting experience by a net $35 million. This includes seasonally lower reserve gains in retirement and an estimate of $60 million for COVID-19 claims experienced in the fourth quarter. Third, we expect expenses and other items to be $70 million higher in the fourth quarter, primarily due to seasonal expenses and implementation costs.", "Fourth, we expect the net operating costs due to COVID-19 to be 5 million lower in the fourth quarter. Fifth, we anticipate net investment income will be reduced by $15 million, reflecting the difference between new money rates and disposition yields of our investment portfolio. And last, we expect the fourth-quarter effective tax rate to normalize for third-quarter items. These items combined get us to a baseline of $2.48 per share for the fourth quarter.", "I'll note that if you exclude items specific to the fourth quarter, earnings per share would be $2.93. The key takeaway is that our underlying earnings power increased slightly from last quarter, including the benefit from higher equity markets as of quarter end. While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the fourth quarter. In addition, as we look forward, we have increased the expected benefits from our cost savings program by $250 million by the end of 2023.", "We expect these benefits will be largely self-funded, with incremental net savings emerging in 2022 and 2023. We will provide additional details about this program on our earnings call in February. On Slide 11, we provided an update on the potential impact of the pandemic. The estimated sensitivity of operating income per 100,000 of incremental US deaths due to the pandemic remains unchanged at $70 million.", "Based on our updated outlook, our fourth-quarter baseline includes a net mortality impact of $60 million due to COVID-19. The actual impact will depend on a variety of factors such as infection and fatality rates, geographic considerations and progress in testing and medical treatments. Also, we continue to expect incremental operating costs due to COVID-19 to be $5 million in the fourth quarter. This includes additional operating costs of $25 million, partially offset by $20 million of lower travel and entertainment expenses.", "Turning to Slide 12. We continue to maintain a robust capital position and adequate sources of funding. Our capital position exceeds our AA financial strength targets. And we have liquid assets at the parent company that are greater than three times annual fixed charges, and we have substantial sources of funding.", "Our cash and liquid assets at the parent company were $6.1 billion at the end of the quarter, which includes the proceeds from the sale of Prudential Korea. And other sources of funds include free cash flow from our businesses and other contingent capital facilities. Turning to Slide 13 and in summary. During the third quarter, we continued to successfully execute our strategic priorities for 2020.", "We have taken additional steps to expand our cost savings program. And we continue to benefit from the strength of our rock-solid balance sheet, which includes -- which gives us the confidence and flexibility to navigate the changes in this economic environment. Now, I'll turn it over to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] And our first question will come from the line of Erik Bass with Autonomous Research. Your line is open." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. Can you provide some more details on where you expect the additional expense savings to come from? And how much of the cuts are efficiency initiatives? And how much are sort of reflecting a reappraisal of business volumes in the revenue environment?" ] }, { "name": "Ken Tanji", "speech": [ "Erik, this is Ken. I'll start. And just by way of background, earlier this year we put in place a transformation office, and it's led by one of our senior business leaders, Phil Waldeck. And it's given us the capabilities to identify, prioritize and implement with a continuous improvement mindset.", "It involves all of our US businesses and all of our functions. And so we're finding efficiencies through combining client service centers, process engineering, automation, through procurement strategies. And so, it's a culmination of transformation across the company. So, that's generally what's driving that." ] }, { "name": "Andy Sullivan", "speech": [ "And Erik, it's Andy. I would just add, it's really not related to business volumes or revenues. It is core efficiency improvement, where we're applying process and technology and able to hit a number of cost reduction levers. So, it's becoming more efficient at the business that we have." ] }, { "name": "Erik Bass", "speech": [ "Got it. And then, you've talked about sort of all options being on the table for your in-force individual life and annuities blocks, and we've started to see an increase in transaction activity across the industry. So, hoping you could talk a little bit about what you're seeing in terms of buyer interest for liabilities like yours and maybe the current bid-ask spread in the market?" ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. This is Charlie. Let me take it kind of at a high level and then turn it over to Andy. But Erik, over the past couple of years, we've been really active in beginning to change our business mix.", "So, as you know, we've sold our operations in Poland, Italy and Korea, now have agreement in Taiwan. And we continue to focus on rotating our earnings mix to higher-growth markets internationally. Now looking at the US in terms of changing the focus within the business, we're on a path to de-risking. And have made major pivots to less interest rate-sensitive and more capital-light solutions in our individual annuities and in our life business.", "And specifically you've seen us pivot away from the VAs with lifetime income guarantees to less market-sensitive products. And at the same time, you've seen us in our life business pivot to simpler non-guaranteed products. But what we've also said is that we want to accelerate the transformation. And I've said that we'll explore reinsurance and potentially the sale of certain blocks.", "But I'd add the caveat that these type of transactions are complex and they take time. And as we explore our options, we want to make sure that we're making good economic decisions that are in the best interest of shareholders. So, we're going to take all these things into account as we go forward. Andy, I don't know if you want to add on to that." ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Maybe I would just add, Erik, you also, I think, asked about what's the marketplace for these types of transactions. And while we'll not quote on any specific deals that are going on, I think there are two important takeaways that we should discuss. One is I think we've generally believed that a number of these blocks of business and our block of business, its value is not fully appreciated in the marketplace.", "And I think if you look at the recent transactions that certainly has been, I think, proven out. The other thing is that there is capital moving toward these types of deals and that there's capacity. So, as Charlie said, we've begun to work on these alternatives. And when we have something more to report, we'll certainly do so." ] }, { "name": "Erik Bass", "speech": [ "All right. Thanks for the comments." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of Humphrey Lee with Dowling and Partners. Your line is open." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning and thank you for taking our questions. I'm just trying to bridge the comments or your kind of sentiment toward the decision to not reinstate your share repurchase this year, given the credit concern, and at the same time, your confidence about your balance sheet. I guess what kind of -- what do you need to see now to make you feel comfortable to resume buyback?" ] }, { "name": "Charlie Lowrey", "speech": [ "So Humphrey, it's Charlie. Let me take a stab at that one. In line with the risk framework that we have in place, we paused share repurchase in the second quarter. But it's really about this: Until we have better visibility into the depth and the duration of the pandemic, a possible recession and the credit cycle, which still may be before us, we're going to maintain our financial flexibility and the resiliency.", "And when we get clarity into those issues that I just mentioned, we'll share the timing with you of our plan to resume share buybacks and by how much. But until then, we're going to focus on maintaining our financial strength with many of the unknowns still in front of us." ] }, { "name": "Humphrey Lee", "speech": [ "I guess just for a quick clarification, so do you suggest -- you do not intend to reinstate buyback this year. But does it preclude you from using some of your capital strength for acquisitions?" ] }, { "name": "Charlie Lowrey", "speech": [ "Not necessarily. But again, we're going to take a very measured approach to that because we want to maintain our financial flexibility. So, we're not going to comment about any business or specific transaction. But if I can take a step back for a moment again and just make a more general comment on how we think about capital allocation and particular optimization, as we look across our businesses, both domestically and internationally, we want to ensure that we're optimizing capital deployment.", "And you've seen us do that with some of the sales we've done internationally, but we're going to continue to look for ways to optimize capital and capital deployment to maximize outcomes for shareholders. But at the same time, we're going to take a hard look at the environment in which we're operating. And make sure that, again, we maintain our financial strength and our financial flexibility and our resiliency as we go forward." ] }, { "name": "Humphrey Lee", "speech": [ "That makes sense. And then, my next question is related to Assurance IQ. So, I think in the prepared remarks, you talked about you're excited with the activity so far in the quarter. Granted it's still very early in terms of the customer demand.", "I think last year, the challenge was you see -- you saw similar -- you saw strong demand, but then you were not able to cope with the processing of those kind of incoming demand. So, maybe can you talk about like how -- like in terms of the demand relative to your current capacity, where do you stand so far for the enrollment period?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah, Humphrey, it's Andy. So, I'll take your question. And as we discussed sort of from a lessons learned perspective from last year, we've done a lot this year to make sure that we were better prepared for the annual enrollment period. We direct contracted with the health carriers, which gives us a lot more flexibility and agility.", "We invested much more heavily in agent recruiting, licensing and training. And we began to bring on agents this year in the month of July, which was much earlier than last year. So repeating what Rob said, we're only about three weeks into the season, but we certainly see evidence that our investments are paying off and that we're having stronger performance than we had in 2019. Having said that, about 50% of industrywide Medicare Advantage transactions occur in the last two weeks of the annual enrollment period, and that's the first two weeks of December.", "So, while we like what we see from a growth perspective in these early days, it's certainly too early to draw definitive conclusions." ] }, { "name": "Humphrey Lee", "speech": [ "Do you feel like, given the activities that you're seeing and some of the preparedness you have already in place, do you think Assurance IQ could turn positive for the fourth quarter?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. And I think in our materials, we had given a walk to about 25 million for the fourth quarter." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. Thank you." ] }, { "name": "Andy Sullivan", "speech": [ "Oh, actually, I had that number wrong. It was 15, Humphrey. Sorry, I was off. Looked at the wrong line." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question comes from the line of Tom Gallagher with Evercore. Your line is open." ] }, { "name": "Tom Gallagher", "speech": [ "Charlie, just wanted to circle back on capital deployment as my first question. If we think about 2021, at this point, do you have a preference of buybacks or M&A? And I ask in particular because if you do free up capital from a risk transfer deal, there also happens to be, say, more activity, more things on the market now than there were recently. So, curious what your view is, if you're more likely to want to do M&A or buybacks at this point?" ] }, { "name": "Charlie Lowrey", "speech": [ "Tom, thanks for the question. I guess a couple of things. One, again I would caution the people in thinking we're going to free up capital immediately. These transactions take a long time, and therefore we have to think through that.", "Secondly, I think it depends on the deal. What we have said before is given where our stock price is, there's a fairly high hurdle, right? On the other hand to your point, there could be some very interesting things on the market. So, we're going to have to balance, if you will, short-term accretion from stock buybacks and long-term growth. And we'll have to weigh those two against the opportunity set that's out there and the stock purchase price at the time." ] }, { "name": "Tom Gallagher", "speech": [ "That's helpful. And would defined contribution be on the wish list of M&A interest from your perspective? Because I know you've done more international than you did Assurance IQ in recent times." ] }, { "name": "Andy Sullivan", "speech": [ "So Tom, it's Andy. I'll take your question. We've been very focused on strengthening out our value proposition in our full-service retirement business. We've talked a lot about, over the last couple of years, the work that we've done in financial wellness.", "We've pretty heavily invested in digital and mobile, and that has resulted in very good organic growth on that platform. If you look at our net flows over time, it's been very positive. We're completing our third year of record sales. We had our largest corporate client ever in the quarter.", "So we've seen great success. Even though we certainly pay attention to the consolidation on the space, we've seen great success organically growing the business, and that maintains our focus." ] }, { "name": "Tom Gallagher", "speech": [ "OK. And then, just as a quick follow-up, the elevated level of non-backable expenses at Gibraltar, is that like -- and I guess for the guide for 4Q, is that likely to continue into 2021, or is there something that's more, I would say, temporary regarding the lower earnings and higher expenses at Gibraltar?" ] }, { "name": "Scott Sleyster", "speech": [ "Tom, this is Scott. The Gibraltar run rate base has been impacted by really two factors. And one here, this first one is more permanent. We adjusted our compensation structure for life consultants to better balance policyholder servicing, things like customer business persistency and so forth with new business production, and then this led to a lower level of deferrable commissions.", "Overall the commissions have not actually changed, but our immediate run rate was impacted by roughly $10 million a quarter, and we view this as permanent. Now, we recapture that over the life of the products, but that takes quite a while to pick up. By the way, we do not expect this to have any impact on Gibraltar's cash flow. Second, Gibraltar does have a large block of US dollar business, which is experiencing spread erosion due to declines in US dollar interest rates.", "So, it's really those two factors combined with the biggest being the first." ] }, { "name": "Tom Gallagher", "speech": [ "OK. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. [Operator Instructions] Next, we will go to the line of Suneet Kamath with Citi. Your line is open." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. I wanted to circle back to Assurance IQ. If we assume your placeholder of $15 million for the fourth quarter is right, I think it would still put you at a loss for the year versus your original guidance of EPS accretion in 2020. So just curious what's driving that? And then should we -- do you think we can get back on track to your -- I think you had guided to $0.30 to $0.35 in 2021.", "Should we assume that you can kind of get back on track there, or do you think it's sort of more of a challenge to get this back to profitability for the full year -- for a full-year thing?" ] }, { "name": "Andy Sullivan", "speech": [ "So Suneet, it's Andy. I'll take your question. And let me maybe raise it up a level. So, we're very pleased that we bought this business model and this set of capabilities, a model that's not sensitive to interest rates or equity markets.", "Obviously, with what happened in the March time frame, we're even more pleased to have this as part of the fold. We immediately got very focused on building out and expanding the business model, so that we could care for more needs in the mass market and middle market consumer set. So, as we've really worked on the business internally, success, for us, is not about near-term AOI. Success, for us, is very much about continuing to expand the reach and breadth of the platform and is very much measured in how we grow our revenues.", "It's very much measured in the products that we have on the platform. So we began with life. You saw us immediately lean into Medicare Advantage. And then, more recently, we've leaned into property and casualty.", "And again, I always remind this is from a distribution perspective, not from a manufacturing perspective. And these bring fee-based earnings that are very capitally efficient. So, our focus is really expanding this out as rapidly as we can." ] }, { "name": "Suneet Kamath", "speech": [ "OK. And then, I guess a bigger picture question on your financial wellness initiative. When you guys talked about this at your latest investor day, we spent a lot of time talking about marketing at the work site, reaching the employees of your corporate customers. So, if we assume that we're going to be in this work-at-home environment for longer, how are you modulating that initiative to make sure that you're still capturing the growth opportunity that you guys talked about, when you can't do these group meetings that you guys discussed at the investor day?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Suneet, it's Andy. And I guess right up front, I'll draw a very sharp distinction in our financial wellness work from what I would call worksite marketing, which I know a number of voluntary products are more worksite marketing with feet on the street in the employer. Ours was very much about building a set of capabilities that could really reach people when, where and how they want it.", "So, there was a real digital focus to what we've built. We've had accelerating success. If you remember, there were sort of a couple of stages to what we were trying to accomplish. At this point, we've had a large portion of our employers adopt our capabilities.", "We have 20 million individuals that have access to the platform. That's ahead of our goals for 2020. We've, my words, permissioned 12 million individuals that they can access, we get access to market our retail solutions. That is also ahead of our goals.", "And at this point, we've put 15,000 retail customers into Prudential through the platform. As COVID came in, the base capabilities were such that we were able to pretty quickly even expand upon, as an example, our Prudential pathways program and make it purely digital with webinar capabilities. And at this point, that's now reaching about 8.5 million folks. So, we don't see the current environment actually hindering us at all, and it's really about how we built the whole platform." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Thanks, Andy." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of Ryan Krueger with KBW. Your line is open." ] }, { "name": "Ryan Krueger", "speech": [ "Good morning. I had a couple of annuity questions. One, in recent years, you've been sending dividends up to the holding company from the annuity subsidiary, it seems like in kind of the roughly billion-dollar range, give or take. I guess, so first question is to what extent was that negatively impacted by new business streams associated with writing VAs with living benefit guarantee? So I guess should we see some improvement there? And do you view the roughly $1 billion per year as sustainable in the current interest rate environment?" ] }, { "name": "Ken Tanji", "speech": [ "Ryan, it's Ken. Our annuity business, as we've mentioned in the past, has been very well-hedged and very well-capitalized, and as you mentioned, providing a regular source of dividends to the holding company. Now, that has moderated over time. As our sales have been below our outflows, the business has been getting smaller.", "And although we're quite happy with the launch of our FlexGuard products, it won't be, in the near term, sufficient to outpace the outflows that we have on our in-force block. So, over time, that will decrease our level of earnings and cash flow, and you could see that as a moderating trend." ] }, { "name": "Ryan Krueger", "speech": [ "Got it. And I guess from a legal entity standpoint, I know you probably -- it sounds like you're more likely to pursue a reinsurance. But just in general, is there any highs legally between the Prudential annuity subsidiary and PICA or other life insurance subsidiaries, or is it really completely separate?" ] }, { "name": "Ken Tanji", "speech": [ "Our annuity business, it actually involves a couple of major legal entities. One would be our Pruco Life of Arizona company, which is a subsidiary of PICA. That had been historically been the legal entity that we use to underwrite annuity business. But you may recall, many years ago we acquired an annuities company from American Skandia, that's what we call Prudential Assurance -- Life Assurance Company, or PALAC.", "And that also has a variable annuity business in it. And so, it's in a couple of different legal entities that are involved." ] }, { "name": "Ryan Krueger", "speech": [ "OK. Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of John Barnidge with Piper Sandler. And your line is open." ] }, { "name": "John Barnidge", "speech": [ "Thank you. You didn't really address this in the commentary on cost cutting, but when adding $250 million, pushing out to 2023, is this real estate savings that is far off -- far out enough that it could address leasing?" ] }, { "name": "Andy Sullivan", "speech": [ "So John, it's Andy. This is really just an expansion of our program to, as Ken said earlier, every business and every function. So, it is -- real estate's part of it, but there are a number of different buckets. It really is across real estate.", "It's across better vendor management and procurement, more efficiency from a travel perspective. So, it really goes across a number of areas. We learned a lot in the first 12 to 18 months of this program. We saw a lot of what was possible and feasible, and we basically expanded it to every corner of the organization.", "So, it's not one particular category. It's just from the success of the overarching program and accelerating it." ] }, { "name": "John Barnidge", "speech": [ "OK. And my follow-up would be the products within annuities and life that you suspended this year, can you talk about the amount of assets associated with that that were suspended, respectfully?" ] }, { "name": "Andy Sullivan", "speech": [ "So from an annuities perspective, I'm not going to get this exactly right, but I think it's in the 110 billion, 120 billion range. And I will -- I don't have the guaranteed universal life in front of me." ] }, { "name": "John Barnidge", "speech": [ "Thanks for the answers." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Jimmy Bhullar with JP Morgan. And your line is open." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hi, thanks. So, first, I just had a question on your disability loss ratio. It's actually -- margins in the business have been pretty good. Are you starting to see, or expecting to see, any impact from sort of higher unemployment and just a weaker economy on your benefits ratio in the disability business?" ] }, { "name": "Andy Sullivan", "speech": [ "It's Andy. I'll take your question. So, we've actually been very pleased. We have not seen an uptick in incidents in either our short-term disability business or our long-term disability business.", "That being said though, obviously we've operated this business for many, many decades, and we know that in recessionary environments, there's generally somewhere in the neighborhood of a year lag from when that incident shows up. So, we have invested to make sure that our claims teams have low, what we call desk loads, so that if and when that incident starts to tick up, we're well prepared for it. But we have not seen evidence of that yet." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. And then, on -- just on Japan sales, obviously you benefited this quarter from sort of front-ending prior to a price increase. But so I'm assuming you expect sales to decline a decent amount next quarter. And then, also, if you could just talk about how the conditions are in that market in terms of agents' ability to meet with prospects and like, given social distancing and everything else that's going on?" ] }, { "name": "Scott Sleyster", "speech": [ "Sure. Thanks, Jimmy. This is Scott. Well, as Rob noted in his remarks, with a significant decline in US interest rates, we implemented pricing changes in August across all of our US dollar products in Japan.", "As you know, it's common for salespeople to use such a pricing change to stimulate client contact. And that tends to accelerate sales from maybe the quarter ahead prior to such a change. Sales in 3Q also did benefit from the relaxation of social distancing requirements in Japan that were implemented in the beginning of June, and I think you also asked on that question. We expect that such enhanced demand will taper off in the following quarter, but then we are expecting things really to normalize as we head in to 2021.", "Overall our distribution in Japan is largely operating in kind of a back-to-normal mode, and I think that really reflects the strength of our differentiated business model." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Josh Shanker with Bank of America. Your line is open." ] }, { "name": "Josh Shanker", "speech": [ "Yeah. Thank you. If we go back in time maybe three years ago, I think that you would have said that individual variable annuities is a core competency of the company, that a lot of your competitors don't understand or are backing away from the market. Many of them pivoted to buffer annuities and whatnot? With you discontinuing sales of variable annuities with living benefits, can you talk about what's the return characteristics of that product have been over the past three years, where they stand today, and what it means for the back book?" ] }, { "name": "Andy Sullivan", "speech": [ "So Josh, it's Andy. I'll take that. So our HDI and PDI block of business is a very high-returning block of business. As Ken talked about earlier, it's a well-capitalized block and well-hedged block and creates good cash flows.", "It's more of a go-forward perspective if you think about the decision-making around our product pivot. We're working toward more of what I would frame as an all-weather portfolio, where we're taking less fully on ourselves the interest rate and equity market risk. HDI is our most sensitive product in that regard. So we think from a go-forward perspective, as you noted, we are very, very good in the annuity space.", "We believe there still is a deep-seated need to help people with accumulation and to help them with de-cumulation from a longevity insurance perspective. And we think our go-forward product portfolio does that, it does that well, but does it in a way that's more shareholder-friendly." ] }, { "name": "Josh Shanker", "speech": [ "Do the financial advisors who work with you need a product like that in their silo from you, for you to remain competitive with them?" ] }, { "name": "Andy Sullivan", "speech": [ "No. Now, if you're asking about do they need the sort of the HDI, PDI types of product, no. We've actually -- I think we benefit from our brand and our strength of our distribution. And I think that's really why you see such a strong start to our FlexGuard buffered annuity.", "It was 38% of our sales here in the third quarter, and we recently went through $1 billion in sales. And we haven't even finished fully rolling it out to all states and all advisors. So, we think our product portfolio will meet the needs the advisors and we'll see good growth in it." ] }, { "name": "Josh Shanker", "speech": [ "Thank you for the answers." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of Elyse Greenspan with Wells Fargo. Your line is open." ] }, { "name": "Elyse Greenspan", "speech": [ "Thanks. Good morning. My first question is going back to the capital conversation. You guys mentioned you have over 6 billion of capital at the holding company.", "That's around three times your fixed charges. And so can you remind us what you typically like under normal times to keep at the holding company? And then, as we think about 2021, and you mentioned reevaluating capital return. Once we kind of get out of COVID, will you go back to what you view as kind of that normal level of fixed charges at the holding company, or do you think that you're, going forward after this, will look to hold on to an extra buffer as well?" ] }, { "name": "Ken Tanji", "speech": [ "Elyse, it's Ken. Our target for highly liquid assets, in typical times, is 3 to 5 billion. And we think that's a good level to carry to have the flexibility that a company like ours needs. So, we are above that.", "We think these are different than typical times. And I think as Charlie mentioned, that's a prudent thing to do. And we'll continue to evaluate a number of factors, including the credit markets, as we go forward. But again, our target is typically 3 to 5 billion.", "That gives us ample flexibility in ordinary times, and we think now is a good time to be above that." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. And then, I was hoping to get more color on the PRT environment. Obviously, with rates lower, do you see deal activity slow in the third quarter. Typically, volume does pick up in the fourth quarter as we close years out.", "Could you just give us some color on the pipeline there and thoughts about transactions that we could potentially see in the fourth quarter?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Elyse, it's Andy. I'll take your question. So, you're absolutely right.", "If we look at sort of 2020, the marketplace -- size of the marketplace versus 2019, 2020 is definitely going to be down. We think it's going to be somewhere in the neighborhood of 20%-ish or so. Third quarter was relatively quiet. We are seeing a building pipeline in 4Q, but I would point out that with a lower overall market size, we also have talked about in the past that we're now probably up to five-plus competitors that can do deals of 1 billion-plus.", "So, we think it's going to be a very competitive environment in the fourth quarter. We're going to be very disciplined about how we approach the marketplace, and we're going to pick our spots." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. Thank you very much." ] }, { "name": "Operator", "speech": [ "Thank you. And with that, I'd like to turn it back over to Mr. Charles Lowrey for any closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you very much. So, in closing today, I hope today that we've demonstrated our commitment toward, and the ongoing momentum we have, to transforming our business and financial performance in ways that deliver meaningful outcomes to our customers, as well as to our investors and other stakeholders. We continue to move with urgency and conviction to execute on and be true to our purpose of solving the financial challenges for more people. So, thanks again for joining us today.", "We appreciate it." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2022-02-04	[ { "description": "Vice President, Investor Relations", "name": "Bob McLaughlin", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "", "name": "Andy Sullivan", "position": "Other" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Andrew Kligerman", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Dowling and Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Head of International Businesses", "name": "Scott Sleyster", "position": "Other" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Mike Zaremski", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to Prudential's quarterly earnings conference call. At this time, all participants have been placed in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator instructions] As a reminder, today's call is being recorded.", "I will now turn the call over to Mr. Bob McLaughlin. Please go ahead." ] }, { "name": "Bob McLaughlin", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of U.S. businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could results to differ materially from those in the forward-looking statements, please see the slides titled forward-looking statements and non-GAAP Measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.", "And now, I'll turn it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Bob, and thanks to everyone for joining us this morning. Prudential delivered strong financial results for the fourth quarter and the full year, reflecting favorable investment performance and continued high demand for the products we introduced during the pandemic to address our customers' evolving needs. 2021 was also a pivotal year for Prudential and our efforts to become a higher growth, less market-sensitive and more nimble company. First, we are repositioning our business mix to generate sustainable long-term growth with reduced market sensitivity.", "Second, we continue to advance our cost savings program. And third, we maintained our disciplined and thoughtful approach to deploying capital. I'll provide an update on each of these areas before turning it over to Rob and Ken. Moving to Slide 3.", "We are making significant progress repositioning our business for sustainable long-term growth with reduced market sensitivity through a mix of divestitures and strategic programmatic acquisitions. Following the successful completion of the sales of our Korea and Taiwan insurance businesses, which produced $1.8 billion in proceeds, we reached agreements to divest our full-service business and a portion of our traditional variable annuities. We are on track to close both of these transactions in the first half of 2022 and generate additional proceeds of over $4 billion. We are redeploying capital in part through highly targeted acquisitions and investments in asset management and emerging markets.", "Last year, PGIM acquired Montana Capital Partners, a European-based private equity secondaries asset manager; and Green Harvest, a separately managed account platform that provides customized solutions for high net worth investors. Meanwhile, on the emerging markets front, we closed on an investment in ICEA LION Holdings, a highly respected financial services market leader in Kenya with operations in Tanzania and Uganda. Turning to Slide 4. We continue to advance our cost savings program and are on track to achieve $750 million in savings by the end of 2023.", "To date, we have already achieved $635 million in run-rate cost savings, exceeding our $500 million target for 2021. We have also taken steps to improve experiences around the world for our customers and employees through innovation. This includes using automation, artificial intelligence, and other technology to expedite underwriting, reduce and simplify processes, provide faster, more convenient service options, and deliver meaningful financial advice in the ways our customers want it. I'll touch more upon how we're using the technology in a moment.", "Turning to Slide 5. We have maintained a disciplined and balanced approach to deploying capital by enhancing returns to shareholders, reducing financial leverage, and by investing in the growth of our businesses. We currently plan to return a total of $11 billion of capital to shareholders between 2021 and the end of 2023. This includes $4.3 billion returned during 2021 through share repurchases and dividends.", "As part of this plan, the board has authorized $1.5 billion of share repurchases and a 4% increase in our quarterly dividend beginning in the first quarter. This represents our 14th consecutive annual dividend increase. We also reduced debt by $1.3 billion in 2021. In addition to the acquisitions I previously mentioned, we also made investments in our businesses to drive long-term growth and to meet the evolving needs of our customers.", "In PGIM, for example, we have significantly strengthened our suite of environmental, social, and governance bond funds to better serve sustainability-focused investors. Meanwhile, in our insurance businesses, we market-sensitive and have higher growth potential, such as our FlexGuard and variable life products, with a focus on improved customer experience and driving greater operational efficiency. One example, as I mentioned earlier, is our use of artificial intelligence. We use AI to quickly and accurately assess risk in our life insurance businesses and to expedite the application and underwriting process.", "The application of innovative technology generated significant efficiencies for our global businesses during 2021, while delivering a dramatically better experience for our customers. We will continue to expand the use of AI and other emerging technologies across the firm. Our capital deployment strategy is supported by a rock-solid balance sheet which includes $3.6 billion in highly liquid assets at the end of the fourth quarter and a capital position that continues to support our AA financial strength rating. Turning to Slide 6.", "Our ongoing efforts to transform the company in 2021 go hand-in-hand with Prudential's long-standing commitment to sustainability. This commitment is reflected in several significant enhancements to our environmental, social, and governance framework last year. We committed to achieve net-zero emissions by 2050 across our primary global home office operations, with an interim goal of becoming carbon-neutral in these facilities by 2040. We are also reviewing our general account investment holdings and have restricted new direct investments in companies that derive 25% or more of their revenues from thermal coal.", "On the social front, the Prudential Foundation surpassed $1 billion in grants to partners primarily focused on eliminating barriers to financial and social mobility around the world. This achievement follows another milestone that we reached in 2020 when our impact investment portfolio exceeded $1 billion. We also continue to advance our nine commitments to racial equity through investments in funding for organizations committed to diversity, equity, and inclusion, and through internal measures, including diversity training and our commitment to equitable compensation for our employees. Our governance actions reflected a shared commitment to diversity and inclusion, beginning at the top with over 80% of our independent board directors being diverse.", "It also includes the steps we are taking to improve diverse representation throughout Prudential and to provide greater transparency around the composition of our U.S. workforce. In 2021, we enhanced our diversity disclosures by publishing EEO-1 data and the results of our pay equity analysis for our U.S. employees.", "We also expanded our policy of tying compensation plans for senior executives to the achievement of workforce diversity goals. As I noted earlier, we believe our sustainability commitments and transformation to become a higher growth, less market-sensitive, and more nimble business are closely connected. Together, they help us fulfill our purpose of making lives better by solving the financial challenges of our changing world by expanding access to investing insurance and retirement security for customers and clients around the globe. Before turning it over to Rob, I'd like to thank all of our employees for their unwavering dedication to the customers and communities we serve, particularly in light of the continued challenges created by the pandemic.", "I am proud of the progress we made and the momentum we built in 2021 and look forward to making an even more meaningful difference in the lives of all our stakeholders in 2022 and beyond. Thank you for your time this morning. And with that, I'll turn it over to Rob." ] }, { "name": "Rob Falzon", "speech": [ "Thanks, Charlie. I'll provide an overview of our financial results and business performance for our PGIM, U.S., and international businesses. I'll begin on Slide 7 with our financial results. For 2021, pre-tax adjusted operating income was $7.3 billion or $14.58 a share on an after-tax basis.", "Results for the year included a benefit from the outperformance of variable investment income that exceeded target returns by about $1.6 billion, reflecting market performance, strategy, and manager selection. In the fourth quarter, pre-tax adjusted operating income was $1.6 billion or $3.18 a share on an after-tax basis, while GAAP net income was $3.13 per share. Of note, our GAAP net income includes realized investment gains and favorable market experience updates that were offset by a goodwill impairment that resulted in a charge of $837 million net of tax. This charge reflects two main drivers of a reduction in the estimated fair value of Assurance.", "First, we acquired capabilities to increase access to more customers, and we have experienced good revenue growth. However, this growth has been slower than expected and we are now assuming it will take longer to monetize into earnings and cash flow. And second, we have seen a significant decline in publicly traded peer valuations, which is a key input in our assessment of fair value. Turning to the operating results of our businesses.", "PGIM, our global asset manager, had record asset management fees driven by record account values of over $1.5 trillion. Relative to the year-ago quarter, earnings reflected the elevated level of other related revenues last year as well as higher expenses supporting business growth in the current period. Results of our U.S. Businesses increased 13% from the year-ago quarter and reflected higher net investment spread, including a greater benefit from variable investment income, higher fee income, primarily driven by equity market appreciation, partially offset by higher expenses driven by a legal reserve and less favorable underwriting experience due to COVID-19-related mortality.", "Earnings in our international businesses increased 5%, reflecting continued business growth, lower expenses, and higher net investment spread. Turning to Slide 8. PGIM continues to demonstrate the strength of its diversified capabilities in both public and private asset classes across fixed income, alternatives, real estate, and equities as a top 10 global investment manager. PGIM's investment performance remains attractive with more than 95% of assets under management outperforming their benchmarks over the last three, five- and 10-year periods.", "This performance has contributed to third-party net flows of $11 billion for the year, with positive flows across U.S. and non-U.S.-based clients in both public and private strategies. As the investment engine of Prudential, success, and growth of PGIM and of our U.S. and international insurance businesses are mutually enhancing.", "PGIM's asset origination capabilities, investment management expertise, and access to institutional and other sources of private capital provide a competitive advantage by helping our businesses to bring enhanced solutions, innovation, and more value to our customers. And our businesses, in turn, provide a source of growth for PGIM through affiliated flows and unique access to insurance liabilities that complement its successful third-party track record of growth. PGIM's sixth consecutive quarter of record asset management fees reflect strong business fundamentals and record assets under management. We continue to expand our global equity franchise to grow our alternatives and private credit business, which has assets in excess of $240 billion across private credit and real estate equity and debt and benefits from our global scale and market-leading positions.", "Notably, PGIM's private businesses deployed nearly $50 billion of gross capital, up 33% from last year. Now turning to Slide 9. Our U.S. Businesses produced diversified earnings from fees, net investment spread, and underwriting income and also benefit from our complementary mix of longevity and mortality businesses.", "We continue to shift our business mix toward higher growth and less interest rate-sensitive products and businesses to transform our capabilities and cost structure and to expand our addressable markets. Our product pivots have worked well, demonstrated by continued strong sales of our buffered annuities, which were nearly $6 billion for the year, representing 87% of total individual annuity sales. These sales reflect customer demand for investment solutions that offer the potential for appreciation from equity markets combined with downside protection. We have also exercised discipline through frequent pricing actions and our sales benefit from having a strong and trusted brand and a highly effective distribution team.", "Our individual life sales also reflect our earlier product pivot strategy with variable products representing 71% of sales for the year. Our retirement business has market-leading capabilities, which drove robust international reinsurance and funded pension risk transfer sales, including a $5 billion transaction, which was the fourth largest in the history of the market during 2021. And reflected strong persistency and revenue growth in 2021 across all segments. With respect to Assurance, our digitally enabled distribution platform, total revenues for the year were up 43% from last year.", "Turning to Slide 10. Our international businesses include our Japanese life insurance companies, where we have a differentiated multichannel distribution model as well as other businesses focused on high-growth emerging markets. We remain encouraged by the resiliency of our unique distribution capabilities, which have maintained the stability of our sales and our in-force business despite the pandemic. In Japan, we are focused on providing high-quality service, growing our world-class sales force and expanding our geographic coverage and product offerings.", "Our needs-based approach and mortality protection focus continue to provide important value to our customers as we expand our product offerings to meet their evolving needs. In emerging markets, we are focused on creating a carefully selected portfolio of businesses and regions where customers' needs are growing where there are compelling opportunities to build market-leading businesses and partnerships and where Prudential -- the Prudential enterprise can add value. As we look ahead, we're well-positioned across our businesses to be a global leader in expanding access to investing, insurance and retirement security. We plan to continue to invest in growth businesses and markets to deliver industry-leading customer experiences and create the next generation of financial solutions to better serve the diverse needs of a broad range of customers.", "And with that, I will now hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 11, which provides insight into earnings for the first quarter of 2022 relative to our fourth quarter results. Pre-tax adjusted operating income in the fourth quarter was $1.6 billion and resulted in earnings per share of $3.18 on an after-tax basis. To get a sense for all our first quarter results might develop, we suggest adjustments for the following items: first, variable investment income outperformed expectations in the fourth quarter by $440 million.", "Next, we adjust underwriting experience by a net $90 million. This adjustment includes a placeholder for COVID-19's claims experience in the first quarter of $195 million, assuming 75,000 COVID-19-related fatalities in the U.S. While we have provided this placeholder for COVID-related claims experience, the actual impact will depend on a variety of factors such as infection and fatality rates, geographic and demographic mix and the effectiveness of vaccines. Third, we expect seasonal expenses and other items will be lower in the first quarter by $105 million.", "Fourth, we anticipate net investment income will be reduced by about $10 million, reflecting the difference between new money rates and disposition yields of our investment portfolio. And last, we expect the first quarter effective tax rate to normalize. These items combined get us to a baseline of $2.73 per share for the first quarter. I'll note that if you exclude items specific to the first quarter, earnings per share would be $3.17.", "The key takeaway is that the underlying earnings power per share continues to improve and has increased 9% over the last year, driven by business growth, the benefits of our cost savings program, capital management and market appreciation. While we have provided these items to consider, please note there may be other factors that affect earnings per share in the first quarter. As we look forward, we have also included seasonal and other considerations for 2022 in the appendix. Turning to Slide 12.", "We continue to maintain a robust capital position and adequate sources of funding. Our capital position continues to support a AA financial strength rating and we have substantial sources of funding. Our cash and liquid assets were $3.6 billion and within our $3 billion to $5 billion liquidity target range and other sources of funds include free cash flow from our businesses and contingent capital facilities. Turning to Slide 13 and in summary, we are executing on our plans to reposition our businesses and we are on track to achieve our targeted cost savings.", "And with the support of our rock-solid balance sheet, we are thoughtfully deploying capital. Now I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our first question today is coming from Ryan Krueger from KBW. Your line is now live." ] }, { "name": "Ryan Krueger", "speech": [ "Hi. Good morning. The recent acquisitions that you've talked about have not utilized a material amount of capital. I guess, given the amount of capital that you are freeing up from the full-service retirement and variable annuity block sales, would you consider deals that were a bit larger in size if they're available and they need the opportunities you're looking for?" ] }, { "name": "Charlie Lowrey", "speech": [ "Hey, Ryan. This is Charlie. I'll answer that question. And let me offer a couple of comments.", "First, one of the major tenets of our strategy is to be prudent stewards of capital. And we're doing that by balancing three factors. One is investment in our existing businesses to achieve business growth. The second is programmatic M&A, and the third is returning capital to shareholders.", "But with regards specifically to your question in terms of acquisitions, what we can say is they're going to be consistent with our stated strategy of growing PGIM and emerging markets, by which we can expand and extend our capabilities or our distribution or increase the scale of our existing businesses. And to your point, we'll be looking at a variety of opportunities in different sizes. But what we can also say is that regardless of size, we will evaluate the strategic and financial merits of each transaction with the obvious observation that the larger the transaction, the more financially compelling that transaction needs to be. And as we've said, we will have a programmatic approach, right, as demonstrated by the three acquisitions we did last year and as we've actually done for a couple of decades in both areas where you've seen us make numerous acquisitions in both emerging markets and asset management at various scales." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks. And then from a divestiture standpoint, are you still looking to do more, whether it be in U.S. individual life or more in variable annuity?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah. Sure. Ryan, it's Charlie again. I'll take that.", "So first of all, we're focused on closing the existing transaction that you referred to. And that we've signed -- and just as an update, we're on track to close both those transactions in the first half of 2022. But we continuously see opportunities within the businesses and the existing blocks that we have to optimize capital and reduce market sensitivity while improving the consistency and the predictability of our financial results with the goal of creating additional value for shareholders. But as we've said in the past, we'll continue to be thoughtful as we progress toward the goal of becoming a more nimble, less market-sensitive and a higher-growth company.", "So we'll continue to look for opportunities as they arise and execute accordingly." ] }, { "name": "Andy Sullivan", "speech": [ "Ryan, it's Andy. Let great progress on derisking in our annuities business. And as we've talked about before, that's a two-step process to derisk the legacy. Step one is all about runoff, and we are very much on track.", "We're seeing the expected runoff. We saw a $3.8 billion in runoff in the quarter. And we saw over $18 billion in runoff in the year. So runoff is a significant contributor to derisking.", "As Charlie said, step two was about doing the derisking transaction. And obviously, we're very pleased with the PALAC sale and that represents about 20% of our legacy account values. So as Charlie said, we're going to continue to explore how to further derisk the remaining legacy, but we are very focused right now on closing the Fortitude Re deal in a high-quality manner." ] }, { "name": "Ryan Krueger", "speech": [ "OK." ] }, { "name": "Operator", "speech": [ "Your next question is coming from Elyse Greenspan from Wells Fargo. Your line is now live." ] }, { "name": "Elyse Greenspan", "speech": [ "Thanks. Good morning. My first question is on the write-down that you guys took within Assurance IQ. Can you just give us a sense of the contributions? You mentioned lower earnings and cash flows as well as public peer valuations.", "Can you give us a sense of the contributions of each when you came up with the goodwill write-down that you took in the quarter?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. It was -- Elyse, it's Ken. It is a good combination of both. So we -- each quarter, we assess the conditions and the fair value of the business.", "We've been doing that since we've acquired it. We incorporated the recent experience from the Medicare annual enrollment and we looked at the updated values for multiples of peers. And so that all went in. And so it was both a combination of our updating for recent experience as well as the recent multiples in the market for peers." ] }, { "name": "Elyse Greenspan", "speech": [ "OK, thanks. And then maybe a follow-up on the capital side. So you guys mentioned that the PALAC and full-service retirement transactions are on track for a half year 1 close. At some point, if M&A transactions either don't materialize or don't materialize to a higher magnitude, would you guys consider raising the repurchase authorization for 2022 above the $1.5 billion?" ] }, { "name": "Charlie Lowrey", "speech": [ "So Elyse, this is Charlie. I think what we've said and what we'll continue to say is, again, we're going to be prudent stewards of capital. And to the extent that we can't find opportunities to execute on our strategy, we'll consider returning capital. And if you saw what we did last year, we actually increased the share buybacks by $1 billion in two $500 million segments.", "We've done it in the past, and we will continue to be prudent stewards of capital as we go forward and consider all our opportunities." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Next question is coming from Erik Bass from Autonomous Research. Your line is now live." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. Can you talk about flow trends at PGIM in the new business pipeline heading into 2022? And are you seeing much shift in demand for fixed income given the rise in interest rates?" ] }, { "name": "Andy Sullivan", "speech": [ "Eric, it's Andy. I'll take your question. As we've discussed in the past, obviously, PGIM flows will vary quarter to quarter. And in the fourth quarter, we experienced overall flat flows.", "As you saw, our retail outflows were $3.6 billion. Market volatility really led to client rotation out of our sub-advised equities and out of our core and core-plus fixed income into shorter duration strategies. That was counteracted by very strong inflows on the institutional side and in particular, in fixed income, as many pension plans allocations rotate in this type of an environment. I would say it's important to note, if you look at our fixed income business overall across both institutional and retail, overall, we had positive flows in the quarter despite facing the rising rate environment.", "That is a real testament to the diversification of our distribution and of our portfolio. As we've always said, we think it's very important to look at the long-term track record when it comes to flows. We have done 60 billion in flows over the last five years and we did 11 billion in 2021. Specific to your question around the retail side and what we are seeing from a fixed income perspective, we have seen 27 billion in retail flows over the last five years and our retail assets under management have doubled in that timeframe, really driven by the positive flows that we see, the alpha performance that we've seen and end markets.", "So we've been very successful there. Flows are an outcome of having outstanding capabilities, exceptional investment performance and great distribution, and we feel very strongly we have all of those and we'll be a net winner over time, and we've proven our ability to succeed across all different market conditions." ] }, { "name": "Erik Bass", "speech": [ "Thank you. And then can you provide some more color on your group results this quarter, both for group life and disability?" ] }, { "name": "Andy Sullivan", "speech": [ "Sure, Eric, it's Andy. I'll keep going, and I'm going to split this out between group life and group disability. I'll start on the group life side. As we've all seen Delta and now omicron are having a big impact on the country.", "U.S. deaths were higher than 3Q. So we saw 126,000 U.S. deaths in 4Q versus 94,000 in 3Q.", "As a top-three life carrier, we have a big broad book of business. There's two effects really on the Life side that I would note. The first very similar to third quarter. And that's we have a high concentration of large retail and healthcare employer accounts.", "If you think about it, those are employers that have a high number of frontline workers that are out and about and exposed on a daily basis. And also many of those workers are in low vaccination geographies. The second effect we saw is while in this quarter, we did see a slight shift to older age, we're still seeing significant increase in incidence rates in the under 55 population. And that population tends to have larger dollar amount policies.", "If I shift over to the disability side, I'd start by saying most of our impact in the quarter in the business was on the Life side. But we are seeing some impacts on the disability side as well. I would frame this, it's what we expected to see and what we prepared for, for the disability business. Our ratio -- benefit ratio was 87.3.", "That was 320 bps better than a year ago. There's really two effects. On the STD assets side of the business, we are seeing increased volumes. If you think about the impact that omicron has had as an example and the isolation rules, that drives the STD in absence.", "But that's a fee-based business. So the effect we're seeing there really is enhanced expense showing up in the admin ratio. We staffed up to make sure that we're there for our customers because that's job 1. On the LTD side, much like third quarter, we continue to see about a 10% increase in incidents and about a 10% increase in severity.", "But again, it's what we expected, and it is what we prepared for from a claims management perspective. So we're just proud to be able to deliver on our promises to our customers. And as the pandemic subsides or as it flows into being more of an endemic, we know that our benefit ratios will come back into the normal range." ] }, { "name": "Erik Bass", "speech": [ "Thank you. Appreciate the color." ] }, { "name": "Operator", "speech": [ "Your next question is coming from Andrew Kligerman from Credit Suisse. Your line is now live." ] }, { "name": "Andrew Kligerman", "speech": [ "Hey, thanks a lot. Want to kind of shift back to M&A. As I think about the Prudential over the last two decades, the company has done a lot of excellent M&As. But the Assurance IQ, which -- with this write-down today, kind of puts a little bit of a shade on it.", "And Charlie, you've talked about programmatic M&A, being prudent. So what I'd like to know is how does the Assurance IQ acquisition, how does that I think you think about acquisitions going forward, particularly in terms of accretion dilution?" ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. It's Charlie. So let me take that, Andrew. Let me take a step back and explain exactly why we did the assurance transaction and the function it plays within our business mix.", "Assurance is a young and innovative company that it is completely aligned with our purpose and our strategy. It's helping us expand our addressable market which is something we want to do and increase access to more customers, especially a customer base that's traditionally been underserved by our industry, and that's absolutely aligned with our purpose. Secondly, it's a digitally based platform, frankly, in which we were underinvested and is a new space for us, but one that we wanted very much to be in. And third, from a strategic perspective, it's helping us to reduce market sensitivity by increasing our mix of fee-based earnings which is entirely consistent with what we talked about of becoming a more nimble, less market-sensitive and higher-growth company.", "Now as we look forward, as I mentioned earlier in the call that the acquisitions we'll be making, they are going to be in PGIM and emerging markets, and they'll be focused on -- will be focused on acquiring more mature businesses, again, by which we can expand and extend our capabilities or our distribution or our scale over time. And this is absolutely in our wheelhouse, right? This is what we've been doing for decades in both emerging markets and asset management. And have made, I won't say hundreds, but tens of successful acquisitions over that time period. So we feel very good about the strategic merits of the Assurance deal and the role it plays within our company." ] }, { "name": "Andrew Kligerman", "speech": [ "And any comment on accretion dilution you might add to that?" ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. Let me talk about the metrics that we use for a moment. So when we think about acquisitions from both -- we think about them both from a strategic and a financial perspective. And strategic perspective, we look to add capabilities, as I said, such as product or distribution or increasing scale in a market or country.", "And from a financial standpoint, we look at a variety of metrics when assessing potential acquisitions such as earnings contribution and growth, etc. Now obviously, the larger the transaction, the more compelling the financial aspects of the transaction has to be. But importantly, I think our focus is on becoming a higher growth, again, less margin-sensitive and more nimble business, and we're going to continue to be extremely thoughtful and disciplined goal of creating value for all our stakeholders." ] }, { "name": "Andrew Kligerman", "speech": [ "OK. Got it. And just real quickly on the expenses. It looks great that you're targeting $750 million in savings by '23.", "And that's -- I think you've completed 635 so far per the slides, and that's up from an initial 500. Do you think beyond that, you could do more in expense saves?" ] }, { "name": "Ken Tanji", "speech": [ "Andrew, it's Ken. We've made excellent progress, both in terms of not just gaining efficiencies and lowering costs, but also building capabilities. And as we have done that on an accelerated basis relative to our initial targets, we remain certainly focused, again, both on building capabilities, but also gaining efficiency to drive growth going forward. We're very much on track to achieve $750 million by 2023.", "And at this point, we've really institutionalized both capabilities but also a mindset across the company of continuous improvement. And we're getting good payback on our initiative costs. So we expect to maintain a budget for that and also maintain this discipline going forward. Right now, we're focused on achieving that $750 million by 2023, and that's our main objective." ] }, { "name": "Andrew Kligerman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question today is coming from Tom Gallagher from Evercore. Your line is now live." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. Just a question on sort of sources and uses of capital. How should we think about the $4.5 billion of proceeds plus coming from the deals? How much of that do you think is free and clear for you to use? How much do you think you might need to use to bolster capital levels, if any of it is? I ask only because just looking at the HoldCo levels, I guess you're getting closer to the low end of the target now. I'm wondering if you want to bolster that back up to the top end.", "And also maybe any comments you have at any subsidiary levels that you'd like to strengthen capital, if at all, or you find across the board there? And any debt reduction?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Tom. It's Ken. I'll take that.", "You should think of that $4 billion of or more proceeds coming in from our two transactions as free and clear and readily deployable. It will quickly move to the holding company upon the close of the transaction. And just in general, we've had a very consistent approach to capital management. Our businesses are generating free cash flow.", "And also last year, we reduced debt. So that we thought it was a good time to reduce debt. And so we certainly have debt capacity as well. And now we also have the $4 billion of proceeds coming in.", "So we feel really good about our capital position and our liquidity and our flexibility and including being well-positioned to meet our objective of returning $11 billion to shareholders over the three-year period 2021 to 2023." ] }, { "name": "Tom Gallagher", "speech": [ "Got you. Thanks, Ken. And then my follow-up is just I was looking at your supplement and saw that you had operating debt of $5.6 billion that was issued out of the holding company. Now I guess I've always typically thought about operating debt getting issued out of the operating subs, not out of the holding company because it's kind of higher-rated entity.", "But can you talk a little bit about what is that exactly, the operating debt that's issued out of the holding company?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. So we consider operating debt to be funding that fund sort of a specific asset or structure that where the cash flows from that asset or structure will pay off the debt. And some examples would be within our PGIM business. We do co and seed investments that are funded both with capital to support the risk of those investments, but also operating debt.", "And we find that efficient to do that from the holding company. Our PGIM business also has an agency mortgage business, where we fund loans from time to time, again, where those loans would support that operating debt. So those are two examples. But again, it's where specific assets or structures will support that debt." ] }, { "name": "Tom Gallagher", "speech": [ "Got you. Thanks." ] }, { "name": "Operator", "speech": [ "Next question is coming from John Barnidge from Piper Sandler. Your line is now live." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much. My first question, is there any way to bifurcate VII between marks and realized gains?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. We do look at that and you should think of it as variable investment income is both balanced between cash coming from distributions as well as appreciation in the mark-to-market. Usually, it's pretty balanced. Last year, a little bit more appreciation than cash just given the move in the market." ] }, { "name": "John Barnidge", "speech": [ "Great. And my follow-up, given the focus on large and jumbo within group, how much of the contracts there have seen pricing increases since COVID emerged?" ] }, { "name": "Andy Sullivan", "speech": [ "So it's John, Andy. I'll take your question. So I don't have the exact percentage at my fingertips, but I'll make some high-level commentary. So as I think you're very aware, those contracts renew anywhere from every two years to say, every five years, and it's very much based on the size of the business with the smaller cases renewing more frequently every two years and large national accounts renewing approximately every five years.", "80% of our group insurance block of business is national accounts. So our renewal cycle, they would tend to be more toward the longer end of that spectrum. . From a pricing perspective, now that we're entering the third year of the pandemic and it's probable at least that this will go from pandemic to endemic, we very much felt that we needed to take our COVID experience from the last 24 months and to put it into our new business and renewal business pricing. And we have done that on both the life and disability side.", "So that business will reprice over the next few years." ] }, { "name": "John Barnidge", "speech": [ "Thank you. Best of luck." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question is coming from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. I wanted to circle back to your comment about completing a $5 billion PRT deal, the fourth largest in market history. So I recall, Andy, in a group meeting, you mentioned that more competitors have entered the space something like 15 to 20, and probably six or seven of those are consistently trying to do these over $1 billion transaction. So I'm just wondering if pricing is getting too frothy for these mega deals and have your view of IRR change due to competition?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Tracy, so it's Andy. Thank you for your question. So yes, we did two transactions in the fourth quarter for $210 million.", "And as you noted, that was on the heels of a very successful transaction in 3Q, which ended up being the largest transaction of the year and we were one of the top writers of the year. I guess I'd make two comments. One, the market outlook here for the size of the market remains very strong. The funding levels are at the strongest they've been in 10 years, funded status at the end of November was at 98%.", "So we believe that the market is going to stay large. And as a pioneer and a leader in the space, to your point, despite it becoming more competitive, there are more competitors, we are still seeing that we -- by being disciplined with underwriting and pricing, we could pick our spots. And we could pick our spots and given the size of the market, we'll win our fair share and we'll be able to continue to grow that business, thanks to our brand and our capabilities." ] }, { "name": "Tracy Benguigui", "speech": [ "That's very helpful. And here's like, I guess, a bigger picture question on wage inflation. I guess, on one hand, that could maybe boost sales. But on the other hand, there are these talent shortages.", "So I'm wondering how that may also impact expenses, if you could provide some color?" ] }, { "name": "Rob Falzon", "speech": [ "Tracy, it's Rob. I'll take a first stab at that. And Andy, if you want to jump in, please feel free to do so. I guess, Tracy, I'd start by bringing it up a level, which is the most significant impact of inflation would be on rates.", "And that would be -- if inflation actually leads to higher rates, that's a good thing for the industry and for us included as a part of that. With respect to operating costs, your specific question, one, I would note that our ongoing efficiency initiatives will help to mitigate any impact that we would have on increases that come through. Secondly, we are quite comfortable that we have sufficient pricing power in most -- in our most material products and markets that if the -- that to the extent there's a residual impact, we'll be able to incorporate that into pricing. And I'd add that while inflation is a macro factor that we're very much looking at how it influences the upcoming year, there are a number of other things happening from a macro standpoint beyond inflation.", "And we believe that there will be drivers actually to tailwinds that will get created for our businesses, things like higher rates and an improving outlook for COVID. Andy, I don't know if you want to add anything more specific on a business-level basis." ] }, { "name": "Andy Sullivan", "speech": [ "Maybe the only thing I would add is, Tracy, both our U.S. insurance and retirement businesses and our PGIM business, we're big, we're broad, we're well diversified. And there are plenty of spots in our business system where this environment is very good. And I just mentioned, we are one of the largest real estate investors in the world, No.", "3 by assets under management. And obviously, an inflationary environment could be very helpful for that business." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question is coming from Humphrey Lee from Dowling and Partners. Your line is now live." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning, and thank you for taking my question. I just have a question related to group disability. In the slide deck, you talked about you looking to diversify your group insurance portfolio and looking to expand into group disability and voluntary product. Can you just talk about how you are planning to do that, especially with some of the industry disability results recently seeing some pressure? How do you balance growing market share at the same time achieving adequate pricing?" ] }, { "name": "Andy Sullivan", "speech": [ "Sure, Humphrey. It's Andy. So let me first bring it up a level to talk about how do we think about this strategically. So as we've talked about expanding our addressable market and bringing more solutions to more people, we continue to believe that the workplace is a great place to grow because of the reach and access that it gives us.", "We've been executing on a strategy in our group business very consistently over the last five years to grow and in particular, to grow in certain spots, to grow in middle market, so smaller cases, to grow our disability block and to grow our voluntary capabilities in block so that we diversify the business further. And that makes a lot of sense because a lot of clients in the group space bundle. As I said earlier, the majority of our business at group insurance is large national account and the majority is life. So we feel we have a lot of room to grow.", "And in essence, we're going to stay the course on our value prop. We've invested quite significantly in strengthening our overall value prop, both our financial wellness capabilities but also our core fundamental capabilities in both life and disability. Your question about how do you do it in an environment like we're in? It's all about discipline, right? It's about being disciplined in pricing and underwriting and making sure that you -- especially on the disability side, that you maintain strong disability claims expertise and staffing, so that you could properly manage the business in an environment where we're seeing increased incidence and severity." ] }, { "name": "Humphrey Lee", "speech": [ "So my follow-up to that is in kind of your strategic review, you talked about M&A area would be asset management and emerging markets. But given your interest now in expanding disability and voluntary benefits in the work site, is now group insurance be in other area of potential M&A? Or are you still sticking to kind of asset management in emerging markets?" ] }, { "name": "Charlie Lowrey", "speech": [ "So Humphrey, this is Charlie. For now, our concentration is going to be on asset management and emerging markets. Those are two areas where we think we have we can benefit significantly from the increase in capabilities and scale in the markets in which we already are doing business. And so that's going to be our focus in the -- certainly in the near to medium term.", "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from Suneet Kamath from Jefferies. Your line is now live." ] }, { "name": "Suneet Kamath", "speech": [ "Great. Thanks. Charlie, a year ago, we talked about wanting to increase the earnings contribution from growth businesses from, I think the math was 18% to over 30%. And I'm just wondering, is that still on the table because it would seem that that might be difficult without M&A, but I was just wanting to get your thoughts on whether you can get there organically." ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. That remains our goal in two to three years. But as you point out, we'll be doing it through a combination of a couple of things. One is -- or three things, really.", "One is organic growth. So we will be continuing to invest in our businesses. One is to get there. And the third is really the dispositions of either lower growth or market-sensitive businesses.", "And you've seen us begin to execute on that with the two transactions that we're going to close this year.And that's all within, again, the context of being prudent stewards of capital, of investing in our business, having programmatic M&A, and returning capital to shareholders. So the short answer of your question is, yes, that still remains our goal, and we'll do it through a combination of factors." ] }, { "name": "Suneet Kamath", "speech": [ "And is it fair to say that the M&A piece might need to be the biggest of the 3? Or do you think it's sort of evenly distributed across the 3?" ] }, { "name": "Charlie Lowrey", "speech": [ "It's hard to say whether -- what the percentages will be. It will depend on the opportunities we see, both organically and inorganically, and the dispositions that we make. So it's sort of a multivariable equation, if you will, but we're looking to balance that equation and do it thoughtfully and prudently." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. Makes sense. And then I just wanted to ask about international sales, if we focus on Japan and Gibraltar. It looks like sales have kind of been flattish.", "Just wondering if -- or is the reason sort of the COVID impacts and lack of face-to-face or do you have to do some more work in terms of the product set that you guys are offering, both in Gibraltar and the Life Planner model." ] }, { "name": "Scott Sleyster", "speech": [ "Suneet, this is Scott. Let me give a little more context on why the sales are down, and then I can talk about what we're doing. First of all, our bank channel is subject to a higher level of variability and given when there are shifts in the competitive market. And given both COVID-related headwinds, but also higher U.S.", "dollar interest rates, the regional banks have shifted to easier to sell investment products. As you know, we maintain a strong pricing discipline on deposit products, and we've always concentrated our efforts on selling recurring premium death protection products in that channel. There was a second factor during the fourth quarter, where we're making some product shelf adjustments in our Life Consultant channel, and we're in the process of updating our U.S. dollar annuity offerings and we expect the majority of the new products to be in place by the end of the first quarter.", "So I think that explains why we were down. The actions that we're taking, in the bank channel, look, we intend to maintain our discipline, but we do think the market will evolve over time, especially as COVID restrictions are relaxed. Additionally, in Japan, we continue to go front and center with our death protection products. But increasingly, we've been adding to our product line with more retirement, wealth transfer, and health products.", "And we believe, given those product line increases, coupled with really high-quality distribution there in Life Planners and Life Consultants, we'll be able to counteract this. We're actually pretty optimistic about going forward there." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Alex Scott from Goldman Sachs. Your line is now live." ] }, { "name": "Alex Scott", "speech": [ "Yeah. I guess for my first one, I just had a follow-up on international. When I think through sales and persistency, it seems for at least the near term, I think premium growth will kind of continue to be the same or if not a little lower than you've had. And when I look at earnings over the last few years, it seems like G&A expenses declining has allowed for you guys to defend earnings in a pretty strong way.", "And I just wanted to probe there a little bit and understand what have you been doing to take expenses out? And is that something you can continue to do to help earnings in international?" ] }, { "name": "Scott Sleyster", "speech": [ "Yes. There's a couple of different comments I'll give there. First of all, just like the U.S. transformation, the international business, Japan, and others have been looking for ways to be more efficient and to use automation and other activities to control costs.", "Also in some of our emerging markets, we're experiencing faster growth. So we're starting to see some scale benefits. And then finally, we've done a good job of cost control at the corporate center level. That being said, I think our opportunities to grow earnings internationally are much more driven by the revenue actions that I alluded to in the product actions and the distribution force actions that are taking place in both LP and LC.", "So we're always going to be disciplined on the expense front, but I think it's more of the product and the emerging market growth areas that we think will be more important going forward. Lastly, I would say, of course, COVID has made it more challenging to recruit Life Planners and Life Consultants. And we do expect that to ease as the pandemic eases or turns into an endemic." ] }, { "name": "Alex Scott", "speech": [ "Got it. And then maybe for a follow-up, there was a long-term care insurance underwriter that had a pretty sizable gross charge associated with reimbursement policies and the impacts of inflation. And I just wanted to find out from you all, what do you feel like your exposure is to that? And will that have any impact on your stat filings and the required reserves? And is there any material impact to cash flow we should consider?" ] }, { "name": "Ken Tanji", "speech": [ "No. The short answer is no. We do factor in inflation into our assumptions, and we're well-positioned for an elevated level of inflation in the near term. And we continue to see claims experience consistent with our assumptions and actually a little bit more favorable." ] }, { "name": "Alex Scott", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Our next question is coming from Mike Zaremski from Wolfe Research. Your line is now live." ] }, { "name": "Mike Zaremski", "speech": [ "OK, great. Just one question and a follow-up on the pension marketplace comments. You mentioned that funding levels at their highest levels looks like since the great financial crisis, but not above 100 yet. Just curious, is there kind of like a magic number, given there's costs associated with it, pension funding levels, let's say, we had a good market in -- macro market in '22, if they got to like 103, 105.", "Or is there a magic number that would kind of cause sales to an uplift?" ] }, { "name": "Andy Sullivan", "speech": [ "Mike, it's Andy. I'll take your question. And the answer is, we don't believe so. At 98%, plan sponsors are very willing to lean in and to transact.", "I think plan sponsors, when they're in this range and they see the volatility in the marketplace, it really drives the desire to transact and to derisk their pension plans. So there's no magic number. Having said that, we think at these levels, we're going to continue to see robust markets." ] }, { "name": "Mike Zaremski", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. We've reached end of our question-and-answer session. I'd like to turn the floor back over to Mr. Lowrey for any further or closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, and thank you for joining us today. 2021 was a year of transformation for Prudential in which we reached a record high level of after-tax operating earnings, distributed a record amount back to shareholders, and made real progress toward becoming a more nimble, less market-sensitive, and higher-growth company. As we look ahead to 2022 and beyond, we are focused on creating and driving growth and becoming a global leader in expanding access to investing insurance and retirement security. We are both excited about and confident in our strategy and our ability to create value for all our stakeholders by building even further upon our progress.", "We look forward to sharing more with you along the way, and thank you again for joining us today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2018-02-08	[ { "description": "Senior -- Vice President", "name": "Mark Finkelstein", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "John Strangfeld", "position": "Executive" }, { "description": "Vice Chairman", "name": "Mark Grier", "position": "Executive" }, { "description": "-- Chief Financial Officer", "name": "Rob Falzon", "position": "Executive" }, { "description": "-- Head of Domestic Businesses", "name": "Steve Pelletier", "position": "Executive" }, { "description": "-- Head of International Businesses", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "-- Autonomous -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "-- Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "-- JP Morgan -- Analyst", "name": "Jimmy Buehler", "position": "Analyst" }, { "description": "-- Dowling & Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by. Welcome to the Prudential Quarterly Earnings Call, Fourth Quarter 2017. During today's conference all participants will be in a listen-only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. If you should require assistance during today's conference, please press the * followed by the 0 on your telephone keypad and a specialist will assist you offline. As a reminder, today's conference is being recorded. I now like to turn the conference over to your host, Mr. Mark Finkelstein. Please go ahead." ] }, { "name": "Mark Finkelstein", "speech": [ "Thank you, Shannon. Good morning and thank you for joining our call. Representing Prudential on today's call are John Strangfeld, CEO, Mark Grier, Vice Chairman, Charlie Lowrey, Head of International Businesses, Steve Pelletier, Head of Domestic Businesses, Rob Falzon, Chief Financial Officer, and Rob Axel, Principle Accounting Officer.", "We will start with prepared comments by John, Mark, and Rob, and then we will answer your questions. Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the section titled Forward-Looking Statements and Non-GAAP Measures of our Earnings Press Release, which can be found on our website atwww.Investor.Prudential.com. And with that, I will had it over to John." ] }, { "name": "John Strangfeld", "speech": [ "Thank you, Mark. Good morning everyone and thank you for joining us. 2017 was a strong year for Prudential. We exceeded our earnings objectives for the year and are showing solid momentum across our business. I will provide some higher level observations on results for the fourth quarter and full year, the underlying fundamental trends in our businesses, and capital deployment. I will then hand it over to Mark and Rob to go through the specifics.", "Fourth quarter operating earnings excluding market-driven and discrete items of $2.68 per share exceeded the prior year of $2.43 per share. The increase reflects business growth and higher PGIM incentive fees, partially offset by lower underwriting margins and an increase in expenses. Recall, that fourth-quarter results typically include elevated expenses, which we estimate to be approximately $0.25 per share for the current quarter.", "Turning to full-year results, operating earnings excluding market-driven and discrete items were $11.31 a share for 2017, well above the prior year of $9.65 per share. This also exceeded the top end of the guidance range we established in December of 2016. Similarly, the operating return on equity of nearly 14% for the year was above our 12 to 13% near-to-intermediate term objective. While full-year results benefited from favorable markets and investment results, as well as other items that can fluctuate, we are pleased with the core growth and underlying margins in our businesses overall.", "I would also highlight that adjusted book value per share increased 12% over the prior year-end. While this includes a benefit from the Tax Cuts and Jobs Act, which Mark will discuss in more detail, adjusted book value per share increased a solid 8%, excluding this benefit.", "So overall, it was a very good year on almost all measures. While our base case for 2018 does not assume that we will produce the same return on equity that we did in 2017, the underlying themes around the quality of our businesses and consistency in execution should enable us to continue to produce returns exceeding industry averages and generate significant free cash flow while also enabling us to continue to invest in our businesses for future growth.", "I will now touch on some of those themes in discussing the performance of our businesses. I'll start with our retirement business, which continues to perform exceptionally well. Core growth remains robust with nearly $9 billion of positive net flows during 2017, which contributed to 11% year-over-year account value growth. Likewise, underwriting margins in the business continue to exceed our expectations, particularly in our flagship pension risk transfer business. Our success in this business is a direct reflection of the differentiating capabilities that we deliver and we continue to see retirement as a source of long-term growth going forward.", "In investment management, we achieved another important milestone. As 2017 marks the 15th year of positive net flows from institutional clients and 13th consecutive year from retail clients. Over the last five years, unaffiliated third-party assets under management have grown annually at above 10%, including 15% in 2017. We continue to benefit from our multi-manager model, strong investment performance across strategies, positive outcomes from our recent initiatives. And while there are many challenges facing active investment managers, which we're not immune to, we continue to generate strong growth in assets under management and stable overall fee rates leading to favorable financial results and a positive outlook.", "We are also seeing strong performance out of our individual annuities business. Although industrywide sales have been under pressure, we've taken thoughtful steps to manage the business more efficiently and effectively, and this has resulted in higher margins, increased amounts of free cash flow, and reduced capital volatility. Over the last two years, we have generated deployable capital in excess of $3 billion from the individual annuities business, including over $1 billion in 2017.", "In group insurance, we are pleased with the performance of the business following the pricing and underwriting actions we took several years ago. The benefits ration for 2017 was at the low end of our targeted range with solid underwriting results in both group life and disability. In individual life, while results in 2017 were below what we anticipated due to adverse mortality and actions taken as part of our annual review of assumptions, this is a well-underwritten business, and we continue to actively manage the composition of sales as the environment evolves.", "Turning to our international operations, we continue to deliver steady core growth and solid earnings and returns, including an ROE of 17% for 2017. We are particularly pleased at how our Japanese business adapted to price changes on Yen products in early 2017 through increased sales of foreign currency denominated products. Notably, US Dollar products grew 16% in 2017 and comprised over 60% of Japan's sales for the year. Looking forward, we expect our differentiated distribution model to continue to deliver stable growth at attractive margins, despite some notable headwinds that we and others face in Japan. And we continue to be optimistic that newer markets, like Brazil, will have a more meaningful impact on results over the next several years.", "I will now turn to capital deployment. We returned about $635 million to shareholders in the fourth quarter. This brings our full-year shareholder returns to $2.6 billion, about equally split between dividends and share repurchases. We generate considerable free cash flow from our businesses, which we now estimate to be about 65% of earnings over time. As a result of the higher earnings level, along with the increased share of earnings that are deployable, we have increased the amount of capital we are returning to our shareholders. In that regard, we are pleased that yesterday our board authorized a 20% increase in our quarterly dividend. This follows a similar increase in our 2018 share repurchase authorization announced in December.", "We continue to put a high priority on capital generation and return to shareholders and we do so while continuing to invest in our businesses and maintaining a strong balance sheet.", "To sum up, we're quite pleased with 2017 results. We exceeded our earnings objectives for the year and continue to show good growth and margin fundamentals across our businesses. We are also excited about the longer-term investments we are making, including those that will enable us to connect with customers with greater agility, and over time, accelerate our growth rate. The recent realignment of our domestic business organizational structure will help facilitate these initiatives.", "While items like the positive impact to earnings from the tax act will provide a near-term boost, our focus is, and always has been, on delivering long-term growth and shareholder value. We remain confident that the combination of our superior business mix and track record of innovation and execution will enable us to do just that.", "With that, I'd like to hand it over to Mark." ] }, { "name": "Mark Grier", "speech": [ "Thanks John. Good morning, good afternoon, or good evening. I'll take you through our results and then I'll turn it over to Rob Falzon, who will cover liquidity, leverage, and capital highlights. I'll start on Slide 2. After-tax adjusted operating income amounted to $2.69 per share for the quarter compared to $2.46 a year ago. After adjusting for market-driven and discrete items of $0.01 per share, EPS amounted to $2.68 for the quarter, up from $2.43 a year ago.", "Core performance of our businesses overall was solid in the quarter with results benefiting from higher fees on our annuities and investment management businesses and continued business growth in international insurance on a constant currency basis, partially offset by higher expenses. In addition, other related revenues in our investment management business of $92 million in the quarter were $70 million higher than the year-ago quarter. As a result of higher incentive fees and stronger strategic investing results. Together, these items had a net favorable impact of approximately $0.27 per share on the comparison of results to a year ago.", "Current quarter results also reflect a net benefit from certain items that varied from our average expectations. This includes non-coupon investment returns and prepayment income, which were about $90 million above our average expectations in the quarter. This was offset by the impact of less favorable underwriting results relative to expectations in our individual life and retirement businesses and other refinements that amounted to $45 million. The net effect of these items resulted in a benefit of about $0.07 per share.", "In thinking about our earnings pattern, I would also note that we estimate current quarter expenses for items such as technology and business development, advertising, annual policy holder communications, and other variable costs, were about $165 million, or $0.25 per share, above our quarterly average for the year, consistent with the historical pattern we mentioned when we discussed our third quarter results. On a GAAP basis, we reported net income of $3.8 billion for the current quarter, or $8.61 per share. GAAP net income in the current quarter was about $2.6 billion higher than our after-tax adjusted operating income and included a $2.9 billion, or $6.64 per share estimated tax benefit related to the enactment of the Tax Cuts and Jobs Act, and about $600 million of pre-tax net realized investment losses.", "Turning to Slide 3, I'll address the financial impacts of the tax act. The current quarter tax benefit of $2.9 billion from the enactment of the Tax Cuts and Jobs Act includes two key components: a $3.4 billion benefit from the remeasurement of net deferred tax liabilities arising from a lower US corporate tax rate and the adoption of a territorial tax system, and a one-time tax expense of about $500 million from the deemed repatriation of unremitted taxable earnings of foreign subsidiaries as part of the transition to the territorial tax system.", "In addition, the $2.9 billion net tax benefit increased GAAP book value per common share, as of December 31, 2017, by $6.59. This compares to an increase in adjusted book value of $2.74 per common share. The difference relates to an adjustment for deferred taxes that were originally established through accumulated other comprehensive income, primarily related to the deferred tax impact of unrealized gains and losses.", "Looking forward, we now expect that 2018 effective tax rate on adjusted operating income to be approximately 22%, as compared to our 26% expectation provided in December in connection with our 2018 financial outlook. The reduction is primarily due to applying a lower tax rate to our US business earnings.", "Moving to Slide 4, I'll cover the market-driven and discrete items for the quarter, which had a relatively small impact on results. These items include a benefit from our quarterly market and experience unlocking in the annuity business, driven mainly by the performance of equities and customer accounts, partially offset by costs incurred in corporate and other related to a debt exchange transaction, which we completed in December.", "Moving on to Slide 5, which shows the items affecting pre-tax net income that are not included in adjusted operating income. Our current quarter GAAP net income includes pre-tax net realized investment losses of $581 million and divested business results and other items outside of adjusted operating income, amounting to a net pre-tax gain of $26 million. Of note, the loss of $500 million from risk-management activities was driven by currency hedges as the US Dollar weakened compared to certain other currencies, and losses on other derivatives used in risk mitigation.", "Product-related embedded derivatives and associated hedging had a negative impact of $332 million, largely driven by the non-economic impact of applying tighter credit spreads in the calculation of our non-performance risk related to the annuities living benefits. The $338 million gain from the general investment portfolio and related activities was driven by equity and fixed income security-related gains in our international relations.", "Slide 6 shows financial highlights for the year. Earnings per share for 2017 based on after-tax adjusted operating income amounted to $11.31 after adjusting for market-driven and discrete items, which implies an ROE of 13.9%. The full-year earnings per share increased by 17% from 2016, driven by strong underlying performance across our businesses and tailwinds from equity markets and non-coupon investment returns. Also, as I noted earlier, our adjusted book value per share as of December 31, 2017, of $88.28 includes a $2.74 benefit from the impact of the tax act.", "-- our business results, I'll start on Slide 7. Let me first highlight that effective this quarter, our business segments are organized consistent with the new US business structure we announced in July. The new organization structure retains our existing segments but realigns them under new divisions.", "I will discuss the comparative results for each segment, excluding the market-driven and discrete items I mentioned previously. Annuities earnings were $525 million for the quarter, up by $103 million from a year ago. The increase was primarily driven by a greater contribution from policy charges and fee income, reflecting a 7% increase in our variable annuity average separate account values and lower risk-management costs, driven by favorable markets and hedging results, and the ongoing benefit from our second quarter update of actuarial assumptions. Partially offsetting this increase was a lower contribution from net investment spread results, primarily due to the impact of lower reinvestment yields. Returns on non-coupon investments and prepayment fees were approximately $10 million above our average expectations in both the current quarter and the year-ago quarter.", "Annuities return on assets, or ROA, of 125 basis points is down modestly from last quarter's record level. As we mentioned during our financial outlook call, a portion of the elevated ROA compared to last year is sustainable, including the impact of the Annual Actuarial Assumption Updates, and therefore, we expect to exceed our long-term ROA target of about 115 basis points in the short- to medium-term. However, over time, we expect higher risk-management costs and lower average fee rates to cause our ROA to migrate to the long-term target level.", "Slide 8 presents our annuity sales. Total annuity sales in the quarter of $1.6 billion are slightly the year-ago, but $300 million higher than last quarter. The sequential quarter increase was driven by higher HDI sales as a result of our repricing actions in October. Although account values of $165 billion set a new record driven by market appreciation, we continue to experience net outflows due to lower than historical sales levels and higher withdrawals.", "Turning to Slide 9, individual life earnings were $98 million for the quarter, compared to $138 million a year ago. The decrease primarily reflects unfavorable claims experience and the adverse ongoing impact of the second quarter 2017 annual review and update of actuarial assumptions and other refinements.", "The net contribution to current quarter results from claims experience inclusive of reinsurance, associated reserve updates and amortization, was approximately $25 million less favorable than our average expectations, compared to approximately $15 more favorable than our average expectations in the year-ago quarter. We experienced a higher-than-expected level of large claim activity in the current quarter. Partially offsetting this decrease was the absence of updates to other reserve balances and related items, which negatively impacted the year-ago quarter by $25 million, and this year, a greater contribution from net investment spread results.", "Earnings for the current quarter included income from non-coupon investments and prepayment fees about $5 million above our average expectation.", "Turning to Slide 10, individual life sales based on annualized new business premiums of $183 million were consistent with the year-ago quarter. Lower guaranteed universal life sales were offset by higher sales across the other products, reflecting our product diversification strategy and specific distribution and product actions we have taken, as well as an increase in large-case variable life placements in the quarter.", "Turning to Slide 11, retirement earnings were $291 million for the quarter compared to $298 million a year ago. The decrease reflects less favorable case experience and higher expenses, partially offset by a greater contribution from net investment spread results.", "Current quarter case experience was about $10 million less favorable than our average expectations compared to about $10 million more favorable than average expectations a year ago. The greater contribution to net investment spread results included current quarter returns on non-coupon investments and prepayment fees, which were about $50 million above our average expectations. Compared to returns, about $30 million above expectation a year ago, partially offset by continued spread compression.", "Turning to Slide 12, total retirement gross deposits and sales were $17.1 billion for the current quarter, compared to $8.9 billion a year ago. This increase was driven by gross sales of institutional investment products in the current quarter, which amounted to $10.3 billion, including roughly $4 billion of longevity reinsurance transactions, $3.3 billion of funded pension risk transfer cases, and $3 billion of stable value wraps.", "Total retirement account values were a record at $429.1 billion, up 11% from a year earlier. This increase includes the benefit for market appreciation, as well as about $8.9 billion of positive net flows over the past year, split about evenly between full-service and institutional investment products. I would highlight that the institutional net flows included about $6 billion of new, funded pension-risk transfer cases, which more than offset our run-off of the in-force business.", "Turning to Slide 13, group insurance earnings were $22 million for the quarter compared to $43 million a year ago. The decrease reflects higher expenses, including the impact of non-linear items, such as premium taxes, and less favorable group life underwriting results, partially offset by a higher contribution from net-investment spread results. Included in the current quarter, underwriting result was approximately $10 million of unfavorable reserve and premium refinement. In addition, current quarter net investment spread results included returns on non-coupon investments and prepayment fees, which were approximately $10 million above our average expectations in comparison to returns approximately $5 million above our average expectations in the year-ago quarter.", "Turning to Slide 14, investment management earnings were $306 million for the quarter, compared to $224 million a year ago. The increase in earnings was driven by a $70 million greater contribution from other related revenues as a result of higher incentive fees and stronger strategic investing results. The earnings contribution of other related revenues is inherently variable, since it reflects changing valuations and the timing of transactions, and amounted to $92 million in the current quarter, about $60 million above the average of the trailing 12 quarters. In addition, higher asset management fees net of related expenses reflect a 7% increase in average assets under management driven by fixed-income net inflows and equity market appreciation.", "The investment management business reported $1.4 billion of net positive, unaffiliated, third-party flows in the quarter excluding money market activity. Net retail inflows of $1.5 billion driven by fixed-income strategies were slightly offset by institutional net outflows driven by equities. For the year, we produced $15.7 billion of positive, unaffiliated, third-party net flows. Another strong year for our growing investment management business.", "Moving to the international insurance businesses and turning to Slide 15, earnings for our life planer business were $383 million for the quarter compared to $395 million a year ago. Excluding a $5 million negative impact of foreign currency exchange rates, earnings decreased by $7 million from a year ago. The decrease was driven by higher expenses and less favorable policy benefits experience, partially offset by continued business growth with constant dollar insurance revenues up by 7% from a year ago.", "Claims experience in the current quarter was consistent with our average expectation, and in the year-ago quarter was approximately $15 million more favorable than our average expectation. In addition, the current quarter contribution from net investment spread results included returns on non-coupon investments and prepayment fees approximately $15 million above our average expectation.", "Turning to Slide 16, Gibraltar Life earnings were $394 million for the quarter compared to $360 million a year ago. This increase primarily reflects more favorable policy benefits experience and continued business growth driven by the increase in US-denominated product sales over the past year.", "Turning to Slide 17, international insurance sales on a constant dollar basis were $644 million for the current quarter, down $69 million, or 10% from a year ago. We've experienced similar trends in both Life Planner and Gibraltar operations, where sales decreased by $37 million and $32 million, respectively, compared to the year-ago quarter. This decrease primarily reflects lower sales in Japan following elevated sales levels in the first half of the year.", "Yen-based product sales in Japan decreased by $131 million compared to the prior year, due to the elevated level of sales in the first half of this year, which occurred in advance of rate increases that were driven by the lower standard discount rate which was effective in the second quarter. This was partially offset by an increase in US Dollar denominated sales in Japan of $66 million, driven by the continued attractiveness of US Dollar products in the current environment, which further benefited from the introduction of new US Dollar whole life products earlier this year. As a result, 78% of sales in Japan were US Dollar denominated in the quarter.", "Sales outside of Japan were consistent with the year-ago quarter, as growth in Brazil was offset by modest declines in other markets. On a full-year basis, 2017 total sales of $3 billion and Japan sales of $2.5 billion were consistent with the prior year, however, with a greater mix of US Dollar denominated sales.", "Turning to Slide 18, the corporate and other loss was $451 million for the current quarter compared to a $441 million loss a year ago. The increased loss was driven by higher expenses, including non-linear items which can fluctuate, and lower investment income net of interest costs.", "Partially offsetting this increase was higher income from our pension plan, following our assumption updates at year-end last year. Higher expenses drove the sequential quarter income in the loss. Of the company's $165 million overall excess of fourth-quarter expenses in relation to the quarterly average for the year that I mentioned, about $70 million resides in corporate and other.", "Before I hand it over to Rob, I'd like to cover one other topic that may be on your mind, and thus wanted to address it now. The topic relates to guaranteed group annuities and MetLife's disclosure that it plans to strengthen reserves to address a pool of missing annuitants. We have read MetLife's disclosures, but we don't know the specifics of their situation. In terms of our retirement business, we take fulfilling our obligations to our customers seriously. Under our policies and procedures, we use internal and external tools and resources to locate customers. We also have policies on the development of our reserve estimates. We are comfortable with our overall reserves and that we are complying with our policies and procedures and meeting our obligations to customers.", "Given the size and the age of our block of business, there are inevitably some customers we can't locate for a number of reasons, but that number is small. We regularly review, test, and enhance the processes and tools we use to locate customers, and over time, we expect them to continue to evolve. This issue is certainly getting a lot of attention in the market, and ultimately, we could see greater standardization of what may currently be divergent practices across the industry.", "Now, I'll turn it over to Rob." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Mark. Now turning to Slide 19, I'm going to provide an update on key balance sheet items and financial measures. We view the RBC ratios at Prudential Insurance, or PICA and PALAC, as well as the composite RBC shown here to be important measures of our financial strength. Having said that, as we've highlighted previously, we manage our annuity risks using an economic framework that includes holding total assets to a CTE-97 level with the ability to maintain that level through modern stresses. As a consequence, over time, we may see some variability in the excess of PALAC's RBC over our target ratio.", "We expect that the reduction in the corporate tax rate from 35% to 21% as part of the tax act will result in a reduction of statutory deferred tax assets and an increase in certain statutory reserves, which will adversely affect the statutory capital position of our domestic insurance companies for 2017. However, though statutory results are not yet filed, we expect that our Prudential Insurance PALAC and composite RBC ratios will each continue to be above our current 400% AA target as of year-end, including the estimated impacts from the tax act.", "In Japan, Prudential of Japan and Gibraltar Life reported strong solvency margins of 893% and 935%, respectively, as of September 30. These solvency margins are comfortably above our targets and we estimate that they continue to be so as of the end of the year.", "Looking at liquidity, leveraging capital deployment highlights that are on Slide 20. Cash and liquid assets at the parent company amounted to $4.4 billion at the end of the quarter, which was consistent with last quarter. Cash inflows during the quarter supported approximately $635 million of shareholder distributions, which were about evenly split between dividends of $321 million and share repurchases of $313 million. It also funded debt maturities in other business operations.", "Our financial leverage and total leverage ratios as of year-end remained within our targets, and as John noted, we returned $2.6 billion to shareholders during the year through dividends and share repurchases and announced a 20% increase in our quarterly dividend yesterday.", "I would also remind investors of two items we communicated in our guidance that we expect to have a positive impact on adjusted book value in the first quarter of 2018 of roughly $1 billion. We will implement the new accounting standard that impacts the treatment of equity investments and which will result in a reclass of net unrealized gains of approximately $900 million from AOCI to retained earnings. In addition, we intend to eliminate the one-month reporting lag in our Gibraltar operations, so that Gibraltar's first quarter results reflect January through March activity. This would not result in an extra month of Gibraltar earnings in our 2018 results, but instead would essentially result in an adjustment to opening equity.", "Now, I'll turn it back over to John." ] }, { "name": "John Strangfeld", "speech": [ "Thank you, Rob. Thank you, Mark. We'll now open it up for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press * then 1 on your telephone keypad. You will hear a tone indicating that you've been placed in queue. You may remove yourself from queue at any time by pressing the # key. Once again, if you do have a question, please press * then 1 at this time.", "Our first question is from the line of Ryan Krueger with KBW. Please proceed with your question." ] }, { "name": "Ryan Krueger", "speech": [ "Hi, thanks. Good morning. Following the impacts of tax reform and the varying impacts to both cash, taxes, and GAAP-effective tax rates, do you still feel comfortable with the 65% free cash flow conversion guidance?" ] }, { "name": "Rob Falzon", "speech": [ "Ryan, it's Rob. Yeah, we're comfortable that, again, on average, over time, the 65% ratio of free cash flow is something that the businesses will continue to produce. If we look at the impact of tax reform, we expect cash taxes to actually be lower over the course of the next few years, primarily from non-incurring US taxes on repatriations from Japan and the utilization of accelerated tax credits on our US taxes. So we expect most of the near-term increase in after-tax AOI resulting from tax reform to actually translate into free cash flow, even including the amortization of the one-time toll tax that we mentioned of about a half a billion dollars.", "Longer-term, there are more variables that come into play. But we generally expect reform to be neutral or a positive to future year's cash and cash flow and so we remain with our guidance around the 65% free cash flow ratio." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks. And then a related question on the, I believe it was the Outlook Call, you stated that you expected the PICA RBC ratio to remain above 400, even if the NAIC changes the denominator factors. Is that still the case, as well?" ] }, { "name": "Rob Falzon", "speech": [ "Yes, it is. So what you saw is two of the biggest pieces related to that came through as of year-end. So that was the reduction in the DTAs and the increasing of reserves, primarily around AAT reserves that get adjusted as a result of the lower taxes. So those are both baked into the numbers that we'll produce as of year-end. And while we haven't published those yet, and therefore, we don't want to be overly specific, we're comfortable that that number is going to come out ahead of our -- or above our 400% target for AA, as we're currently labeling that.", "The remaining piece that's a potential, would represent about half of the 100 basis point decline in RBC that we had given for the totality of the impact of tax reform. When and how that actually manifests itself is still unknown. But we've assumed that a recalibration of the metrics without any adjustments going from 35 down to 21, that the impact of that is something where we would still be able to maintain our 400% RBC, using our available cash or our available capital capacity. Some of that capital capacity exists within our on-balance sheet, off-balance sheet, and earnings that we obviously generate during the course of the year, as well." ] }, { "name": "Ryan Krueger", "speech": [ "Okay, great. Thank you." ] }, { "name": "Operator", "speech": [ "The next question is from the line of Erik Bass with Autonomous. Please go ahead with your question." ] }, { "name": "Erik Bass", "speech": [ "Hi, thank you. Sticking on the topic of taxes, as you look across your US businesses, how do you see tax reform affecting competitive dynamics and pricing?" ] }, { "name": "Steve Pelletier", "speech": [ "Erik, this is Steve. Let me address your question. And I'll just start by saying that, as you know, we regularly review our product pricing and update key assumptions as appropriate. And there are a number of factors that we consider as part of that, tax impact being just one of them. I think the most meaningful impact from the tax reform will likely not really be derived in regard to new product sales, but rather simply from applying lower tax rates for the results of our in-force business.", "For products that do -- where our at-issue returns to benefit from the tax reform, I think it'd be reasonable to expect that some portion of the benefits realized from that will be competed away over time. However, we see this happening over time, and at varying rates of speed in our varying businesses, depending on the competitive landscape in each of those businesses. And throughout this, our primary focus will continue to be in ensuring that we price our products for sustainable, profitable growth.", "In terms of the lowering of tax rates, and does that impact the value proposition that we offer to customers? We don't believe so. We believe that even at lower tax rates, our insurance solutions continue to offer a strong value proposition and help to meet our customers' financial needs." ] }, { "name": "Erik Bass", "speech": [ "Thank you. And I guess, post-tax reform, we've also seen a number of large corporates that have announced contributions to their pension plans, and when we combine that with rising interest rates and higher PBGCCs, are you seeing an increase in interest in PRT transactions, particularly among jumbo plan sponsors?" ] }, { "name": "Steve Pelletier", "speech": [ "Yes, Erik. Well, we do see a very, very healthy pipeline at the start of the year. And it's for the reasons that you mentioned. Ability to transact is bolstered by increasing funding levels. And that's driven by both an uptick in rates and the contributions that you mentioned. A significant number of plan sponsors have made contributions in 2017 to their plans, and they have until September to do so and to take advantage of the lower 2017 tax rates.", "So ability to transact is very strong, and propensity to transact continues to be bolstered by the factors that we've mentioned before on these calls, such as rising PBGC premiums, increasing awareness of the longevity risk, and that increasing awareness being reinforced by new mortality tables. So all of those factors around both ability and propensity to transact really make for a healthy pipeline, here, at the early stages of the year." ] }, { "name": "Erik Bass", "speech": [ "Great, thank you." ] }, { "name": "Operator", "speech": [ "And the next question is from the line of Suneet Kamath with Citi. Please proceed with your question." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks, good morning. I wanted to start with the VA business, in particular on the hedging program. Just giving a lot of the volatility that we've seen just in the past week, particularly related to volatility-related products, do you have any exposure to those products, or can you talk about what you've just seen in your hedging program just recently?" ] }, { "name": "Rob Falzon", "speech": [ "Sure, Suneet. It's Rob. So first of all, big picture, this is a good story. And it's consistent with the prior messaging that we've been giving around the increased stability and predictability around our annuities business. So let me break it down to the pieces. Let me talk first about the last part of your question, which is the hedge performance during the course of the quarter. So do we include volatility in our hedging? We don't hedge the VIX directly, but we have options in other things, and so volatility is expressed through that. Our actual breakage month-to-date for February was only around $45 million. Now, I'll remind you that's not a liability. That's an excess of $9 billion. And so that's consistent with, kind of, hedging efficiency that -- an effectiveness that we've been seeing in prior quarters and prior years. If you look back at the fourth quarter, the way in which we look at our effectiveness, we're at 90% or above, in terms of our hedge effectiveness.", "So the second piece then, in terms of volatility. So obviously, there are multiple pieces of volatility that you want to think about. There is a direct increase in hedge costs when volatility increases within a period. And to the extent that volatility gives rise to breakage, you have that indirect cost, as well. Now, those costs are subject to the fact that: 1.) is I noted, we hedge it; 2.) recall that we have our auto-rebalance feature, and that allows us, as volatility is typically associated with declining markets, we're rebalancing out of equities and into fixed income. And so our exposure to that is declining as markets increase in volatility and decline.", "In terms of, the broader that impact of vol on our earnings, the long-term cost of our hedging is included in our AOI. That's the AP factor that we said upfront when we look at our fees and we anticipate how much of that is going to flow into AOI, as opposed to what's needed in order to settle out the liability. The period costs in any given period, the plus or the minus is part of how we define breakage in that period. So if volatility goes up and the cost of our hedging goes up, that's going to be defined in our breakage and then to the extent that we have any inefficiencies, that will be in there, as well. That gets amortized into our AOI via changes in our benefit ratios, and to date, that's actually been a positive number, and it's contributed modestly to the elevated ROAs that we've been reporting.", "And so as part of our guidance, I'll remind you that what we did is we said that we were expecting that that mid-125ish ROA would migrate down over time, as we took the opportunity of relatively high equity markets and high profitability coming out of the business, to recalibrate how we go about hedging our annuities book, an increase in the use of derivatives and hedges as we did that.", "And so we undertook that, and that was fully in place by the end of the fourth quarter, and therefore, we further benefited from the fact that we had, in addition to our product hedges, a capital hedge overlay on top of that against equity market volatility. And all of that's consistent with what we've been messaging in the last four quarters around expect a slight decline in ROA and the exchange for that is going to be less volatility in our earnings and our cash flow, which we think is a good trade, particularly given the elevated levels of both markets and our profitability.", "The final piece of that, equity markets. Obviously, if vol is up and equity markets are down, all things being considered, we would rather equity markets were up. That enhances the profitability of not only the annuities business, but our other businesses, as well. Any equity market declines are ultimately reflected in our earnings through unlocking of the K-factor in our benefit ratios. But recall a couple things. One is there's a mean reversion assumption in there, and that mutes the impact of it. And because of the hedging that we do, both the product hedge and the capital hedge that I described before, we significantly offset the impact of a decline in equity markets. And that's what we've been talking about, again, over the last few quarters. We're using the higher level of earnings to reduce that volatility and then shore up our earnings and our cash flow or reduce the volatility around that.", "So we do better in a rising equity market, but we're well-protected in downturns and expect a muted earnings impact from what we saw -- the likes of what we saw in February from the combination of volatility and directions in markets." ] }, { "name": "Suneet Kamath", "speech": [ "Okay, that's helpful. The other follow-up I had was related to the auto-rebalance. So the trend has been falling equity markets and rising interest rates. And as you pointed out, I think the algorithm would shift funds into fixed income options. What happens if we sustain this type of environment, i.e. equity markets continue to drop and interest rates rise? Doesn't that auto-rebalance end up working against account value growth at some point?" ] }, { "name": "Rob Falzon", "speech": [ "To the extent the auto-rebalance leaves people within -- more skewed toward bonds than equities, they stay in that position until a point at which the equity markets rise, and the auto-rebalance begins to work in the other direction. So if you have an environment where equity markets remain relatively flat, they'll be in fixed-income instruments. Obviously, the duration of that fixed-income fund is, sort of, it's a mid-range duration. I don't remember it specifically, five, six years, something like that. So as interest rates rise, as they're in that over time, they'll get higher yields out of that, as the yield on the assets in that fund increase.", "Now, if equity markets further decline, obviously, they're going to be protected from that because we'll continue to auto-rebalance out of equities and into fixed-income. And so they'll eventually hit a floor where further equity market declines will be -- they'll be fully insulated from those kind of movements.", "Steve, I don't know if you want to elaborate on that." ] }, { "name": "Steve Pelletier", "speech": [ "Yeah, I just had a couple of points, Rob. First of all, just remember that the fixed income vehicle is a corporate bond fund, and so spreads come into play, as well. But also, just a more fundamental point that we've consistently emphasized. The auto-rebalancing program is not an account value optimizer. That's not what it's about. It's about the support of our risk profile over an extended period of time and making sure that we're able to responsibly offer the benefit that we do in our product design. So that's really the underlying and fundamental purpose that we very much discuss with our customers about the auto-rebalancing program. It's not meant to optimize account values." ] }, { "name": "Suneet Kamath", "speech": [ "Okay, thanks." ] }, { "name": "Operator", "speech": [ "And the next question is from the line of Alex Scott with Goldman Sachs. Please proceed with your question." ] }, { "name": "Alex Scott", "speech": [ "Good morning. First question just on the investment management business and some of the incentive and transaction fees, or the strategic things you mentioned. Can you discuss the timing of those and if you have any kind of visibility that they will remain elevated for some period here in 2018?" ] }, { "name": "Steve Pelletier", "speech": [ "Alex, it's Steve. I'll address your question. First of all, incentive and performance fees often do have some seasonality. It's not unusual to see them emerge in the fourth quarter if we've earned them. In terms of what happened this quarter, we saw those elevated incentive fees actually across multiple asset classes. We saw it in fixed income, both public and private. We saw it in real estate, and we saw it in our equity businesses, as well.", "Over time, we have been drawing increasing flows to strategies that do carry incentive fees. And that's particularly true in our fixed income business. So it would not be unusual to see a growth in these strategies over time, and possibly emergence of greater incentive fees in our earnings patterns over time." ] }, { "name": "Alex Scott", "speech": [ "And follow-up question on individual annuities. The surrenders and withdrawals, kind of, picked up a bit more than in previous quarters. Is that a trend that you'd expect to escalate? Are there any things that you're doing on the sales front related to, maybe, offer products that don't require rebalancing or things like that, that you'd expect to help sales and offset some of the outflow?" ] }, { "name": "Steve Pelletier", "speech": [ "Alex, again, I'll address your questions. It is not at all surprising for us to see elevated lapses and withdrawals in this quarter. I had mentioned a couple of things. First of all, just in terms of the market conditions, we expect to see elevated lapses in our -- as interest rates rise. And interest rates rising is usually associated with alternative solutions becoming available that clients may go into. I would also recall that that correlation of rising interest rates is built into how we manage our actuarial assumptions in the business and our risk management in the business. So that kind of dynamic relationship between rising interest rates and lapsation is really built into what we do.", "On a longer-term basis, I'd also recall that as more and more of our in-force business emerges from a surrender period, we would expect to see that. In terms of new product design, we just last week launched a fixed-index annuity product, and so we see that as offering a fuller suite of product designs to our distribution partners and their clients. And we have other products in the course of this year that we expect to introduce into the marketplace." ] }, { "name": "Alex Scott", "speech": [ "Thanks for the answers." ] }, { "name": "Operator", "speech": [ "The next question comes from the line of Tom Gallagher with Evercore ISI. Please proceed with your question." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning, Steve. Another one for you just on the auto-rebalance highs daily value product. I just want to make sure I understand the dynamics that are happening with it and the way the product works again. So correct me if I'm wrong, but my understanding is the vast majority of your portfolio has the highest daily feature. If equity markets decline over 10%, the auto-rebalance kicks in, and I think fully moves into fixed income, or largely moves into fixed income at down 20. Is that the way the product works? And just a related question, would you have to respond and start altering your hedge program with a pretty big asset reallocation? And what would that do to you ROA in the scenario that the market continues to weaken?" ] }, { "name": "Steve Pelletier", "speech": [ "Tom, I'll address your question. The activation of the auto-rebalancing program is not based on overall certain level of market decline. Actually, auto-rebalancing, under normal circumstances, kick-in well before a 10% market decline. Again, to emphasize, the auto-rebalancing program is driven by our evaluation of the risk profile in each and every one of our HDI products, and then the aggregation of that change in risk profile of all those individual contracts. That's what drives auto-rebalancing activity, change in risk profile of each and every contract. As to the asset reallocation topic, maybe I'd ask Rob to comment on that." ] }, { "name": "Rob Falzon", "speech": [ "Yeah, so a couple of things, Tom. First, just to put some numbers on Steve's point. If we look at what happened in February, so the big movement on the 5th of February, we were down about 4%. It was a little over a half a billion dollar transfer in the auto-rebalance out of equities into fixed-income as a result of that movement. So well before we hit the 10%. But again, put that in the context of a $9 billion overall liability and you, sort of, get some sense for how that works.", "With respect to your return on asset, the implications on the return on assets is sort of what I was going through before, Tom. Is it actually, that in and of itself, the algorithm, the rebalancing in and of itself is not going to change the ROA that we're getting out of the business. Recall first that the fees are charged on the guaranteed value.", "And so therefore to the extent that we're in fixed-income, or otherwise our markets move down, our fees are not diminished by virtue of that, and then secondly, the fact that we actually have less hedging cost, just like if we had more hedging costs, we're going to look at that as being periodic. And we have a longer-term view of what the hedging costs would be over the life of the contract. And absent changing that, in that particular case, lower hedging cost if we're more in fixed income than equities is something that we're going to amortize in over the life of the contract. So it would have probably a modest positive impact in terms of less hedging cost than what we've built in, but not material in any way, and not highly volatile, either.", "And I'm sorry, was there another part to your question, Tom?" ] }, { "name": "Tom Gallagher", "speech": [ "No. That was good, Rob. That did it on VA. And then just my follow-up is just on the topic of long-term care. I know it's something that you all took a charge on several years back. I'm going to say, maybe, four years ago, or five years ago. Just out of curiosity, do you still have -- after that charge, just based on your experience to date, is there still margin there? Is that something we should be watching out for from a development standpoint, 2018, 2019? Can you comment a bit about what you're seeing on an underlying trend there?" ] }, { "name": "Rob Falzon", "speech": [ "Yeah, so let me share a couple of observations, Tom. First, let me start with the caveat that our book here is a relatively small book. So we've got 215,000 policies, $6 billion in reserves, and you can, kind of, put that in the context of others in the industry that are much more significantly in this product. A couple of other things I'd also mentioned, just to sort of lay out the nature of our book. The more recent vintage book, Tom -- so that's when plan designs got more conservative, and about two-thirds of the book is group as opposed to individual. And again, the plan designs were more conservative in the group long-term care policies than they were in the individual.", "With respect to our assumptions, we look at those every year. So yeah, we did the big assumption update in 2012 and had the GAAP loss recognition event. I think that's what you're referring to. But every year, we continue to look at that. And the assumptions that we have in place for that book, we look at both with regard to our own experience, and with regard to industry experience. And we are inline, if not generally on the more conservative end, of that industry experience that's available to us.", "Now, I throw a caveat in there. And that is that our book is relatively nascent, as I mentioned. So it's got about, a little over 1% of the book is actually in payout at this point in time. And I'd say the same thing of the industry, which is that the experience of people is still evolving. And then we all have to watch for how that experience may change what we've currently seen. So while assumptions may reflect experience to date, that's not to say that experience can't change as more and more of the book goes from the deferred status to active status.", "And then to get to your very specific question, we have a cushion above our loss-recognition. It's in excess of half a billion dollars. And so we feel pretty comfortable with that level of cushion, with the realization that we'll constantly be updating our assumptions and we'll look to do that in the second quarter of next year." ] }, { "name": "Tom Gallagher", "speech": [ "Okay, thanks, Rob." ] }, { "name": "Operator", "speech": [ "The next question is from the line of Jimmy Buehler with JP Morgan. Please proceed with your question." ] }, { "name": "Jimmy Buehler", "speech": [ "Hi, good morning. I had a couple of questions. The first one just on the VA business. Your surrenders picked up significantly, and I realize the book is aging, but they did pick up noticeably from the previous quarter. So what drove that and what's your outlook for just withdrawal rates, in general, in the VA business. And then secondly, just on international agent counsel. So Gibraltar, the agent count, I think, was down a little bit sequentially. Japan Life Planner declined, as well. Is that more seasonality, or is something else going on, and your outlook for that as well?" ] }, { "name": "Steve Pelletier", "speech": [ "Jimmy, it's Steve. I'll answer the first part of your question. As I mentioned, in a rising interest rate environment, we would expect to see withdrawals and lapses in the variable annuities business. Rising interest rates are usually associated with the emergence of alternative solutions and thus it would be only natural to see increased lapsation in that for that reason. In addition to the emergence from surrendered charges, as you mentioned, as a longer-term trend. And again, I just mentioned that we have thoroughly incorporated that correlation into our actuarial and risk management underpinnings for this business. The assumptions that we make call for a dynamic relationship between direction of interest rates and lapsation." ] }, { "name": "Charlie Lowrey", "speech": [ "Jimmy, it's Charlie. Let me talk about both Life Planners, and then as you mentioned, Life Consultants. So in Life Planners, in Japan, they were up 3%. But to your point, you are correct. There is some seasonality with regard to life planners. So recall that transfers to sales managers generally happen twice a year in the second quarter and the fourth quarter. And we had a high number of LPs transferred this quarter, resulting in an increase in sales managers, year-over-year, by 11%.", "Now, that's good because these new sales managers will contribute to a future recruitment and continued LP growth, but they do lower the current LP count. We also had a higher number of secondees that were transferred to the bank channel. So there are a lot of ins and outs, especially in the second and fourth quarter. But the long-term average for POJ, and frankly for life planners in general, is about 2 to 4%. So if you look over a five-year period for all of Prudential International Insurance, the LP growth rate in total has been about 2%, or so. So slow and steady growth of 2% over the long-term is what you should anticipate.", "Now, with the life consultant count, that's a bit of a different story. So the life consultant count decreased by about 6%, year-over-year. And this is due to the adherence of more stringent valuation and recruiting processes that we put into effect and that we talked about last quarter. And it really has a double effect. The first is that there are more terminations from stringent validation requirements that are being enforced. But also with higher recruiting standards, you have less recruits.", "And it's tough to do this because when you elect to do this, there's a bit of a J-curve of sorts. So while we were flat versus prior quarter, we're not yet at the bottom of the J-curve. And I think we said last quarter, it'll take really most of this year to get to the bottom. But we think we'll hit the bottom later this year. And it's exactly what we've done in several operations outside of Japan over the past 18 months, including Korea and Taiwan, going back to the basics and increasing the quality of the field.", "Now a proof-point to what we're doing is the fact that while LC count, the life consultant count, decreased by 6%, sales only decreased by 4% in this market. And therefore, what you'd expect to see and what you're seeing, especially at first, is that as you take off, essentially, the bottom of the life consultants, if you will, the ones that aren't performing well, you'd expect to see sales go down less in the life planner account, and that's exactly what we saw. That won't happen every quarter, but we did expect to see it in the first quarter, and that's what we saw." ] }, { "name": "Jimmy Buehler", "speech": [ "Thank you." ] }, { "name": "Rob Falzon", "speech": [ "Shannon, do we have time for one more call, question?" ] }, { "name": "Operator", "speech": [ "And the final question comes from the line of Humphrey Lee with Dowling and Partners. Please proceed with your question." ] }, { "name": "Humphrey Lee", "speech": [ "Thank you for taking my questions. A question on investment management. So the fee rate has been pretty stable to slightly improving, and part of it, I believe is from the make-shift choice of fixed-income. I guess at a high level, how much better is your average fee rates for your in-flows, versus your average fee rates for your outflows?" ] }, { "name": "Steve Pelletier", "speech": [ "Humphrey, it's Steve. I'll address your question. We've seen secular pressure on fees in the investment management industry overall. And actually, that's been not just in the active space, but also in the passive space, there has been considerable fee compression. In the face of that, we have been able to keep, actually, pretty stable fees overall in our book. Now, to address your question, rather than speak about the fee rate on outflows versus fee rate on inflows, I'd point out, we have not been immune on all portions of our platform to fee compression. That's not where our stable fee rate comes from. We've experienced that fee compression in various parts of our platform, in particular in retail portions. However, we have been able to draw flows into higher fee yielding strategies, particularly in fixed income, as you mentioned, and in other areas as well, such as real estate. So given the multimanager model, and given our ability to draw flows into a variety of strategies, including ones that yield higher fees, we feel well-positioned to compete even in this period of secular pressure on fees." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. And then just a follow-up question to Tom's earlier question on long-term care. So you mentioned there's $6 billion of reserves. Is that GAAP or stat?" ] }, { "name": "Rob Falzon", "speech": [ "That was stat." ] }, { "name": "Humphrey Lee", "speech": [ "Okay. And then would the reserves be, kind of, similar to the split between the group and the individual side? Kind of, one-third, two-thirds? Or how should we think about that?" ] }, { "name": "Rob Falzon", "speech": [ "So remember, the size of the book is -- yeah. If you look at the two-thirds versus the one-third, that would be probably a pretty good indicator. I don't have the number off the top of my head, Humphrey, but I think it's -- we'll have someone follow-up with you specifically. But I would think of that as being that order of magnitude because they're both relatively nascent books." ] }, { "name": "Humphrey Lee", "speech": [ "Okay, got it. Thank you." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Teleconference. You may not disconnect." ] }, { "name": "Humphrey Lee", "speech": [ "More PRU analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
PRU	2022-11-02	[ { "description": "Vice President, Investor Relations", "name": "Bob McLaughlin", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Executive Vice President and Head of U.S. Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "AllianceBernstein -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "Head of International Business", "name": "Scott Sleyster", "position": "Other" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Raymond James -- Analyst", "name": "Wilma Burdis", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Mike Ward", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to Prudential's quarterly earnings conference call. [Operator instructions] I will now turn the call over to Mr. Bob McLaughlin. Please, go ahead." ] }, { "name": "Bob McLaughlin", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of U.S. businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions that we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-Looking Statements and non-GAAP Measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.", "And now, I'll turn it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Bob, and thanks to everyone for joining us today. Our third quarter financial results reflect the impact of market conditions, including the variability in alternative investment returns and lower fee income, as well as an elevated level of COVID-19 hospitalization claims in Japan, partially offset by underlying business growth, including the benefit from rising interest rates. We continue to transform our businesses to be less market-sensitive and better positioned to deliver sustainable long-term growth. This includes investing in products and solutions that meet the evolving needs of our customers and achieving our $750 million cost savings target one year ahead of schedule.", "Our rock-solid balance sheet provides the financial strength to navigate the current macroeconomic environment and support our customers, shareholders, employees, and other stakeholders. Turning to Slide 3. I'll start off today with an update on how we are investing in long-term growth opportunities that meet the evolving needs of our customers and support our vision to be a global leader in expanding access to investing, insurance, and retirement security. In September, Prudential was selected by IBM for a 50% participation in the second largest pension risk transfer transaction in U.S.", "market history, with a total value of over $16 billion. This transaction builds upon our leadership role in this market, where we have helped employers safeguard their workers' retirements since pioneering the first jumbo PRT transaction a decade ago. We are well-positioned to continue to benefit from the growing PRT market, which is expected to have over $50 billion of total industry transactions in 2022. In the individual retirement market, our FlexGuard suite continues to grow in both sales volume and product scope, with an additional $1 billion in sales, bringing the total to nearly $12 billion since its launch in 2020.", "Building upon FlexGuard's tremendous success, we plan to introduce FlexGuard Life, an index variable universal life product later this month. We expect our businesses will benefit from the increased demand for retirement decumulation products over the next decade, as we strengthen our role as a leader in the $300 billion annuities market. We're making similar growth investments on behalf of our international customers as well. During the third quarter, we expanded into Argentina, our partnership with Mercado Libre, Latin America's largest e-commerce platform with approximately 200 million users.", "Our expanded partnership follows our initial launch with Mercado Libre in Brazil earlier this year, which delivers life insurance and accident and health products tailored to the platform's mass market customer base. Moving to Slide 4. As I noted earlier, we have now achieved $765 million of annual run rate cost savings, exceeding our target of $750 million, and completed this one year ahead of schedule. This includes $180 million realized in the third quarter.", "To achieve these cost savings, we carefully assessed all aspects of our business and operations from our physical office space, to how we leverage technology to deliver more efficient customer experiences. For example, by embracing a hybrid work model, we reduced our office space footprint in the U.S. by approximately 50%, which results in an annual run rate savings of about $50 million. On the customer experience front, our use of artificial intelligence accelerated our individual life underwriting from 22 days to 22 seconds.", "And our new digital claims processing capability can now deliver funds to most customers in six hours as opposed to six days. We also automated and reduced the timing of fund verification and processing on about one-third of new annuity sales from what was two to three weeks to now two to three days. And our group insurance claims processing is now three times faster, thanks to new data systems we have installed. Turning now to Slide 5.", "Our rock-solid balance sheet and disciplined approach to capital deployment has helped Prudential navigate financial and macroeconomic challenges for nearly 150 years. Consistent with our AA financial strength rating, we have a strong capital position, a high-quality, well-diversified investment portfolio and approximately $5 billion in highly liquid assets at the end of the third quarter. We continue to balance investing in our businesses for long-term growth with shareholder distributions. In addition to the investments in our businesses that I previously mentioned, we also returned over $800 million to shareholders during the third quarter through dividends and share repurchases for a total of $7 billion since the beginning of 2021.", "Looking ahead, we expect higher interest rates will economically benefit our business over time. We have the financial strength to continue to navigate the current economic and market environment. As we monitor developments, we will maintain our disciplined approach to capital management and redeployment, and our board will review our 2023 capital plan early next year. Before turning it over to Rob, I'd like to touch upon the leadership transition we announced last week as part of our thoughtful approach to creating a sustainable, long-term leadership structure.", "Beginning early next year, Andy Sullivan will move from his current role as head of our U.S. businesses, including PGIM, to lead our international businesses and PGIM. Caroline Feeney, who currently leads our U.S. retirement and insurance businesses, will take on an expanded role as head of our business portfolio in the U.S.", "and will join our executive leadership team. Scott Sleyster, who currently leads our international businesses, will retire in the first quarter of 2023. We thank Scott for his tremendous contributions to Prudential over the course of his 35-year career with the company, and look forward to working closely with Andy and Caroline in their new roles. I'll now turn it over to Rob for an update on our business performance." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results and business performance for our PGIM, U.S., and international businesses. I'll begin on Slide 6 with our financial results for the third quarter of 2022. Pretax adjusted operating income was $1 billion, or $2.13 per share on an after-tax basis, and reflected lower variable investment income driven by market conditions and an elevated level of Japan COVID-19 hospitalization claims, partially offset by underlying business growth, including a benefit from rising interest rates.", "Our GAAP net loss per share was $0.78 on an after-tax basis, primarily reflecting realized investment losses largely driven by higher interest rates. Turning to the operating results from our businesses compared to the year-ago quarter. PGIM, our global investment manager, reported lower asset management fees resulting from a reduction in assets under management, reflecting higher interest rates, widening credit spreads, and declines in equity markets. Results of our U.S.", "businesses were lower than the year-ago quarter, reflecting lower spread income due to less favorable variable investment income and lower fee income resulting from the sale of a portion of the legacy variable annuities business, the decline in equity markets, and net outflows, partially offset by more favorable underwriting as COVID-19 transitions to an endemic level in the U.S. The decrease in earnings in our international businesses reflected elevated COVID-19 hospitalization claims in Japan and lower spread income driven by less favorable variable investment income. Turning to Slide 7. PGIM, our global active investment manager, has diversified capabilities in both public and private asset classes across fixed income, alternatives, real estate, and equities.", "PGIM's long-term investment performance remains attractive with more than 80% of assets under management outperforming their benchmarks over the last five- and 10-year periods. PGIM experienced retail outflows, primarily in fixed income, consistent with industry trends, due to the rising rate environment, while institutional net flows continue to be positive. As the investment engine of Prudential, the success and growth of PGIM and of our U.S. and international insurance and retirement businesses are mutually enhancing.", "PGIM's asset origination capabilities, investment management expertise, and access to institutional and other sources of private capital are our competitive advantage. This helps our businesses bring enhanced solutions and create more value for our customers. Our insurance and retirement businesses, in turn, provide a source of growth for PGIM through affiliated flows and unique access to insurance liabilities that complement its track record of third-party growth. PGIM's annual fee rate increased due to the continued shift toward higher fee strategies, including our alternatives and private credit business.", "We continue to grow our alternatives in private credit business, which has assets under management of nearly $230 billion across private credit, real estate equity and debt, and private equity secondaries, and benefits from our global scale and market-leading positions. Across PGIM's private platform, we deployed $9.6 billion of capital this quarter. As we continue to invest in growth areas that are aligned with the needs of our clients, we also remain disciplined in finding opportunities to protect operating margins by managing the business more efficiently. Turning to Slide 8.", "Our U.S. businesses produced diversified earnings from fees, net investment spread, and underwriting income, and benefit from our complementary mix of longevity and mortality businesses. We continue to shift our business mix toward higher growth and less market-sensitive products in markets, transform our capabilities and cost structure, and further expand our addressable markets. Retirement strategies achieved robust sales in the third quarter across its institutional and individual lines of business.", "Institutional retirement closed nearly $10 billion of pension risk transfer transactions in the third quarter, including being selected by IBM for a 50% participation in a $16 billion pension risk transfer transaction. Our focus on superior execution, supported by the experience of our high-quality PRT team, and our continued market leadership in the U.S. pension risk transfer market contributed to IBM selecting us. We continue to see a significant opportunity in the growing PRT market.", "In individual retirement, product pivots have resulted in continued strong sales of more simplified solutions with $1 billion of FlexGuard and FlexGuard income sales in the third quarter, as well as increased fixed annuity sales. Our individual life sales also reflect our earlier product pivot strategy, with variable life products representing approximately 70% of sales for the quarter. Group insurance experienced a 50% increase in sales compared to the year-ago quarter, reflecting higher national account life and disability sales and execution of our product growth strategy to drive supplemental health. Turning to Slide 9.", "Our international businesses include our Japanese life insurance companies, where we have a differentiated multichannel distribution model, as well as other businesses aimed at expanding our presence in high-growth emerging markets. In Japan, we are focused on providing high-quality service and expanding our geographic coverage and product offerings. Our needs-based approach and protection product focus continue to provide important value to our customers as we expand our product offerings to meet their evolving needs. For example, we launched a yen-denominated investment product with a joint survivorship feature in the bank channel in the third quarter.", "In emerging markets, we are focused on creating a carefully selected portfolio of businesses and regions where customer needs are growing, where there are compelling opportunities to build market-leading businesses and where the Prudential enterprise can add value. In the third quarter, we continued to focus on expanding product and business capabilities to meet the evolving needs of customers. In Brazil, we expanded our digital sales application and achieved record sales for the second consecutive quarter, driven by strong performance across all distribution channels. We further expanded our product offerings on the Mercado Libre platform in Brazil and successfully launched the sales platform in Argentina, as Charlie mentioned.", "In addition, we completed our tender offer for Alex Forbes, expanding our ownership to 33% of a leading provider of integrated retirement, investment, and wealth management services in South Africa. As we look ahead, we're well-positioned across our businesses to be a global leader in expanding access to investing, insurance, and retirement security. We continue to invest in growth businesses and markets, deliver industry-leading customer experiences, and create the next generation of financial solutions to better serve the diverse needs of a broad range of customers. And now, with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 10, which provides insight into earnings for the fourth quarter of 2022 relative to our third quarter results. As noted, pre-tax adjusted operating income in the third quarter was $1 billion and resulted in earnings per share of $2.13 on an after-tax basis. To get a sense for how our fourth quarter results might develop, we suggest adjustments for the following items.", "First, variable investment income was below expectations in the third quarter by 295 million. Next, we adjust underwriting experience by a net 165 million. This adjustment includes a placeholder for COVID-19 claims experience in the fourth quarter of $20 million for our international insurance businesses. We expect a lower level of hospitalization claims due to the recent government supported industry revision of eligible benefits for policyholders recovering from COVID-19 at home in Japan.", "And last, we expect seasonal and other items to reduce adjusted operating income by 166 million, primarily driven by the seasonally elevated expenses expected in the fourth quarter. These items combined get us to a baseline of $2.71 per share for the fourth quarter. I'll note that if you exclude items specific to the fourth quarter, earnings per share would be $2.96. The key takeaway is that our underlying earnings power improved due to business growth, including the benefit of higher interest rates that more than offset equity market depreciation.", "While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the fourth quarter. Turning to Slide 11. Our capital position supports our AA financial strength rating. Our cash and liquid assets were $5 billion at the high end of our liquidity target range after investing in our businesses to support long-term growth, including the capital to support our IBM pension risk transfer transaction.", "We have substantial off-balance sheet resources, including contingent capital and liquidity facilities. Over the long term, a higher interest rate environment is economically beneficial. In the near term, the current market environment and the annual assumption update reduce our regulatory capital and excess liquidity. We will remain prudent in our capital deployment, balancing the preservation of financial strength, investment in our businesses for sustainable long-term growth, and shareholder distributions.", "Turning to Slide 12 and in summary. We are executing our plans to reposition our businesses, we achieved our targeted cost savings one year ahead of plan, and we are navigating the current macro environment with the financial strength of our rock-solid balance sheet. Now, I'll turn it over to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question today is coming from Tom Gallagher from Evercore ISI. Your line is now live." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. The -- my first question is just on the decline in the holding company cash balance that dropped 2 billion sequentially despite the increase in net debt by 500 million. Ken, can you comment on whether there were any contributions to subs. I assume there were no dividends taking out, but a little bit of color for what happened there." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Tom, sure. I'll cover that. We did make a capital contribution of $1 billion to PICA, our main U.S.", "life insurance company. And that is to support a high volume of business growth, including the, you know, IBM and other pension risk transfer transactions that we did. We also made a $200 million of contributions to fund a few international joint venture investments that's part of our programmatic M&A into emerging markets. And then, as we mentioned and highlighted that we funded shareholder distributions of 800 million.", "The 500 million of net debt increase that we had, as we refinance our debt profile, was essentially offset by holding company costs, including interest. We did not have dividends from our subs in this quarter. You know, the timing of dividends from our subs to the holdco tend to vary and tend to be greater in the fourth quarter and first quarter. Putting that all together, we ended with highly liquid assets, 5.1 billion, still above our target range.", "So, you know, in sum, the primary reason our holdco HLA decline, highlight liquid assets decline, was due to the 1.2 billion of business growth. You know, I also -- I just thought it would be helpful to remind people what I said on our last call is that we expect the statutory funding needs for our U.S. life insurance business, including our assumption updates, to be comparable to our GAAP -- the GAAP impact that we recorded in 2Q. The reserve strengthening will be higher, stat is more conservative, and that's going to be fully reflected in our stat results in the fourth quarter.", "As I also mentioned on our last call,, you know, we have excess capacity already in PICA available to meet that need. So, you know, the combination of the capital that we contributed to support business growth this quarter and the excess capacity we had in PICA -- within PICA will remain with RBC ratios consistent with our AA financial strength target. You know, in terms of shareholder distributions, we will complete our shareholder distributions for this year in the fourth quarter with both dividends and share [Audio gap] they'll consider our capital position, opportunities to invest in our businesses and now, increasingly so, the volatility uncertainty of the economy and markets looking ahead. So, we'll factor that all in.", "But we'll, you know, continue with our philosophy of being thoughtful and disciplined with our capital and balance investment in our businesses with long-term growth and maintaining financial strength and returning capital to shareholders." ] }, { "name": "Charlie Lowrey", "speech": [ "Hey, Tom, it's Charlie. Let me just add one thing because I think part of your question is about can we execute on a long-term plan. And I'll just take it up a level and say, we have additional levers we can pull and resources that we can use to do just that, to execute on our long-term plan." ] }, { "name": "Tom Gallagher", "speech": [ "Thanks a lot guys. That was very comprehensive. And, Charlie, just -- so, you'd still -- I think it was the $10 billion three-year total capital return plan. You still feel good about that given the levers that you have to work from?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah. Ken, do you want to comment on that?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Yeah. Again, we're -- you know, we will complete -- we've already returned 7 billion through the third quarter. We'll complete our plans for this year.", "And again, you know, our board will factor in all the considerations that I mentioned into their decisions in early part of next year." ] }, { "name": "Tom Gallagher", "speech": [ "OK. Thanks a lot, guys." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. First, congratulations to Scott, your retirement; Andy, Caroline, in your new role. I'm wondering, given your progress to date and thinking about market opportunities, do you feel like you need to elongate the three-year timetable of reallocating 5 billion to 10 billion of capital to higher growth, less market-sensitive business." ] }, { "name": "Charlie Lowrey", "speech": [ "Sure, Tracy. It's Charlie. Let me take that one. So, let me start by saying we remain totally focused on executing on our transformation strategy to become a less market-sensitive and higher-growth company.", "As you've seen, we've made a number of programmatic acquisitions in PGIM and emerging markets. And in the second quarter, we completed two key divestitures that reduced our overall market sensitivity by 20%. So, we're well on our way. Now, our path may not be linear as different growth opportunities present themselves at different times.", "And I would note that our diverse set of businesses provides opportunities to grow in different market environments as we've seen with this market environment. And we're well-positioned to benefit from this diversification. For instance, in the third quarter, our retirement strategies business did nearly $15 billion of sales, including a significant PRT transaction, that demonstrate our leadership position in this market where we believe there's just tremendous growth potential going forward. But our business system is also self-reinforcing.", "And as an example, the recent IBM PRT -- with the recent IBM PRT transaction, which is in the institutional retirement business, that also brought in over $8 billion in AUM to PGIM. So, by saying we're focused on our high-growth businesses, naming PGIM and emerging markets, doesn't mean we're not looking to grow our other businesses as well. So, you know, in summary, what I'd say is we're definitely committed to becoming a higher growth, less market-sensitive company. But our progress will depend upon a couple of things.", "One is the opportunities that arise, and the second is the macroeconomic conditions." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. That's very helpful. So, it sounds like you have organic growth opportunities. You're not only relying on programmatic acquisition.", "So, speaking of organic and you mentioned PRT, I'm just wondering if we should expect to see more coinsurance in the future for these large deals. And also, if you could comment on, you know, funded status these days and, you know, what you've seen in the pipeline would that prohibit some deals getting done." ] }, { "name": "Andy Sullivan", "speech": [ "So, Tracy, good morning. It's Andy. And first, let me thanks for -- I appreciate the congratulations. You know, you probably could tell we're exceptionally proud of our team and of our capabilities in our pension risk transfer business.", "You know, the fact that we conducted the second largest transaction in history is second only to the ground breakage transaction we did with General Motors about a decade ago for $29 billion. You know, this transaction, we did split 50-50 between us and another provider. And for clarity, the decision to split a deal is made by the plan sponsor versus carriers bidding together. As we look forward, we don't think deal splitting will be atypical, and we will always be open to that type of situation depending on the deal's characteristics.", "You know, overall, the market in pension risk transfer remains very robust. The industry experienced a third successive record-breaking quarter. Third quarter came in at 28 billion, which was a 60% increase from last year. Funded status remains near record levels at 106%.", "So, we now expect this year, as you heard in Charlie's remarks, to come in above $50 billion for the industry. And we believe that we'll consistently see about $40 billion going forward. You know, given the size of that market, despite that it's a competitive market, we expect, given our industry-leading track record and our capabilities, we're going to continue to find success at picking our spots. And net-net, this will be a nice organic growth area for us over time." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Ryan Krueger from KBW. Your line is now live." ] }, { "name": "Ryan Krueger", "speech": [ "Hey, thanks. Morning. I had a question on individual retirement earnings. I think on a core basis, they were up about 60 million sequentially.", "Can you help us think through the key drivers of that and, you know, if you'd expect that to be sustainable longer term?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. So, Ryan, it's Andy again. Good morning. Thanks for your question on the individual retirement business.", "We're very pleased with the momentum that we're seeing this quarter. Let me speak first about our core earnings progress, and then I'll talk about our continued success at FlexGuard. We saw a material lift in our core earnings, thanks primarily to the change in the interest rate environment. And that's both on the short and long end of the curve.", "We get lift from interest rates on our collateral on the short end, and we're getting lift on the long-term side in our portfolio as well. And we're seeing the FlexGuard block grow. That's why you saw the step-up in our core earnings. And I would just kind of go back to what Ken said earlier, higher rates are a good thing overall for Prudential.", "Additionally, we're very pleased with the continued progress at building a very healthy FlexGuard block of business. Quarter in and quarter out, we remain a top share player in the market. We've achieved 11 billion in sales life to date. We very much like the profitability of the block that we've brought into the organization.", "And at the end of the day, you know, kind of back to the organic growth discussion, we see the retirement decumulation opportunity in the country as a very good growth opportunity. And we have all the right stuff to capture it." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks. And then just wanted -- I had one quick capital follow-up. Charlie, you had mentioned that you have other levers that you can pull to execute on your long-term capital deployment plan. Seeing if you could expand on that at all.", "And I guess, probably related to that, just, you know, you contributed capital earlier this year to Bermuda. At what point in time do you think you might see more business there to then release capital in the U.S.? Thanks." ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. Let me take the first part of that and then turn it over to Ken. I'll just give you a couple of quick examples. One would be sort of ongoing reinsurance transactions that we continue to review.", "And the other would be, we have levers, both on and off balance sheet that we can pull. So, we have lots of different levers and resources that we can use and regularly look at them in order to access additional capital. And, Ken, do you want to talk about Bermuda?" ] }, { "name": "Ken Tanji", "speech": [ "Yes, Ryan. Yeah, the Bermuda sub that we launched earlier in the year is a good example of the levers that Charlie referenced. We have a new reinsurer in Bermuda. It's called Lotus Re.", "We did capitalize it with $800 million earlier this year, and we've reinsured a block of variable life business to it. So, it will create capital efficiency. And it's a reinsurance capability that's sort of another tool in our toolbox going forward." ] }, { "name": "Ryan Krueger", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question today is coming from Suneet Kamath from Jefferies. Your line is now live." ] }, { "name": "Suneet Kamath", "speech": [ "Hi. Thanks. Good morning. Just wanted to circle back on capital.", "You made comments about 2023 a couple of times. But just to level set, I mean, we're used to thinking about, you know, kind of the 65% free cash flow conversion as sort of, you know, the level of capital return that you guys would do on an annual basis, ex any specific special transactions. Should we be thinking about that as a baseline for next year? Or are you signaling that, you know, the operating environment is a little bit more challenging, so maybe you'd guide to something a little bit lower than that?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Suneet. Yeah, 65%, if you looked at our -- what we've generated in free cash flow from our businesses over time, that's been the average. It's been, in some years, higher than that; and in some years, lower than that.", "Cash flow from our businesses this year is below our historical average. That's both as, you know, we continue to invest in our businesses for long-term growth, but also work through the statutory reserve increases in our life insurance businesses that we updated this year. So, it will vary over time, but, you know, we think given our growth rates and our business profile, that's, you know, what our historical average has been." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Got it. And then just if I could come back to that $1 billion infusion into PICA, I mean, my rough math would suggest maybe half of that was related to, you know, the IBM PRT deal. So, that leaves another $400 million, $500 million left.", "And I hear you on FlexGuard funding that growth, but, you know, individual retirement is still in outflows. And I would have thought the capital release from withdrawals would have sort of supported the new business. I guess, I'm just trying to understand what the other piece of it is into PICA apart from the PRT transaction. Thanks." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. I don't know what rule of thumb you're using on specific business lines, but it was -- for us, it was primarily related to not just the IBM transaction but the other deals that we did as well. And the growth in our FlexGuard business. And, you know, we continue to see good profitability and cash flows from our existing VA business as well." ] }, { "name": "Suneet Kamath", "speech": [ "Was there any impact from interest rate hedges? You had a GAAP loss, but just wondering if there's any impact from that on the statutory results." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. There is, Suneet, is the rise in interest rates has been very swift. And over time, that will allow us to invest our insurance reserves at higher yields and improving profitability and cash flows. But in the near term, our statutory surplus in the U.S.", "business -- for our U.S. business is reduced by what we consider a noneconomic statutory reserve method that tends to manifest itself when rates rise, and we experienced unrealized and realized losses on our fixed income and derivatives. This is not unique to us. We believe it's an issue for the broader industry, and it's uneconomic in nature and should be addressed.", "And there's a lot of discussions going on with regulators in the industry about this. So, we'll manage the change in the rate environment, and we'll maintain regulatory capital is consistent with our AA financial strength objectives. But, you know, there is a short-term impact on our statutory capital." ] }, { "name": "Suneet Kamath", "speech": [ "Can you size that at all?" ] }, { "name": "Ken Tanji", "speech": [ "You know, it's still -- it's going to be subject to, you know, where the rates move. And so, you know, that's still dynamic." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Thanks, Ken." ] }, { "name": "Operator", "speech": [ "[Operator instructions] Our next question is coming from John Barnidge from Piper Sandler. Your line is now live." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much. Seasonally, 3Qs had typically been the best, more talented quarter in any given year. This is a pre-pandemic world, of course. With COVID now clearly endemic, did that typical mortality seasonality return this year?" ] }, { "name": "Andy Sullivan", "speech": [ "Hey, John. Good morning. It's Andy. I'll talk about our COVID.", "We intentionally, as we've talked about many times in the past, manage our business mix to have a good balance between longevity and mortality. That absolutely paid us dividends all throughout the pandemic. During 3Q, the U.S. experienced 42,000 deaths, which was, you know, 17,000 more than our estimate.", "But the fact is, we continue to see a declining impact from COVID in the U.S. Let me just hit a little bit about each business. In group insurance, our life benefit ratio was 91.4%. It did reflect pre-pandemic mortality.", "That was slightly elevated due to accidental death and dismemberment claims that we very much see just as a natural quarter-to-quarter variability, nothing more. We're very pleased that we continue to see working age guests and its impact on working as continuing to decline. In individual life, we saw our mortality actual to expect it at the low end of our range, 97%. And we saw particularly good performance in the smaller face amount bands, and that is typically where we would see the COVID experience show up.", "In institutional retirement, we did see underwriting gains above our seasonalized expectations, particularly in pension risk transfer, but again, not surprising given the average age of that block of business. So, you know, the bottom line is, given the balanced mix of businesses that we have, we very much expect this will be very manageable as COVID continues to shift into an endemic state." ] }, { "name": "John Barnidge", "speech": [ "Great. And then, my follow-up question. Institutional flow is positive but material deceleration in PGIM. Retail improved in outflow.", "Can you maybe talk about how FX impact is changing where you're seeing demand, either a geographic perspective or from an asset perspective? Thank you." ] }, { "name": "Andy Sullivan", "speech": [ "Yeah, John. It's Andy. I'll take your question on flows. You know, as we've always talked about, flows will vary quarter to quarter, so we stay very focused on our long-term track record.", "In Q3, we experienced third-party net outflows of 4 billion, driven on the retail side. Institutional net flows remained positive with strong positive flows into both Jennison equity and real estate debt. So, showing the benefit of our diversified portfolio. We're very pleased with our positive $9 billion in institutional flows year to date.", "I would also note that we experienced good affiliated flows. So, from our insurance transactions, like the IBM transaction, we saw 7 billion in affiliated flows in Q3 and 14 billion year to date. You know, that is a very important part of our strategy. And it reflects the synergies between our liability generation capability, as well as our asset management capability.", "You know, to your specific question about retail outflows were 4.6 billion, that was a marked improvement from the 8.3 billion last quarter. Much like the rest of the industry, we continue to be impacted by headwinds in both active fixed income and growth equity. You know, as far as where are the flows going, the flows are tending to go into passive. And in the short-duration strategies, we're obviously not a passive player.", "As far as FX impacts, we really haven't seen anything material to speak of. You know, at the end of the day, we're highly confident that our diversified product portfolio has us well-positioned that, as the environment settles down and stabilize and flows start to shift back in, we have the experience to succeed and we'll be a net winner as we always have been. As we've talked about before, we've experienced 18 out of 19 years of positive inflows." ] }, { "name": "John Barnidge", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question is coming from Elyse Greenspan from Wells Fargo. Your line is now live." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi. Thanks. Good morning. My first question is on the Japan COVID losses.", "You had guided last quarter to maybe seeing, you know, about 50 million of unfavorable underwriting impact. And that came in at 200 million this quarter. So, are you concerned that some of that leads into the fourth quarter? And do you think that there could be any movement around your reserves?" ] }, { "name": "Scott Sleyster", "speech": [ "Thanks, Elyse. This is Scott. During the quarter, Japan experienced the largest surge of COVID cases since the beginning of the pandemic. Japan sort of did a really good job upfront, but omicron hit them hard much later.", "The new infections were mainly concentrated in younger ages. And they peaked in August, I think, at like over 240,000. They have since declined quite significantly. I think they're running around 40,000 today.", "So, they're down to about a sixth to where they were. From the beginning of the pandemic and consistent with regulatory guidance, A&H claims provided for a policyholder payments related to hospitalizations irrespective of whether the patient actually checked into the hospital. So, with the large sets of COVID cases, we did, in fact, see a big spike in A&H claims, which is what you were seeing. Starting September 26, the industry in agreement or with support from the government determined that hospitalization benefits will no longer be paid if the insured individuals are not actually in the hospital with very few exceptions, things for people over 65, or pregnant women, and certain serious comorbidities.", "So, we expect the change here to be pretty dramatic in the fourth quarter. First of all, the infection levels are down a great deal, and then the qualification levels have been substantially restricted. I think Ken already mentioned that we've got a placeholder for 20 million versus the 180 million for the fourth quarter. So, we'll continue to closely monitor the situation.", "And, you know, as in the past, we remain focused on really taking care of our customers, but also looking out for our employees and maintaining the strength of our distribution channels." ] }, { "name": "Elyse Greenspan", "speech": [ "Thanks. And then, my second question, what are you guys seeing in terms of the base spreads within institutional retirement? How quickly are those accelerating? And how should we think about the earnings growth potential in that segment from rising rates?" ] }, { "name": "Ken Tanji", "speech": [ "Elyse, it's Ken. I'll start. And, you know, we have seen, as the rise in rates and the rising yields have played, out a better opportunity to invest at more attractive terms. And you see that leading to earnings improvement.", "But probably more importantly will be the business growth, particularly with the with the pension risk transfer business that we just put on the books at the end of the third quarter." ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. And, Elyse, it's Andy. I would just add, we have a lot of momentum in our institutional retirement business. We have exceptional people, great capabilities, great brand and distribution systems, that's really second to none.", "And obviously, you've heard about that from a pension risk transfer perspective. But we had 13.5 billion in sales and institutional retirement. So, it goes well beyond just pension risk transfer. We also had 1.5 billion in investment-only stable value and 1.2 billion in longevity reinsurance.", "So, we have very good momentum, and it was a banner quarter for us in institutional retirement." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Erik Bass from Autonomous Research. Your line is now live." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. Your outlook implies higher seasonal expenses of, I think, 115 million in the fourth quarter, which is less than the 125 million to 175 million range that you typically expect. Is this a function of just being disciplined on expenses given the environment? Or should we think of this as a more permanent trend, given the cost-saving actions that you've highlighted?" ] }, { "name": "Ken Tanji", "speech": [ "Hey, Erik. It's Ken. We are being more disciplined, but it's really timing. You know, we see a lot of that coming into the fourth quarter as usual.", "And I wouldn't read too much into that. It's -- yes, we are being disciplined, but there's also timing considerations." ] }, { "name": "Erik Bass", "speech": [ "Got it. Thank you. And then, can you talk about how the yen movements are affecting demand for U.S. dollar-denominated products in Japan? Does this materially change the consumer value proposition and the outlook for demand or persistency?" ] }, { "name": "Scott Sleyster", "speech": [ "Thanks, Erik. This is Scott. I'll go ahead and take that. There are several things that go on from the strength of the U.S.", "dollar. On the one hand, you will have a cohort of customers who have bought, you know, kind of investment products, and they may want to terminate to take a gain if it's a net positive versus any surrender charge. And for people that have permanent life, they may be thinking about reducing coverage because a certain dollar amount will provide more yen coverage, which is ultimately typically what they're looking for. I think your question focused more on the sales side.", "With the dollar being this strong, we think people that will be looking for U.S. dollar products will be sizing down their purchase again because, in general, they are looking back to the coverage of the -- of ultimately how it covers them in yen. That being said, two other good things, I think, are going on with higher rates, U.S. dollar investment products do look more attractive, and ultimately, overtime, while we have some short-term headwinds because we use swaps to hedge.", "In the long fall, this will add to our net investment income, which we view is a tailwind in that market." ] }, { "name": "Erik Bass", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Your next question is coming from Wilma Burdis from Raymond James. Your line is now live." ] }, { "name": "Wilma Burdis", "speech": [ "Hey. Good morning. Could you clarify how the Lotus Re Bermuda entity works to create capital efficiencies? And is there a plan to bring in third-party capital in Bermuda?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. The Lotus Re is an internal reinsurance capability that's based in Bermuda. And we find that certain products in our initial use of it was with variable life that we find that the regime there, which is a very robust, you know, reserving standard is more principle-based and is better aligned with the economics of that business. And as a result, by transferring that to reinsuring that to that regime, we get releases of reserves and capital in PICA.", "And again, it's our efforts to really align the economics of our businesses with reserve and capital standards that are robust and risk-sensitive, recognize the nature of the business and are a better fit for that type of business." ] }, { "name": "Rob Falzon", "speech": [ "Wilma, it's Rob. Just sort of following on the second part of your question. So, in that particular entity, no, our intent is not to bring in third-party capital. As Ken alluded to, it's a kind of a captive vehicle.", "Having said that, we are keenly aware of the increased institutional appetite coming into this sector. And as we've said before, we don't think that there's a firm who's better positioned to figure out how to satisfy the intersection of demand for our customers on the liability origination side with appetite for funding into those sorts of investments from the institutional side. So, nothing to talk about near term there, but we think we're particularly well-positioned in order to be able to exploit that." ] }, { "name": "Wilma Burdis", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Alex Scott from Goldman Sachs. Your line is now live." ] }, { "name": "Alex Scott", "speech": [ "Hi. I had a follow-up on some of the questions on capital and the holdco cash balance. When I think about growth, you know, I appreciate that there's the PRT. Ex maybe some heightened PRT growth, I would think PICA, you know, would be a bit more self-funding.", "And I'm just trying to understand if maybe some of the need-to-fund growth from the holdco balance has to do with the expectation of what's going to happen in 4Q around this UL review. And the reason I ask is just, you know, if that is part of the contemplation, that's fine. And it's actually good because, you know, it means maybe you don't need to contribute anymore in 4Q. And that's really what I'm trying to figure out is, you know, when you go through that review in 4Q, would this need to occur again? Like, will there need to be more cash from the holdco that goes down into PICA to help fund, you know, that impact?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. So, Alex, the -- PICA is generating statutory capital with its business profile. But the size of the business growth that we experienced this quarter was pretty high and unique. And that's why -- we thought it was a very attractive use of capital and deployed capital for that purpose.", "We acknowledged that the assumption update would require funding needs, and that was a use of capital as well. But we had -- at the time of the second quarter, we had -- we're well-positioned to absorb that capital requirement within PICA, including the -- using the cash flow and statutory surplus that's being generated by our businesses. We'll be looking at the fourth quarter and evaluating again -- well, and I should mention, as I also described, we have had some short-term capital that is being held in reserves potentially for what we consider noneconomic reserving, given the rise in rates. And then, we'll, again, as we always do, in the fourth quarter, look at our capital position, our opportunities to deploy capital attractively, and make sure we're maintaining PICA at our AA financial strength standards." ] }, { "name": "Alex Scott", "speech": [ "Got it. That's helpful. And then, maybe a little bit of a more broad question on Japan. Could you talk about how a weaker yen impacts your business, and, you know, if that should be something we contemplate as we think about cash flow in 2023, either positive or negative?" ] }, { "name": "Scott Sleyster", "speech": [ "Thanks, Alex. This is Scott. You know, we've been operating in Japan for a long time. And, you know, in my many years here, I've seen the yen as low as in the high 70s to as high as it is, you know, today.", "So, as that happens, customer preferences will shift. And so we'll see more, you know, yen sales, for example, if dollar products get, you know, priced too high. On the other hand, we may see more dollar deposit type products that will be more attractive in the bank or other parts of the GIB channel, you know, related to where the dollar is. So, I'd say, fundamentally, we have the ability to adapt, and we've demonstrated that we've done that over time.", "I guess, what I would come back to is, I would say, we're very disciplined in how we price our business in Japan. Part of the reason you've seen the bank channel down is we are -- we've maintained our discipline around profitability. We haven't been chasing deposit products when the margins, you know, were really tight. So, I feel very good about the franchise we have there.", "We see less price sensitivity in channels where we have a preferred position like life planners and some of the affinity groups. And, you know, we'll adapt the product mix based on customer demand, but we're always going to keep our pricing discipline front and center." ] }, { "name": "Ken Tanji", "speech": [ "And, Alex, I'll just add. You know, we also have a very established hedging program with our Japanese business that hedges both earnings and net equity position. And, you know, given the strength of the dollar, that has a $1.8 billion gain at the end of the third quarter." ] }, { "name": "Alex Scott", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Mike Ward from Citi. Your line is now live." ] }, { "name": "Mike Ward", "speech": [ "Thank you, guys. So, you mentioned potentially reinsurance as one lever for a source of capital. Just wondering if that means we should sort of be expecting, you know, annuities reinsurance deal? Or could it be life or anywhere else? Any color there?" ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. Let me take that. This is Charlie. You know, first, I'll deal with both annuities and then talk a little bit about life.", "You know, we're really pleased with the valuation for the block of traditional variable annuities with guaranteed living benefits that we sold as evidenced by the gain on sale we reported. And we'll continue to explore possible additional opportunities to derisk in-force blocks of traditional VA business. We expect to reach our goal of reducing market sensitivity through the pallet transaction we just completed and through the natural runoff of traditional variable annuities business over time and as we're not in a position of having to do another transaction. But having said this, we'll continue to explore possible additional opportunities.", "But we'll only do something, as we've said before, if it's in the best interest of stakeholders. So, that's on the annuity side. On the life block side, you know, as we've noted in the past, we've dedicated resources to looking at various opportunities aligned with our strategy of becoming a higher growth and less market-sensitive company. And as a result, we'd certainly consider opportunities for a life sub-block if they came our way, but with the caveat that it has to make sense for shareholders.", "So, we're going to be disciplined in our approach as the individual life business continues to be core to our purpose." ] }, { "name": "Mike Ward", "speech": [ "Great. Thank you. That's very helpful. And then, maybe on PRT, just wondering if there's kind of a benchmark that maybe you could give in terms of how you think about earnings per $1 billion of PRT business or something like that.", "I guess one of your, you know, larger peers has given this in the past, I think it's around $7 million, $8 million of earnings per $1 billion of PRT. Wondering if that sounds ballpark accurate?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Mike, this is Ken. You know, all the deals are a little different. I don't think putting out a benchmark is -- you know, would be appropriate." ] }, { "name": "Mike Ward", "speech": [ "OK. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is a follow-up from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. I just wanted to revisit the statutory reserve charge you'll be taking in the fourth quarter. Just help me understand better why it would be comparable in size on the GAAP side. Because as you mentioned, you know, statutory reserves are more conservative.", "I mean, I would imagine there'd be some cushion there. If you could elaborate on the compatibility." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Tracy, it will be higher. But again -- and because -- generally, because the stat is more conservative. And it's also -- it's just different.", "But again, we have capacity to absorb that, and, you know, we still hold that view." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. When you say higher, you mean on absolute terms, or the contribution will be higher? I'm a little bit confused." ] }, { "name": "Ken Tanji", "speech": [ "No, I'm sorry. When we took the charge, we believe that we had and we continue to believe we have capacity to absorb that within PICA's excess capital position as a result." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. But I think last quarter, I think it was something like 1.4 billion pre-tax. So, are we talking the same dollar amount for stat?" ] }, { "name": "Ken Tanji", "speech": [ "It would be higher again. We're still finalizing those. That will be finalized in our fourth quarter results. But again, we have the capacity to absorb that within PICA, and we'll continue to maintain RBC ratios consistent with our AA standards." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question is a follow-up from Ryan Krueger. Your line is now live from KBW." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks. I figured I just asked this since it wasn't asked last quarter. Would you be able to say what your ULSG stat reserve total is and what you moved to the ultimate lapse rate assumption to when you did the review last quarter?" ] }, { "name": "Ken Tanji", "speech": [ "I think we need to follow up on both of those. They're pretty specific, if that's all right." ] }, { "name": "Ryan Krueger", "speech": [ "Yeah, no problem. I just figured I'd give it a shot. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is a follow-up from Tom Gallagher from Evercore ISI. Your line is now live." ] }, { "name": "Tom Gallagher", "speech": [ "Thanks. Just one question on the holding company cash, again, to come back to the -- the 5.1 billion, I believe, includes 1.5 billion that we should think about for prefunding a debt maturity in the middle part of 2023. I just wanted to confirm that that's the intention. And should we think about the holding company cash really as 3.6 billion on a net basis? Thanks." ] }, { "name": "Ken Tanji", "speech": [ "Yeah, Tom. In our holding company, cash position will vary depending upon the timing of when we issue debt or debt matures or we call it. We've consistently made it a good practice to prefund maturing and callable debt 12 to 18 months in advance. And, you know, this -- what this does is it reduces our refinancing risk and enables us to be selective in the timing of debt funding relative to particular market conditions.", "In August, we issued 1.5 billion of debt, and we've earmarked that for debt that's callable next year. The timing was good. We're happy with the outcome. And we're going to continue to prefund debt as a good practice.", "And overall, though, if you looked at our level of debt over the last three years, it's been at a fairly consistent level. It will vary depending on timing of maturities and issuance. But overall, it hasn't changed that much. We also have -- as we continue to highlight contingent sources of debt.", "So, overall, we feel very good about the level of our debt that's consistent with our AA financial strength rating and how we manage refinancings of our debt very well as well." ] }, { "name": "Charlie Lowrey", "speech": [ "Hey, Tom. It's Charlie. I'd just reiterate what I said in the beginning as well. You know, we believe we have other levers and resources by which to execute on our plan.", "So, there are -- you can look at it in the one way you did. But on the other hand, as Ken said, and as we've reiterated throughout the call, we have other means by which to execute on our plan as well." ] }, { "name": "Operator", "speech": [ "Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Lowrey for any further closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "OK. Thank you, operator. And thank you for joining us today. Before I conclude, I want to acknowledge the unexpected passing of George Paz last week, a member of Prudential's board of directors for the past six years.", "George was an integral member of our board, with a unique perspective and deep business experience that helped us shape our thinking on a multitude of issues. He will be greatly missed and remembered as both a trusted advisor and as a friend. I hope we demonstrated during this call the progress we're making to transform Prudential to deliver sustainable, long-term growth and meet the evolving needs of our customers. Looking ahead, we remain confident in our strategy and the strength of our company.", "For nearly 150 years, Prudential has been there for its customers and other stakeholders, who we will continue to serve as we strive to be a global leader in expanding access to investing insurance and retirement security. Thank you again for joining us today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2020-08-05	[ { "description": "Senior Vice President, Investor Relations", "name": "Darin Arita", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Bob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Dowling and Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Head of U.S. Businesses", "name": "Andy Sullivan", "position": "Other" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Head of International Businesses -- Analyst", "name": "Scott Sleyster", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to the Prudential quarterly earnings conference call. [Operator instructions] I'll turn the call now over to Mr. Darin Arita. Please go ahead, sir." ] }, { "name": "Darin Arita", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Bob Falzon, vice chairman; Andy Sullivan, head of U.S. businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we may make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-looking Statements and Non-GAAP Measures in the appendix to today's presentation which can be found on our website at investor.prudential.com.", "With that, I'll hand it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you Darin. Good morning everyone, and thank you for joining us today. I'll start by saying we hope that you, your families and colleagues remain safe and healthy during these extraordinary times. The events of the past several months have created unforeseen new difficulties for people around the world, while further exposing the deep-seated problem of inequity in our society.", "It's in times like these that we believe our company's purpose of solving the financial challenges of our changing world and standing by our employees, customers and communities is most important. After transitioning over 95% of our U.S. employees and most of our international employees to remote work in March, we continue to seamlessly serve customers, while the vast majority of our employees around the world continue to work in that fashion. This allows us to exercise utmost caution as we evaluate how and when to return to the workplace.", "In the meantime, I am so proud of our people and how they continue to focus on meeting the evolving needs of our customers, many of whom face new challenges related to the COVID-19 pandemic and its economic impact. We'll continue to innovate the ways we serve our customers during and after the pandemic. During the second quarter, we maintained a clear focus on executing against our 2020 initiatives despite the challenging macroeconomic backdrop by delivering on progress on our cost savings targets, aggressively repricing and pivoting products to mitigate the impact of low rates on our performance and rotating our international earnings mix. We're also focused on identifying opportunities for further action, particularly as we look to continue to reduce our sensitivity to markets.", "And we're exploring the potential to generate additional cost savings on top of our existing 2020 targets. Throughout this period, we benefited from the strength of our rock-solid balance sheet which gives us the confidence and the flexibility to navigate changes to the economic environment. I'll touch on each of these points in greater detail before turning it over to Rob and Ken for a look at our second quarter results. Turning now to our 2020 priorities on Slide 3.", "We remain on track to achieve our $140 million cost savings target for the whole year, and have achieved $75 million in savings year to date, with $45 million in the second quarter. We also continue to make progress in shifting our international earnings mix to higher growth markets. We remain on track to close on the sale of Prudential of Korea in the second half of 2020 and are advancing on review of strategic options for Prudential of Taiwan which may include a sale. As I mentioned earlier, we are aggressively modifying our product mix, while exercising a highly disciplined approach to pricing in this low interest rate environment.", "Turning to Slide 4. While we are encouraged by the progress we're making to position our businesses and operations for the future, we continue to look at ways to work smarter and more efficiently in order to achieve cost savings on top of our target of $500 million by 2022. This includes using technology and automation, and leveraging the learnings from operating in a remote work environment to optimize how and where we work. In addition, we're looking at other ways to build upon our repricing and product shift to further mitigate the impact of market sensitivity.", "On Slide 5, we note how we're embarking on these initiatives with the foundational strength provided by our balance sheet and robust capital position including highly liquid assets of $4.5 billion at the end of the second quarter. Prudential Financial and its subsidiaries continue to exceed a AA financial strength rating. Our second quarter assumption update had a modest effect on our financial results, even as we reduced our U.S. long-term interest rate by 50 basis points to three and a quarter percent.", "Lastly, we anticipate receiving the USD 1.7 billion of proceeds from the sale of Korea -- our Korea business by the end of the year. In terms of our capital deployment plans, we'll continue to monitor developments in the credit markets and the economy to determine our strategy. Slide 6 shows our second quarter financial results. This quarter exemplified the benefits of our thoughtful approach to risk management and our complementary business mix.", "We aim to balance mortality and longevity risk, so we don't have a one-sided exposure. In the quarter, we had net favorable underwriting experience. Our adjusted operating income was $931 million in the quarter. While we recorded a net GAAP loss driven primarily by the noncash effect of noneconomic market impacts which have no effect on our regulatory capital position.", "Our U.S. businesses reported adjusted operating income of $455 million due to more favorable underwriting, offset by the unfavorable impact of the assumption update and lower fee and spread income. PGIM reported record adjusted operating income of $324 million as well as record assets under management of $1.4 trillion, a 9% increase from the year earlier period. This growth reflected strong flows into fixed income as well as market appreciation.", "Our international businesses reported adjusted operating income of $693 million, as more favorable underwriting, higher earnings from joint ventures and business growth were offset by the unfavorable impact of the assumption update and lower spread income and higher expenses. Before turning it over to Rob, I'd like to address the recent disturbing incidents of racial injustice and how we, as an organization, are responding to the deep-seated and persistent problem of racism and inequity in society. Last month, we announced commitments to advance racial equity, as highlighted on Slide 7. These commitments were borne out of the courageous candor of our employees, who have shared their experiences and their expectations, and the listening that is taking place all across Prudential.", "Taking a bottom-up approach, we developed concrete and measurable actions spanning our talent practices to how we design and deliver products, to the investments we make and how we foster social and racial equity in the communities where we work and do business. We already had a substantive set of programs under way and a body of work that reflects our long-standing commitment to racial equity including investing over $1 billion in our hometown of Newark. We recognize that this moment calls for us to amplify what Prudential has already been doing to drive change within our company and within society. It is a moral and it is a business imperative that aligns directly with our company's purpose to solve the financial challenges of our changing world as well as our multi-stakeholder commitments to employees, customers, shareholders and society.", "We stand by the promises we make, and we are prepared to be judged for our actions to support our colleagues, customers and communities today and over the long term. And with that, I'll turn it over to Rob." ] }, { "name": "Bob Falzon", "speech": [ "Thank you Charlie. And I want to reemphasize your comment about our commitment as a management team to supporting racial equity. This is an issue that is aligned to our purpose, it's part of the fabric of our culture and critical to our success as an organization. I'll now provide an update on how we are executing on our strategy within our U.S., PGIM and international businesses as well as on the outlook for these businesses, and we'll also provide an update on our investment portfolio.", "Turning to Slide 8. The U.S. businesses produced a diversified source of earnings from fees, net investment spread and underwriting income. We continue to execute on three key priorities.", "First, we've implemented pricing and product actions to simplify and derisk our business mix, while protecting profitability. For example, we took aggressive pricing actions, aligned with our intention to significantly reduce sales of HDI, our legacy flagship VA product, and launched FlexGuard, our buffered annuity product which has been well received by the market, supporting our product mix shift to less sensitive, less interest rate-sensitive solutions. And in our individual life business, we suspended sales of our single life guaranteed universal life product in July. This will result in the continued shift to variable life and other less interest rate-sensitive products.", "We will continue to take product and pricing actions including steps to diversify our mix of business, to maintain profitability in this interest rate environment. As a result, we expect individual annuities and individual life sales to continue to move lower in the near term. Second, as the needs of our customers rapidly evolve including in response to COVID-19 and its economic impact, we are increasingly leveraging technology to enhance customer engagement and efficiency. For example, we've expanded our process to electronically deliver policies from application submission to policy issuance and have increased the use of our Fast Track automated underwriting process.", "And we have expanded the use of electronic signatures and self-service customer capabilities across our businesses. And third, we remain committed to expanding our addressable market. The pandemic has amplified the financial wellness challenges that many U.S. households face and has highlighted the importance of our financial wellness platform and our life insurance, retirement and financial planning solutions.", "We also continue to see increasing interest in our Assurance IQ platform from customers in the healthcare, life and P&C lines of business. Preparation for the Medicare annual enrollment period in the fourth quarter, we've been progressing well with our agent onboarding and training process. Now turning to Slide 9. PGIM is a top 10 global investment manager that continues to demonstrate the strength and resilience of its multi-manager business model.", "Our assets under management reached a record level of $1.4 trillion, up 9% from the year-ago quarter driven by net flows as well as the positive impact from equity and credit markets. PGIM's long-term investment performance remains strong and has rebounded from the temporary downturn in the first quarter. More than 85% of assets under management have outperformed their benchmarks over the last three, five and 10-year periods. This strong investment performance, coupled with diversified investment capabilities across asset classes, regions and client segments, has led to continued growth.", "We generated nearly $4 billion of net third-party flows during the second quarter driven by record retail flows of $9 billion. Institutional outflows were driven by a single passive equity client redemption. Our public fixed income platform generated flows of $10 billion, as it continues to benefit from our broad suite of strategies and the leading position of our franchise. PGIM investments was the No.", "1 ranked U.S. mutual fund franchise across active and passive asset managers based on net year-to-date sales. PGIM's asset management fees were up 3% compared to the year-ago quarter driven by the growth in average assets under management. In addition, other related revenues increased primarily due to higher strategic investment earnings as a result of strong investment performance and the effect of credit spreads tightening, reversing the widening that had occurred in the first quarter.", "We also continue to focus on cost discipline to fund growth and further increase our operating leverage. Turning to Slide 10. Our international businesses including our Japanese life insurance operation, where we have a differentiated multichannel distribution model as well as other operations focused on high-growth markets. As expected, life planner sales decreased 30% compared to the year-ago quarter primarily reflecting lower sales in Japan due to COVID-19-related restrictions on sales activities.", "Life planner headcount however increased 5% compared to a year ago. Similar to life planner, sales for Gibraltar were 34% lower, but the number of life consultants has declined as we continue to focus on quality distribution. Chile, market returns in the quarter were higher than average, and that contributed to an operating income benefit of approximately $25 million, reversing the impact we experienced in the first quarter. With respect to expenses across international, we provided appropriate sales support to protect and care for our captive distribution, as we noted last quarter.", "This contributed $55 million to expenses which we expect to trend lower in the second half of the year. We have seen some recovery in Japan sales beginning in June as the state of emergency was lifted. And over time, we expect sales to normalize. In addition, to mitigate the impacts of reduced face-to-face sales, our agents have adapted to increased usage of virtual tools to connect with customers, and we have seen early signs of success.", "We believe that our needs-based selling approach and death protection product focus continue to provide important value to our customers. With respect to interest rates, we've successfully managed through decades of low interest rates and other market challenges in Japan. As you have seen us do in the past, we adjust our product offering quickly to meet the needs and preferences of our customers, while also achieving our return expectations. We have already taken actions and will continue to do so as needed as we move forward.", "Now turning to Slide 11. We have a conservative, quality-focused investment portfolio that reflects our robust asset liability management practices, commitment to broad diversification and a disciplined interest rate risk management framework. We also leveraged PGIM's expertise across multiple asset classes including its deep and long-standing experience in private placements and real estate. Year-to-date credit migration and losses have trended below our expectations.", "Second-quarter credit losses were $139 million driven by energy and consumer cyclical sectors. While we expect credit losses to be a multiple-quarter story, we feel comfortable that our exposure is manageable and that we are well capitalized to weather whatever emerges. And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "On Slide 12 which provides insight into earnings for the third quarter relative to our second-quarter results. The key point is that our underlying earnings power increased slightly from last quarter primarily reflecting higher equity markets. To help you see this, I'll start with pre-tax adjusted operating income in the second quarter which was $931 million and resulted in earnings per share of $1.85 on an after-tax basis. Then, we adjust for the following items.", "First, the annual review of assumptions and other refinements resulted in a net charge of $334 million in the second quarter primarily driven by a reduction of our long-term interest rate assumption by 50 basis points in the U.S. Next, we adjusted variable investment income to a normalized level which is worth $130 million. Please note that while we have not included an adjustment for variable investment income for the third quarter, the potential exists for continued revaluation of private equity and real estate investments due to the current adverse economic conditions. While returns of our alternative investment portfolio are currently lower than our target returns, and will vary period to period, over time, this portfolio has generated income above our targeted returns.", "Third, we adjusted underwriting experience by $155 million. This reflects $100 million of favorable experience in the second quarter primarily driven by reserve gains in retirement. We estimate claims experience in the third quarter will include $55 million for COVID-19. Next, there are other items that, combined, may be $75 million more favorable in the third quarter primarily related to expenses and markets.", "We expect expenses including implementation costs, to be $130 million lower in the third quarter. This is primarily due to legal expenses in the second quarter. In addition, due to favorable markets in the second quarter, other related revenues in PGIM benefited by $45 million. And income in our Gibraltar segment also benefited by $25 million.", "Fifth, we expect operating costs due to COVID-19 to be $25 million lower in the third quarter. And last, we anticipate net investment income will be reduced by $15 million reflecting the difference between new money rates and disposition yields of our investment portfolio. These items combined get us to a baseline of $2.63 per share for the third quarter. Please note that this baseline includes items specific to the third quarter, that reduced EPS by approximately $0.19 per share.", "While we have provided these items to consider, there may be other factors that affect earnings per share in the third quarter. On Slide 13, we provided an update on the potential impact of the pandemic. We have included a sensitivity for operating income based on the U.S. population experiencing 100,000 of incremental deaths due to the pandemic.", "We estimate that this may lower operating income by $70 million. And this is less than the sensitivity we provided on our last earnings call, as we have seen a lower fatality rate due to COVID-19 in our U.S. insurance businesses than previously estimated. Our third-quarter baseline includes a net impact for mortality due to COVID-19 of approximately $55 million.", "The actual impact will depend on a variety of factors such as infection and fatality rates, geographic considerations and progress in testing and medical treatments. We have also reduced our estimate for incremental operating costs due to COVID-19 and have estimated the potential reduction in other operating costs, such as for travel and entertainment. In the second half of 2020, we expect to incur incremental operating costs of $60 million due to COVID-19, with $40 million in the third quarter and $20 million in the fourth quarter. The estimate of these costs is lower than what we provided on our last call primarily due to lower health benefit costs of our U.S.", "employees and lower cost to support our sales professionals in Japan as their productivity is improving faster than previously estimated. We also expect to have $30 million of lower travel and entertainment expenses in the second half of 2020. Turning to Slide 14. We continue to maintain a robust capital position and adequate sources of funding.", "Our capital position exceeds our AA financial strength targets, and we maintain liquid assets at the parent company that are greater than three times annual fixed charges. We have substantial sources of funding. Our cash and liquid assets at the parent company were $4.5 billion at the end of the quarter. We expect to receive net proceeds of $1.7 billion from the sale of our Prudential of Korea business following the close of the transaction which is expected in the second half of this year.", "And another source of funding is free cash flow from our businesses. In May, we added a new $1.5 billion contingent capital facility that, combined with our previous facility, brings our total available contingent capital funding resources to $3 billion. Turning to Slide 15. And in summary, we remain on track with our objectives for the year as we accelerate the execution of our initiatives.", "We're exploring the potential to increase our cost savings initiative and looking at additional ways to build upon our repricing and product shift to further mitigate market impacts. And we maintain a rock-bound -- rock-solid balance sheet with a robust capital and liquidity position. Now, I'll turn it over to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] First, with the line of Elyse Greenspan with Wells Fargo. Please go ahead." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi. Thanks. Good morning. My first question was just on the mortality assumption you laid out for the third quarter.", "So if I look at your disclosures, longevity did benefit your results in both the Q1 and the Q2 this year. So I'm just trying to understand why that wouldn't at least continue to some degree in the third quarter?" ] }, { "name": "Ken Tanji", "speech": [ "Hi, Elyse. This is Ken. I'll take your question about the COVID mortality into the third quarter. So we -- in our second quarter, we benefited from our longevity business in the U.K.", "Mortality in the U.K. came in a little bit higher than we had previously estimated, and that resulted in a gain from our U.K. longevity reinsurance business. While there was fatalities in the U.K.", "in the second quarter, right now, that seems to be more contained, and we wouldn't expect that to continue given the current fatality rates. So we also, in our new estimate, have incorporated into that sensitivity what we learned from the second quarter which is in our -- also in our life insurance and group insurance businesses, the fatality rates were lower than we previously estimated. So we've incorporated that into our new estimate." ] }, { "name": "Elyse Greenspan", "speech": [ "OK, thanks. And then second, on the capital side, as I said, in your prepared remarks that you would continue to monitor credit markets and the economy in determining your strategy. I guess, as you have one additional quarter under your belt, how are you thinking about capital return? Is it dependent upon getting the capital, the $1.7 billion from the Korea sale toward the end of this year or is it more just dependent upon kind of more time going on and seeing how credit markets develop?" ] }, { "name": "Charlie Lowrey", "speech": [ "Elyse, it's Charlie. I'll take that one. So as you know, we paused our share repurchases in the second quarter, in line with the risk framework that we had in place. And as you said, until we get better visibility into the depth and the duration of the pandemic, the possible recession and the credit cycle, we will maintain our financial flexibility and resiliency.", "When we get the clarity into those issues I just mentioned, we'll then share the timing of our plan to resume share buybacks and by how much. And that would also include the proceeds from the sale or potential sale of the Korean business. So we're going to focus on maintaining our financial strength. But when we get clarity into the issues going forward, we will certainly let you know, and we'll be transparent about it." ] }, { "name": "Elyse Greenspan", "speech": [ "Thank you. I appreciate the color." ] }, { "name": "Operator", "speech": [ "Our next question is from the line of Ryan Krueger with KBW. Please go ahead." ] }, { "name": "Ryan Krueger", "speech": [ "Hi. Good morning. Could you elaborate on I guess the things you're considering that would cause a reduction in your market in interest rate sensitivity? And I guess, in particular I guess I would assume to meaningfully change that, you would -- that would require some sort of an in-force reinsurance transaction. But if you could elaborate some more what you're thinking about?" ] }, { "name": "Bob Falzon", "speech": [ "Ryan, it's Rob. I'll take a shot at that. But first, let me just bring it up a level and say as we sort of think about our strategy on a go-forward basis, we think about the elements of that is, in the first instance, simplifying and derisking the business as we articulated in our opening remarks. The other components of that are about improving near-term earnings through the efficiency initiatives that we've talked about and which we think has some expansion opportunity associated with them.", "And then obviously, continue to expand our addressable market in order to support longer-term growth. Specifically with regard to the derisking, I would characterize the repricing and product shifts that we've done as sort of the first steps in transitioning to lower volatility, less interest rate and general market sensitivity across our businesses. For those products that we've either stepped back from or actually explicitly discontinued, so think about that as being HDI in the variable annuities business and guaranteed universal life in the life business, we'll look actively at opportunities to optimize the economics of the legacy blocks that are associated with those products. And those options range anywhere from simply sort of just running off the blocks to reinsuring indoor -- looking at selling the blocks.", "A couple of other things outside of that across our products, we're actually looking actively at product design as well as individual and aggregate limits that could reduce the amount of potential volatility that we get from any individual product or grouping of products. So you saw us significantly reduce the retention limits that we have within our individual life business by way of example. Charlie hit on financial flexibility and resiliency, so we're going to retain our capital in order to make sure that we have that in place. And we think that that's an element of the derisking, at least in the near term.", "But we're also looking at the investment portfolio and looking at strategic asset allocation, reoptimizing sort of the risk return and volatility trade-offs that are associated with our equity credit and our interest rate exposures, in light of where we are in the cycle and the opportunities that are in front of us. And I guess the last thing I'd mention is that as we look at the growth of the business, on a go-forward basis, our strategic emphasis is really on growing the elements of our business that are less rate-sensitive and more predictable and more capital-light like, for instance, PGIM, our asset management business. So those would be the primary things that we're thinking about on a -- from a derisking standpoint. Charlie, I don't know if there's any further color you'd want to add on to that." ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah. Thanks, Rob. So Ryan, let me just try and connect some dots. Because over the past 18 months, as Rob said, we've taken actions to begin to accomplish many of the objectives that Rob articulated, namely lower market sensitivity, lower capital intensity of our business mix, becoming more competitive in terms of serving our customers with processes, better processes and lower costs.", "And then finally, as Rob said, increasing growth, right? And so let me just tick through a number of things that we've done in order to achieve those objectives. We're sold or selling out of lower-growth businesses, Italy, Poland, Korea and exploring options for Taiwan. We acquired assurance, around which we have high conviction about growth in a business that isn't as market-sensitive, so lower risk. We've significantly reduced or stopped selling certainly highly interest rate-sensitive products and annuities and ILI.", "We introduced less market-sensitive products such as the buffered annuity. We repriced almost our entire product line. We announced and are executing on our future work initiative which will produce $500 million in cost savings with the potential to do more. And as Rob said, we're currently exploring other options on books of business that are market-sensitive.", "So we're executing on a series of incremental changes that we believe will lead to fundamental change in our business mix and ultimately, the trajectory of the firm as we go forward. So that's a foundation off of which we are going to grow going forward." ] }, { "name": "Ryan Krueger", "speech": [ "Thank you. I appreciate it." ] }, { "name": "Operator", "speech": [ "[Operator instructions] And next from the line of Humphrey Lee with Dowling & Partners. Please go ahead." ] }, { "name": "Humphrey Lee", "speech": [ "Goood morning and thank you for taking my questions. Regarding the kind of potential -- hello?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah, Humphrey. We can hear you." ] }, { "name": "Humphrey Lee", "speech": [ "In savings, I know it's still probably in the early stage of planning. But is there any way to help us think about the potential size and scope of that impact? Should it be kind of comparable to what you've been targeting so far or just more of an incremental to what you -- just a modest incremental to what you've been targeting?" ] }, { "name": "Bob Falzon", "speech": [ "Humphrey, it's Rob. I'll take a shot at that. You cut out a little bit, but I think I understood your question. So as we have been in the course of executing on the efficiency initiatives that we had articulated earlier in the year, earlier last year, we've actually accelerated those actions.", "And in the course of doing so, we've actually institutionalized continuous transformation capability. And as a result of that, we're generating new ideas and strategies for further efficiencies that enhance customer experiences. Remember that sort of the first priority of that is they enable our businesses, putting us in more competitive positions, and it increases our operating profits, particularly in light of the -- which is needed in particular in light of the impact of earnings of a low rate environment. The levers we're using, Humphrey, are pretty much the things that we've done to date.", "So increased use of technology and automation, process improvements, sourcing org design, all the things that are classic. We just think there's, as a result of this continuous process, much further that we can go from -- than what we've articulated to date. We're also contemplating learnings from the crisis and some of the implications of the pandemic and our experience in that on things like remote work, changes in communications and travel and use of technology on a go-forward basis. So all of that leads us to be optimistic that we can expand materially from where we are today, but we're not ready to quantify that.", "We'll provide more guidance on that when we get further into the year. And once we finished our work, we'll -- as Charlie indicated, we'll be transparent." ] }, { "name": "Humphrey Lee", "speech": [ "Appreciate the color. Shifting gear, looking at PGIM, as you mentioned, flows were very good in the quarter, especially on the retail side. But on the institutional side, even after that $4.5 billion of passive equity mandates redemption, flows were still kind of negative. So I was just wondering, can you comment on what you saw in the quarter? And then also, how is your pipeline looking out for -- especially on the institutional side?" ] }, { "name": "Andy Sullivan", "speech": [ "Sure, Humphrey. It's Andy. I'll take your question. And you were cutting in a little bit.", "I'm not sure if it was you or me. So retail flows are really a result of three things: very strong investment management performance, a broad and wide product portfolio and strong distribution. And we're performing well on all of those fronts. Our investment performance in the second quarter was very strong.", "All of our PGIM fixed income strategies outperformed benchmark. 96% of our equity -- Jennison equities outperformed benchmark. So very, very strong fundamental performance. As you know, we've been building out our global distribution over time.", "So we were actually quite pleased with our flows in the quarter. We were the No. 1 mutual fund family year to date and had $9.5 billion in positive retail flows. We did have the $4.5 billion index passive flow related to QMA.", "That was a very low fee rate mandate. So think in the neighborhood of 1 to 2 bps. So literally, it was less than $1 million in fees. It also was the last of our what I would call index mandate.", "As you look forward, quarter to quarter, there will be variability. But over the long run, our fundamental investment performance, the strength of our distribution, we have had strong organic flows over the last five years, and we would expect that to continue as we look forward over the next several years." ] }, { "name": "Humphrey Lee", "speech": [ "Andy, you cut out for one sec. You want to repeat the point you were making about -- I don't know if that was well-heard on the number of passive -- large mandate passive funds. That one was a little blurry." ] }, { "name": "Andy Sullivan", "speech": [ "Sorry about that. All I mentioned was the $4.5 billion outflow was the last large passive mandate that we have in our portfolio." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. I appreciate the color." ] }, { "name": "Operator", "speech": [ "And next with the line of Tom Gallagher with Evercore. Please go ahead." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. Charlie, just a follow up on Ryan's question on the -- I guess, the range of things you're considering with risk transfer. I hear what you guys are saying on limiting new sales considering some reinsurance back books, it sounds like maybe on life insurance. Have you considered anything more transformational? And the reason I ask that is kind of a more moderate, we'll say, limited approach to the strategy probably from a shareholder standpoint, is going to result in very limited growth as you have some of these businesses that you still own that are shrinking every year.", "So it becomes kind of a challenge from an annual earnings growth standpoint. Have you considered that? And would you consider something more extreme like an IPO of some of your capital market-sensitive businesses or a bigger reinsurance transaction or are you thinking in a more limited scale?" ] }, { "name": "Charlie Lowrey", "speech": [ "So Tom, thanks for the question. I appreciate it. Let me just take a step back and then I'll answer your question directly, but I'll make a comment about how we think about capital allocation and particular optimization. Because when we look across our businesses, what we try and do both domestically and internationally is ensure we're optimizing that capital deployment.", "So we've mentioned in the past that we're looking at or continue to look at businesses such as ILI annuities and some of our international operations as well as LTC. You've seen us take some bold action in terms of Italy, Poland, Korea, potentially Taiwan, etc. So what we're going to do is -- and what we can assure you is that we will continue to look to ways to optimize capital and capital deployment to maximize outcomes for shareholders, right, be that through significant dispositions, whatever flavor that may take, through potential share repurchases or through acquisitions. And right now, we have acknowledged and we'll continue to acknowledge that there's a high hurdle for any major acquisition, given where our stock price is trading.", "We get that. But we're looking, as you've seen in the actions we've taken to date over the last 18 months. And I think what you'll see us do going forward is look at all our businesses in order to optimize the capital we deploy and how we do that. And that's our commitment to shareholders, and that's what we're doing." ] }, { "name": "Tom Gallagher", "speech": [ "Got you. Appreciate it. The -- I guess, my follow-up is just, it looks like you've reduced pretty substantially the expense drag for the subsidies you were planning on or you've been paying to the life planners in Japan. Is that because you see greater visibility on a sales recovery emerging or have you just lowered the level of subsidy?" ] }, { "name": "Scott Sleyster", "speech": [ "Why don't I go ahead and take that, Tom? This is Scott. I think the answer is multifaceted, but maybe I'll speak first to the question on have we seen a sales recovery. We actually started to see a pretty good bounce back in June to the point where we were starting to get close to even to 2019 sales in both Japan and in Brazil. And that has continued and actually modestly strengthened in the month of July.", "So we are seeing a pretty good sales recovery, and we're encouraged. But of course, that is -- that has to be tempered by any kind of resurgence that could occur. In the case of the life planners, we were actually able to take what was an initial subsidy that was sort of an uncharacteristic payment that we have, and we were able to roll it into their bonusable plan. So a portion of the amount that we have for POJ is actually being deferred into their sales comp.", "So you're not seeing it as directly, but it's still there." ] }, { "name": "Tom Gallagher", "speech": [ "OK. Thanks." ] }, { "name": "Operator", "speech": [ "And next we'll go to Jimmy Bhullar with JP Morgan. Please go ahead." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hi. Good morning. First, just on your annual assumption review and the interest rate assumption. Obviously, it's more conservative than it was before but still fairly optimistic versus market levels.", "So just if you could talk about what went into your thoughts on how much to reduce the rate assumption by? And why did you not like make a bigger adjustment given where market rates are?" ] }, { "name": "Ken Tanji", "speech": [ "Hey, Jimmy. It's Ken. In terms of our long-term rate assumption, we followed a very established process that we've had for a number of years, and it considers multiple perspectives. So we look at again long-term interest rate forecast of economists, banks and managers.", "And we look to be at the median of all those. And for this year, when we looked at that that meant a 10-year U.S. treasury rate in the long-term of 3.25% and 1% for the JGB in Japan. So we followed the same process we've had for a number of years.", "It's also important to know how we grade into that long-term assumption. We do that over 10 years. And the first two years follows the forward curve. And as a result, it's not just the long-term assumption but the path with which we get there.", "And so over the next five years, our average rate would be 1.25%. In 10 years, it's about 1.9%. And so again, we have a pretty established process. We look at third-party inputs and look to be at the median, and that was the result for this year." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. And then any color on how your long-term care block has held up recently? And whether you've seen any benefit on your claims or reserves from the pandemic?" ] }, { "name": "Ken Tanji", "speech": [ "We saw a little bit elevated mortality in our policies that are already on claim, but it was fairly modest, and I wouldn't call it significant." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK, thanks." ] }, { "name": "Operator", "speech": [ "[Operator instructions] And next, we'll go to John Barnidge with Piper Sandler. Please go ahead." ] }, { "name": "John Barnidge", "speech": [ "Great. Thanks and most of my questions have been answered. But can you talk about commercial mortgage loan forbearance in the quarter? Directionality of that as well?" ] }, { "name": "Bob Falzon", "speech": [ "Hey, John. It's Rob. Yes. In -- to date, our -- we've received forbearance requests that are about 8% or so of the portfolio.", "We provided forbearance in 6% of those instances, and the remaining 2% are under review, and that excludes a little bit that we've gotten requests on that were declined. But in that, only about 1% of the requests have resulted in a deferral of interest. In all other instances, we remain current on interest and they've been deferrals of principal. Recall that across our portfolio, our loan to values are actually quite low.", "And so as a result of that, when we defer principal, we're actually not particularly concerned about that because we know that the principal amount is actually quite safe. The average loan-to-value across our entire portfolio based on our internal appraisals is 56-ish percent. Using external appraisals, it will be about 10 points lower than that, so less than 50%. And so given that low LTV, accommodations on amortization of principal or repayment of principal, we believe, is a prudent thing to be doing.", "And if we can remain current on interest, that keeps the loans performing, and that's been sort of our experience to date." ] }, { "name": "John Barnidge", "speech": [ "Great. Thanks for the answer." ] }, { "name": "Operator", "speech": [ "And next we'll go to Suneet Kamath with Citi. Please go ahead." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. Just a question, first off, on variable annuities. One of the things that folks are talking about now is that the NAIC is reviewing the mean to reversion assumption that they include in VA capital reform. So just curious if that's -- if that was changed, are you -- would you expect to see either a big impact on your hedging program or your capital requirements for VA?" ] }, { "name": "Ken Tanji", "speech": [ "Hi. This is Ken. We've -- I guess, a little bit of backdrop on this for us. We've managed our VA business with a very robust economic view and active hedging for many years.", "We're very supportive of a statutory framework that also is based on robust economic scenarios, both in terms of the long term assumptions, but also the dispersion around those assumptions. Our internal scenarios that we use to manage the business are actually more conservative than those being considered by the NAIC. So we continue to advocate for appropriate economic scenarios within the VM-21 framework. And we believe that we'll be well positioned due to our -- the internal framework that we've used to manage the business for many years." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. OK. And then just to shift over to international, if I could. Obviously, a lot of moving parts in terms of COVID, face-to-face sales, low interest rates, expenses.", "But as you think about the longer-term outlook for the Japan businesses, when do you see those businesses sort of back to earnings growth as opposed to either earnings declines or flattish earnings? Again, just conceptually, how are you thinking about the outlook for that business?" ] }, { "name": "Scott Sleyster", "speech": [ "Hi, Suneet. This is Scott again. I'll go ahead and take that. I guess, I'd talk a little bit about capital rotation mixed in with that question.", "We were seeing low growth in the developed markets in Korea, Taiwan and Japan. And you saw that we took actions in Korea, and we're considering those in Taiwan. And the reason that you see a difference between those businesses in Japan is that we have really strong market share in Japan, and we have a really high-performing LP model there. The business generates attractive returns over our cost of capital and it generates a lot of free cash flow to the parent.", "So we really like our Japan operation, and we continue to invest in it. That being said, overall premium growth in Japan has been negative for the last several years and the country continues to face demographic challenges. So the fact that we've been able to continue to grow in POJ has been a significant outperformance in the country. So I guess what I would say is we expect kind of low single-digit growth in Japan.", "And if we're achieving that that's actually very strong relative performance. And then in the context of a business system that's creating a lot of value and cash to the parent. In the meantime, we'll look for redeployment in higher-growth markets, but those are going to have to be opportunistic." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Thanks, Scott." ] }, { "name": "Operator", "speech": [ "[Operator instructions] And seeing no further questions coming in, Mr. Lowrey, I'll turn it over to you." ] }, { "name": "Charlie Lowrey", "speech": [ "OK. Thanks very much. So as we come to the end of the call today, I'd just like to thank you for listening and for your continued interest in Prudential. I also want to take a moment to thank all our employees for the steps they continue to take to support our business, our customers and our community including our collective efforts to address racial equity at Prudential and in society at large.", "We continue to make progress on executing our initiatives for the year, and frankly, are working to do more even as the global health pandemic continues. Backed by our financial strength and guided by our purpose, we'll continue to focus on delivering meaningful outcomes and value to all our stakeholders. Thanks again for joining us today. We appreciate it." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2022-08-03	[ { "description": "Vice President, Investor Relations", "name": "Bob McLaughlin", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Executive Vice President and Head of U.S. Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "Head of International Business", "name": "Scott Sleyster", "position": "Other" }, { "description": "Jefferies -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "Jack Matten", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Mike Ward", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to Prudential's quarterly earnings conference call. [Operator instructions] As a reminder, today's call is being recorded. I will now turn the call over to Mr. Bob McLaughlin.", "Please go ahead, sir." ] }, { "name": "Bob McLaughlin", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of U.S. Businesses; Scott Sleyster, head of International Businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-Looking Statements and Non-GAAP Measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.", "And now I'll turn it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Bob, and thanks to everyone for joining us today. Our second quarter financial results reflect the impact of macroeconomic environments, including the unusual confluence and magnitude of rising interest rates, widening credit spreads and equity market declines. In addition, we strengthened our Individual Life reserves as part of our annual review of assumptions, which had a significant impact on our results. This was primarily driven by an increase in our guaranteed Universal Life reserves.", "As a reminder, we discontinued single life guaranteed Universal Life sales in 2020 as part of our strategy to derisk our product mix. And we continue to make strategic progress in transforming our businesses to be less market-sensitive and more nimble. We also made additional investments to enhance our long-term sustainable growth. We did this in several ways.", "First, we significantly reduced our market sensitivity by completing our planned divestitures. Second, we invested in growth businesses and partnerships to address customer needs and expand access to our products and solutions. And third, we continue to advance our cost savings program and now expect to reach our $750 million target one year ahead of schedule. We executed on these strategic initiatives with the support of our solid balance sheet.", "Our strong financial position provides us with the flexibility to navigate through the current macroeconomic conditions while continuing to invest in the long-term growth of our businesses and return capital to shareholders. We're also confident that our higher rate environment will benefit our businesses over time despite the short-term impacts on our financial performance. I'll now provide an update on the progress of our strategic initiatives. Turning to Slide 3.", "We are executing on our plans to reposition the businesses by reducing market sensitivity and making investments to support long-term sustainable growth. We completed the sales of our Full Service business and a portion of our traditional variable annuities in April. Together, these divestitures resulted in a $1.5 billion pre-tax gain and further reduce the overall market sensitivity of our businesses by approximately 20%. Moving to our growth investments.", "We are investing in programmatic acquisitions and partnerships that will help us grow in emerging markets and expand access to investing, insurance and retirement security around the world. In Africa, we completed our acquisition of an initial minority stake in Alexforbes, a leading provider of financial advice, retirement, investment and wealth management in South Africa. We are now in the process of increasing our stake in the company by up to an additional 18% through a tender offer. In June, we established a partnership with Mercado Libre, the largest e-commerce platform in Latin America with approximately 200 million users.", "This will enable us to deliver life insurance and accident and health products tailored to the platform's mass market customer base. At the same time, we are investing in the growth of our products that meet the evolving needs of our customers. Our FlexGuard buffered annuity product recently surpassed $10 billion in sales since launching two years ago. We are also experiencing strong sales from our more recently launched FlexGuard Income offering.", "Turning to our cost savings initiative on Slide 4. We now expect to achieve our full $750 million cost savings target in 2022, one year ahead of schedule. We recorded $175 million in cost savings during the second quarter for a total of $725 million of run rate savings to date since 2019. We've also implemented a process of continuous improvement to identify and execute on additional cost savings opportunities in the future.", "Turning now to Slide 5. Our robust balance sheet is at the core of all our efforts to transform Prudential to be a leader in expanding access to investing insurance and retirement security around the world. This financial strength also provides the flexibility to balance investing in our businesses with delivering attractive returns to our shareholders. Our robust financial position includes a high-quality, well-diversified investment portfolio; our capital position supports a AA financial strength rating; and we had $7 billion in highly liquid assets at the end of the second quarter.", "During the second quarter, we returned over $800 million to shareholders. And since the beginning of 2021, we have returned a total of $6 billion toward our objective of $11 billion by the end of 2023. Finally, a comment on the environmental, social and governance front. In June, we published our third annual sustainability report, which details the progress of our ESG initiatives, including information on our EEO-1 and pay equity disclosures, commitments to racial equity and achieving net zero emissions.", "We believe in transparency and hold ourselves accountable to the commitments detailed in our report. With that, I'll turn it over to Rob for an update on our business performance." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results and business performance for our PGIM, U.S. and International Businesses. I'll begin on Slide 6 with our financial results for the second quarter of 2022.", "Pretax adjusted operating income was $872 million or $1.74 per share on an after-tax basis and included a $1.4 billion increase in reserves from our annual assumption update and other refinements. We strengthened our Individual Life reserves, primarily reflecting updates to policyholder behavior and revised mortality assumptions. These updates were based on several industry studies, emerging practices and our own experience following our well-established annual assumption update process. Current quarter results also included an $852 million gain from completing the sale of PALAC, a legacy block of variable annuities.", "Our GAAP net loss was $1.4 billion lower than our after-tax adjusted operating income, primarily driven by the mark-to-market impact from higher interest rates on derivatives that are used for asset liability management, partially offset by a gain on the full -- on the sale of our Full Service business. Turning to the operating results of our businesses, excluding the impacts of the annual assumption update and the gain on the sale of PALAC. PGIM, our global investment manager, reported lower other related revenues driven by a decrease in seed and co-investment income and incentive fees as well as lower asset management fees compared to the year ago quarter. Results of our U.S.", "Businesses were lower than the year ago quarter, reflecting lower spread income due to less favorable variable investment income and lower fee income resulting from the decline in equity markets, partially offset by more favorable underwriting. The decrease in earnings in our International Businesses primarily reflected lower earnings from joint venture investments, lower net investment results driven by less favorable variable investment income and less favorable underwriting results, partially offset by business growth. Turning to Slide 7. PGIM, our global active investment manager, has diversified capabilities in both public and private asset classes across fixed income, alternatives, real estate and equities.", "PGIM's long-term investment performance remains attractive, with 75% to 85% of assets under management outperforming their benchmarks over the last three, five, and 10-year periods. PGIM benefited from its diversified business mix as strong institutional net inflows of $8.1 billion, primarily driven by fixed income, offset retail outflows as investors repositioned their portfolios in a rising rate environment. As the investment engine of Prudential, the success and growth of PGIM and of our U.S. and International insurance and retirement Businesses are mutually enhancing.", "PGIM's asset origination capabilities, investment management expertise and access to institutional and other sources of private capital are our competitive advantage, helping our businesses bring enhanced solutions, innovation and create more value for our customers. Our insurance and retirement businesses, in turn, provide a source of growth for PGIM through affiliated flows and unique access to insurance liabilities that complement its successful third-party track record of growth. PGIM's average fee rate increased due to the successful execution of our strategy, including the continued mix shift toward higher fee strategies in our alternatives and private credit business. As a result, asset management fees decreased by only 6% despite assets under management declining by 11% due to rising rates, widening spreads and equity market depreciation.", "We continue to grow our alternatives in private credit business, which has assets under management of approximately $230 billion across private credit, real estate equity and debt and private equity secondaries, and benefits from our global scale and market-leading positions. Notably, across PGIM's private platform, we deployed nearly $15 billion of capital, up nearly 40% from the year ago quarter, reflecting the continued strong environment for private credit. PGIM also raised nearly $3 billion in new private capital commitments across real estate and private credit. Turning to Slide 8.", "Our U.S. Businesses produced diversified earnings from fees, net investment spread and underwriting income and benefit from our complementary mix of longevity and mortality businesses. We continue to shift our business mix toward higher growth and less market-sensitive products and businesses to transform our capabilities and cost structure and to further expand our addressable markets. Retirement Strategies achieved solid sales in the second quarter across its institutional and individual lines of business.", "Institutional stable value sales were $1.6 billion. International reinsurance closed $1.4 billion of longevity reinsurance transactions during the quarter, and U.S. pension risk transfer closed several transactions totaling more than $725 million. Our product pivots in individual retirement have resulted in strong sales of more simplified solutions with nearly $1.5 billion of FlexGuard and FlexGuard Income sales in the second quarter.", "Our strong FlexGuard sales benefited from implementing a fully digital and automated new business experience. This tech-forward approach helps to maintain our record pace of sales. Our Individual Life sales also reflect our earlier product pivot strategy with variable life products representing approximately 71% of sales for the quarter. The improved group insurance benefits ratio for the quarter reflects the transition from a pandemic to an endemic phase of COVID as well as favorable experience in both group life and disability.", "In addition, we're focused on creating the next generation of financial solutions to serve the diverse needs of a broader range of customers and clients. This quarter, we launched the Prudential simplified issue final expense product on the Assurance platform. Turning to Slide 9. Our International Businesses include our Japanese life insurance companies, where we have a differentiated multichannel distribution model as well as other businesses aimed at expanding our presence in high-growth emerging markets.", "In Japan, we are focused on providing high-quality service and expanding our geographic coverage and product offerings. Our needs-based approach and mortality protection focus continue to provide important value to our customers as we expand our product offerings to meet their evolving needs. And we continue to enhance customer experience and agent support, including through digital tools. For example, this quarter, Gibraltar launched an exclusive website dedicated to teachers to help serve this market.", "In emerging markets, we are focused on creating a carefully selected portfolio of businesses in regions where customer needs are growing, where there are compelling opportunities to build market-leading businesses and where the Prudential enterprise can add value. In the second quarter, we continued to focus on expanding product and business capabilities in emerging markets to meet the evolving needs of customers. In Brazil, we achieved record sales, driven by the expansion of our third-party distribution channel, where sales increased 120% compared to the year ago quarter as well as by the continued strength of the Life Planner channel. We established a partnership with Mercado Libre in Latin America to expand access to customers in the region.", "In the first two weeks following the launch in June, we have sold life and A&H policies in every state in Brazil. This was accomplished through a fully digital sales, customer service, and claims experience. We also continue to expand our wellness platform across Latin America by establishing a partnership with Medifé, a health service provider to 300,000 customers in Argentina. In addition, we are expanding our presence in Africa through an investment in South African-based Alexforbes, as Charlie discussed earlier.", "As we look ahead, we're well positioned across our businesses to be a global leader in expanding access to investing, insurance and retirement security. We continue to invest in growth businesses and markets, deliver industry-leading customer experiences and create the next generation of financial solutions to better serve the diverse needs of a broad range of customers. And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 10, which provides insight into earnings for the third quarter of 2022 relative to our second quarter results. As noted, pre-tax adjusted operating income in the second quarter was $872 million and resulted in earnings per share of $1.74 on an after-tax basis. To get a sense for how our third quarter results might develop, we suggest adjustments for the following items.", "First is an adjustment for two onetime items that net to a charge of $571 million in the second quarter. Our annual assumption update and other refinements resulted in a net charge of $1.4 billion, primarily driven by our Individual Life business, as Rob previously described. This was partially offset by an $852 million gain from the sale of a block of legacy variable annuities. Next, variable investment income outperformed expectations in the second quarter by $80 million.", "Third, we adjust underwriting experience by a net $25 million. This adjustment includes a placeholder for COVID-19 claims experience in the third quarter of $50 million for our International Businesses, primarily due to hospitalization benefits for policyholders recovering from COVID-19 at home in accordance with the special regulatory provision in Japan that is currently in effect. We have also updated our mortality assumptions for the U.S. Businesses to include continued COVID-19 mortality with an expected gradual transition to an endemic phase over time.", "While we have attempted to reflect COVID-19-related claims experience, the actual impact will depend on a variety of factors such as infection and fatality rates, geographic and demographic mix and the effectiveness of vaccines. And last, we expect other items to be $30 million lower in the third quarter, primarily due to lower-than-typical expenses in the second quarter that were partially offset by lower other related revenues in PGIM and lower joint venture earnings. These items combined get us to a baseline of $2.63 per share for the third quarter. I'll note that if you exclude items specific to the third quarter, earnings per share would be $2.75, a modest decline primarily due to lower fee income as a result of market depreciation, lower underwriting income due to the updated actuarial assumptions and continued COVID-19 mortality that is now reflected in our U.S.", "Businesses expected results. While we have provided these items to consider, please note there may be other factors that affect earnings per share in the third quarter. Turning to Slide 11. I will now comment on the upcoming adoption of the new accounting standard for long-duration insurance contracts, also known as LDTI, which goes into effect on January 1, 2023.", "The new accounting standard applies to our GAAP financial statements and will have no direct effect on our statutory financial statements, cash flows or dividend capacity. We estimate that adjusted book value, which excludes accumulated other comprehensive income, or AOCI, will be reduced by $1 billion to $2 billion as of December 31, 2021. This reflects the reclassification of nonperformance risk gains from retained earnings to AOCI and other changes in reserves. We believe adjusted book value, which excludes AOCI, remains a relevant measure as AOCI and GAAP equity will continue to lack symmetry in the valuation of invested assets and insurance liabilities.", "We estimate that AOCI will be reduced by approximately $28 billion to $33 billion as of December 31, 2021, primarily due to the remeasurement of long-duration liabilities with a lower discount rates, primarily in our Japan business. Also of note, GAAP equity and adjusted book value will continue to exclude certain unrealized insurance margins from products subject to LDTI. As of December 31, 2021, the estimated after-tax unrealized insurance margins related to those products are expected to be $60 billion to $65 billion, primarily in our Japan business. These margins represent an important factor in determining financial strength.", "Turning to Slide 12. We continue to maintain a robust capital position and adequate sources of funding. Our capital position continues to support a AA financial strength rating, and we have substantial sources of funding. Our cash and liquid assets were $7 billion and above our $3 billion to $5 billion liquidity target range due to the receipt of proceeds from the sales of our Full Service retirement business and a block of legacy variable annuities.", "And other sources of funds include free cash flow from our businesses as well as contingent capital facilities. Turning to Slide 13 and in summary, we are executing on our plans to reposition our businesses. We are expecting to reach our targeted cost savings one year ahead of plan, and our rock-solid balance sheet provides financial flexibility to execute on our transformation and thoughtfully deploy capital. Now I'll turn it to the operator for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our first question today is coming from Tom Gallagher from Evercore. Your line is now live." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. I'd like to start on the mortality assumption review, the charge. Can you talk a little bit about what drove it? Was it more the mortality side? Was it more the lapse side? Was it mainly mortality assumptions pre pandemic? Was there a meaningful adjustment from the experience that you've seen through the pandemic? A little bit of color there would be helpful. Thanks." ] }, { "name": "Ken Tanji", "speech": [ "Yes. Hey, Tom. It's Ken. Let me give you a little bit of background on the assumption update.", "As I think most people know, each year in the second quarter, we examine our updated experience that's available from our own business, but we also look at information that's available from industry studies and other surveys. And again, this year, we followed our process that's quite comprehensive and well established. We did make updates to our Individual Life insurance actuarial assumptions, primarily for policyholder persistency and mortality. Let me start with the policy persistency changes.", "That was mainly with our guaranteed Universal Life products, where we lowered our lapse and surrender assumptions, and that revision reflected information we gained from recently released studies and surveys as well as our recent emerging experience. And so we essentially refined into a more dynamic lapse assumptions for that portion of the business. In terms of mortality, we also included the impact of COVID-19 claims with the expectation of shifting from endemic to -- or from a pandemic to endemic phase. And we also lowered future mortality improvement as well given recent trends.", "Now the majority of the reserve strengthening was the result of the policyholder persistency assumption. The mortality updates were more modest across all of our businesses." ] }, { "name": "Tom Gallagher", "speech": [ "That's really helpful, Ken. Appreciate that color. My follow-up is just, will the -- will this also result in a statutory impact in addition to the GAAP impact? And if so, can you help quantify that and talk about how that could impact capital management, if at all?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. The updated assumptions are applied to our statutory reserves as well. It will have a comparable magnitude of impact, but we're well positioned to maintain strong regulatory capital ratios. We have a strong capital position overall, and we continue to have diverse sources of free cash flow going forward as well." ] }, { "name": "Operator", "speech": [ "Your next question is coming from Ryan Krueger from KBW. Your line is now live." ] }, { "name": "Ryan Krueger", "speech": [ "Hi. Thanks. Good morning. Would you expect much of an impact from updated Q2 factors for longevity risk, which I don't think was in the RBC ratio previously and an updated mortality risk factor when that is implemented, I believe, which may be at year end?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Ryan, it's Ken again. I'll take those. No, we don't expect a significant overall impact for either of those.", "The longevity factors were incorporated, I believe, last year and including some correlation benefits between longevity and mortality and given the updated -- the updates to mortality that have been proposed, those will be manageable and again, reflective of the good combination of business that we have that is both longevity-based and mortality-based." ] }, { "name": "Ryan Krueger", "speech": [ "Got it. Thanks. And then I had a question on the Bermuda subsidiary that you had established earlier this year and contributed capital to last year -- or last quarter. Can you give any more color on kind of what your longer-term plans are for that? And what -- to what extent you may be able to start shifting U.S.", "into Bermuda to get an offsetting benefit from the capital you had contributed last quarter. Thanks." ] }, { "name": "Ken Tanji", "speech": [ "OK. Yes, Ryan, yes. We did launch a new company last quarter. It's a new reinsurance company that's based in Bermuda, which we call Lotus Re.", "We think it's a really good capability to have. We've reinsured a block of variable life policies to that company. We're obviously following the BMA standards. The business is well reserved and capitalized, including the capital that we put in, in it last quarter.", "But it's also very well aligned with the economics of that business. So going forward, we do believe this will be a more efficient capital framework for our variable life business that's well aligned with the economics of that business as well." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question is coming from John Barnidge from Piper Sandler. Your line is now live." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much. Can you maybe talk about persistency trends in group life and disability? There's been increased lapse activity seen by other market participants given kind of the movements in the war on talent among employees. It looks like persistency did go down in 2Q for disability, but not life. Thank you." ] }, { "name": "Andy Sullivan", "speech": [ "Hey, John. Good morning. It's Andy. I'll take your question.", "Maybe I'll bring it up a level and say that the general effect that we saw during the pandemic was companies really pulled back on switching their benefit plans. As we've come through the pandemic and as hopefully we're coming out the other side and it's becoming more endemic, we've seen basically in the marketplace a normal level of RFP activity. So things have gotten sort of back to normal. When we talk about our persistency, we're very pleased with our persistency results.", "And as you would imagine, we track very closely the profitability of the business that we retain versus the profitability of the business that we lose. And part of the secret sauce of managing group insurance businesses is sometimes addition by subtraction. If we can't get the rates that we want to get to move a case to profitability, our plan and our intention and our follow-through is always to let it go. But we're quite pleased at the persistency levels in the business." ] }, { "name": "John Barnidge", "speech": [ "Great. And then my follow-up question, if I may. That unrealized insurance margin in Japan, is that a game that can be harvested through a risk transfer? Or how should we be thinking about Pru realizing those?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. John, it's Ken. Let me just -- the unrealized insurance margin is -- that we're referencing here and quantified is under the GAAP constructs. And you can think of it as basically the present value of future premiums less the amounts of the premiums needed to provide for claims.", "So it's margin above and beyond what's needed to support the expected claims. It is indicative of the profitability of the business, and the majority is from our Japan business, and it's reflective of what we think is the strong profitability of our Japan business. There is good embedded profits there and value, and it is a potential source of free cash flow over time. And if we choose to reinsure a block of it as well, we could release capital that way." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question is coming from Elyse Greenspan from Wells Fargo. Your line is now live." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi. Thanks. My first question, going back to Individual Life. When we normalize for the assumption review, VII and underwriting, it looks like the underlying earnings power of that segment is in the range of $100 million.", "And I think in the slides, you guys put the Q3 baseline at $96 million. So can you talk about if there are any ongoing earnings impact from the assumption review? And is roughly $100 million pre-tax a good quarterly level run rate earnings for that segment?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes, Elyse. This is Andy. I'll take your question. The assumption update does have an ongoing impact on our Individual Life business.", "It reduces our core earnings capability in the neighborhood of $30 million per quarter. So our core run rate was about $105 million before, so it brings it down to $75 million. What you're seeing in our walk on the slide, remember that we expect to have $20 million of higher underwriting gains seasonally in third quarter of '22. So if you make that adjustment, that gets you to that $96 million baseline." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. Thank you. And then my second question is on Assurance IQ, if you guys can just give us some color on the upcoming enrollment season. And then revenues declined there roughly 30% in the second quarter.", "Were revenues, for some reason, impacted by the assumption review? Or should we just think about that $78 million perhaps indicating a lower baseline for that segment?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Elyse, it's Andy. I'll take the question. Let me start by reiterating that we're still very focused on scaling up revenue in each of the distinct product lines in the Assurance IQ platform as that really is what's required to get the business to achieve profitability.", "With that said, and you sort of pointed to this, there are a number of things that are important to discuss this quarter as we've made really good progress in Medicare Advantage that was somewhat masked. First, we did have a $17 million negative LTV adjustment, that is a direct impact on revenue. That was an adjustment -- assumption adjustment based on our persistency. Second, we saw an impact on the under 65 healthcare business versus the year ago quarter as the Biden administration did not open up a special enrollment period like they did last year.", "Those two factors really masked a 64% improvement in Medicare Advantage enrollments and a resulting 35% increase in Medicare Advantage commission revenue versus a year ago quarter. So we are pleased with the continued underlying fundamental strengthening in the Medicare Advantage product line. The first part of your question is how we're feeling about our preparation. We're making very good progress in becoming ready for the fourth quarter open enrollment season from an agent preparedness perspective specifically.", "We've now -- we'll be entering our third year, so we have the benefit of two full cycles underneath us. And candidly, we're seeing great success in hiring agents, partly due to the difficult time that some of the smaller players in the space are having." ] }, { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our next question is coming from Jimmy Bhullar from J. P. Morgan.", "Your line is now live." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hi. Good morning. I just had a question first on the actuarial review and its impact on future income. I think you mentioned $120 million on GAAP.", "Should we assume a commensurate impact on stat income going forward as well?" ] }, { "name": "Ken Tanji", "speech": [ "It would have a similar impact on GAAP earnings. I'm not -- we'll have to get back to you on the quantum of that, but there would be a future impact of strengthen the reserves going forward." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. And then can you talk about your -- the decline in the Life Planner count and Gibraltar life consultants and whether it's sort of -- and what your expectations are for growth in both of those agency channels? Is the decline being caused more by sort of COVID-related factors right now? Or should we assume modest growth going forward in both of those?" ] }, { "name": "Scott Sleyster", "speech": [ "Jimmy, this is Scott. The LP count has been essentially flat with new recruits roughly offsetting LP resignations, and our LC count has actually been slightly negative. As you might expect, it's been more challenging to recruit in a pandemic environment. It's actually a little bit harder to mentor new hires in this kind of environment.", "We expect this situation to remain challenging until the pandemic eases. But we would then expect to see improvement in kind of a return to normal beyond the pandemic. I think it's also worth noting that we continue to focus a great deal of energy on expanding our third-party distribution channels across all of our markets." ] }, { "name": "Operator", "speech": [ "Thanks. Your next question is coming from Suneet Kamath from Jefferies. Your line is now live." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. Just wanted to come back to the assumption review and the impact on statutory. Just given the size of the charge, does this suggest that you're going to need to infuse capital into PICA? Or is there enough excess RBC in there to sort of absorb the similar charge that you took on a GAAP basis?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Overall, this will be very manageable, as I mentioned, where we think we're well positioned to maintain strong RBC statutory ratios. And right now, we're not expecting to have to infuse additional capital as a result." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Got it. And then I guess for Charlie, I'll ask the same question I always ask on the strategy. And this idea of improving the earnings contribution from growth businesses to over 30%, it still seems like you'll need pretty sizable inorganic M&A to get there.", "So just curious what you're seeing out there in the landscape. Are you seeing opportunities to put some of the $7 billion of liquid assets at the holding company to work? I mean just thinking about inorganic growth, what are you seeing out there?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yes. Sure. We're seeing a number of different opportunities. At this point in the cycle, you're beginning to see other things or some things free up that wouldn't have been there before and at reduced multiple.", "So it's a good time to have flexibility in order to be able to think about that kind of acquisition. What I would say is I'll make a couple of observations. The first is our strong balance sheet provides us with the flexibility to manage through whatever macroeconomic conditions we may face as we look forward. And that's going to be an important consideration for us as we go forward.", "But second, to your point, having a strong balance sheet in a dislocated market means that we can take advantage of opportunities that present themselves. So we do have a strong balance sheet. We're going to remain flexible with that balance sheet, and we're going to look for opportunities that may present themselves in the current economic environment." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question is coming from Alex Scott from Goldman Sachs. Your line is now live." ] }, { "name": "Alex Scott", "speech": [ "Hi. First question I had was on the annuities business. Now that the transaction is closed, I was just wondering if you could help us think through earnings power there and just given a lot of moving parts to the transaction equity markets. And then I think maybe the runoff of the block, how should we think of that over the next several quarters?" ] }, { "name": "Andy Sullivan", "speech": [ "So Alex -- go ahead." ] }, { "name": "Ken Tanji", "speech": [ "Go ahead, Andy. All right. Sorry about that. Maybe I'll just comment.", "We did close the PALAC transaction. And it came in as we were expecting and would reduce our earnings by about $75 million a quarter, and that is very consistent with what we had announced at the time of the transaction." ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Ken, maybe I'll just jump in and add. I just may bring it up a level back to our intentional strategy to reduce our exposure to traditional variable annuities with guaranteed living benefits to be less than 10% of our enterprise earnings. And so that reduction is very intentional, and it was the two-step process of pivoting and runoff that remains on track.", "We saw $2.9 billion in runoff this quarter. And then obviously, the derisking transaction. But the other major part of that was pivot to our FlexGuard chassis, a more simpler design, less volatile design. And we're certainly pleased with the continued strength of those sales." ] }, { "name": "Alex Scott", "speech": [ "Got it. And the second one I had for you was on the LDTI. You gave some good disclosure on the book value impact. And I know you mentioned that there's a lot of margin that's sort of left in the reserve because of the pivot sort of approach to LDTI.", "What does that mean to the earnings power? Can you help us think through that, particularly in Japan, where it's a lot about [Inaudible], I assume that a lot of that margin probably has to do with that business. Will this materially change the earnings power?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Overall -- and we'll be providing more disclosure around the whole transition to the new accounting standard as we -- around the time that it is implemented. But let me provide some overall thoughts on earnings. First, overall, we don't expect a significant impact on the level of core operating earnings.", "Certain businesses have little or no impact like PGIM and group insurance. And from our insurance and retirement businesses in the U.S. and internationally, some will be a bit higher, some will be a bit lower. But overall, that's generally offsetting.", "So again, overall, we don't expect a significant change in the level of our core operating earnings." ] }, { "name": "Operator", "speech": [ "Thanks. Our next question today is from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thanks. I have another question on the assumption update. You mentioned industry study. We're in the cheap speed tier.", "Is that something that is widely available? Or if you could provide context regarding who participated in that study and who conducted the study, that would be very helpful." ] }, { "name": "Ken Tanji", "speech": [ "Yes. Tracy, that was done by a private party, and it did involve a number of people in the industry. We're not at liberty to disclose who was in there. That's proprietary information of the study.", "So that's about what I can tell you." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Got it. Also noticed that your corporate expenses were low in the quarter compared to the baseline you provided last year. And I'm just wondering how you're thinking about the full year of $1.65 billion guidance." ] }, { "name": "Ken Tanji", "speech": [ "Yes. During the quarter, we did have some favorable items. We did have an FX gain that was helpful this quarter. We did have some other lower expenses and then there is some timing.", "And we do expect to have seasonally higher expenses in the second half of the year. But given where we are in the first half, we would expect to be modestly below the $1.650 billion guidance that we originally gave." ] }, { "name": "Operator", "speech": [ "Thanks. Our next question is coming from Jack Matten from Wolfe Research. Your line is now live." ] }, { "name": "Jack Matten", "speech": [ "Hi. Good morning. I wanted to ask on the investment portfolio. Are there any metrics you can provide regarding new money rates relative to current portfolio yields? And then what percentage of the portfolio turns over on average in a given year?" ] }, { "name": "Rob Falzon", "speech": [ "Jack, it's Rob. I can provide that for you. In the -- if you compare the new money rates to our portfolio yields, they're up about 20 basis points in the U.S. and 50 basis points in terms of a positive spread in Japan.", "So the rise in rates means we're no longer having a drag on our earnings when we measure our new money rates against that portfolio yield. In terms of rollover, it's somewhere between 5% and 10% on an annual basis." ] }, { "name": "Jack Matten", "speech": [ "Got it. Thank you. And then just a question on the drivers and the outlook for net flows in the PGIM business. And clearly, this quarter, there was a strong recovery in institutional flows, but some pressure on retail flows.", "I guess could you just talk about what's driving some of the divergence across those customer types and maybe your outlook moving forward?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes, Jack, it's Andy. I'll take your question on flows. As we've talked about in the past, flows at PGIM will vary quarter to quarter. So we stay very focused on the long-term track record.", "In Q2, third-party net flows were roughly flat as very strong institutional inflows of $8.1 billion were offset by the retail outflows of $8.3 billion. Let me give you some color on that. So the $8.1 billion of institutional inflows represented our best quarter since 2018, and those flows were positive across every geography that we operate in. The real drivers where we continue to see clients, their algorithms, institutional clients algorithm shifting into fixed income as the rates rise, and we also see those clients continuing to seek yield in our private and alternative strategies.", "On the retail side, I would say the story is we were impacted like the rest of the industry by headwinds in the active fixed income and growth equity space. The industry experienced $305 billion in outflows across active U.S. mutual funds as individual investors continue to reposition. Every top 10 fixed-income manager and nine of the top 10 active growth equity managers posted negative flows.", "So -- but despite that environment, our PGIM investments moved up to the number 16 U.S. mutual fund family in the quarter by assets under management. And the way I typically do, which is we're confident that we're going to be a net flow winner over time. As we look at our business, we have a broad and diversified product portfolio.", "We continue to put up very strong long-term investment performance, and we have great distribution. So we'll continue to build on our track record of 18 of the last 19 years of positive flows, and we're quite proud of that." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question is coming from Mike Ward from Citi. Your line is now live." ] }, { "name": "Mike Ward", "speech": [ "Thanks, guys. Just wanted to follow up on Suneet's question about the transformation. And I think you touched on your strategy in terms of acquisitions. But to his point, it seems like that would require a very decent chunk of inorganic growth.", "So I guess just wondering, should we assume from here that the strategy is primarily around organic growth acquisitions or opportunistic buys? Or do you still look at material kind of divestments or reinsurance from your existing business mix?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yes. This is Charlie. Let me take that one. It's going to be a combination of both, right? Because in the -- as we've done in the past, we're going to continue to be thoughtful about the deployment of proceeds, especially in light of the macroeconomic conditions, and we've always said we're going to be good stewards of capital.", "But we're going to -- what we're going to do is to continue to demonstrate a disciplined, a consistent and a balanced approach to the redeployment of capital within our businesses for acquisitions and to our shareholders while fulfilling a commitment to our financial strength by maintaining a strong balance sheet. So we're going to look at a combination of, again, investment in our businesses, acquisitions, returns to shareholders, but also divestitures if they make sense. And we've always said we'll look at additional divestitures of blocks of business, but only if they make sense. And that's what we're going to do as we go forward.", "So it will be -- we'll get to our goals through both addition and potentially subtraction, but it has to make sense on both sides for shareholders." ] }, { "name": "Mike Ward", "speech": [ "OK. Thanks very much. And so I guess, kind of relatedly, it sounds like a pretty comprehensive review in the life business just thinking about some of the difficulties that segment has faced over the last few years. I guess does this have any impact on your strategic view of the life business? It almost seems like at this point, even if you were to sell it or offload it at a loss, it might be beneficial? Or is the diversification benefit, mortality longevity offset? Is that important to the extent that you're going to hang on to life? Thanks." ] }, { "name": "Charlie Lowrey", "speech": [ "Yes. Let me start, and then Andy, you may want to add some commentary on it. But for the life business, we still think there's a significant potential for growth in the industry. You have a $12 trillion insurance -- life insurance gap.", "You have increasing sales as shown by last year's industry with sales being the best they have been in about two decades. And from an enterprise perspective, the life business continues to be a really helpful component in balancing our longevity with our mortality. So there's a lot of interconnection with the other businesses along with PGIM, and it's a business that we would like to remain in, but we'll do so very, very carefully as we go forward. Andy?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes, Charlie. I would just add that we've had a very explicit strategy that we remain committed to, and the path forward is clear. We recognize the disappointing and volatile aspects of GUL. But remember that our strategy has been about pivoting and derisking the business.", "We see selling GUL -- single life GUL in third quarter of '20 and we began to rotate the product portfolio toward simpler designs, inclusive of variable universal life final expense and simply term. We also have been very much leaned into reducing expenses to make the business more efficient. So as we're doing that, we're seeing the new business sales where we have a lot of pricing power and we like the positive returns of that block of business that we're putting on, and we're filling that gap that Charlie talked about." ] }, { "name": "Operator", "speech": [ "Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Lowrey for any further closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "OK. Thank you very much, and thank you for joining us today. We've made significant progress reducing our market sensitivity while investing in sustainable long-term growth, advancing our cost savings program and returning capital to shareholders. Looking ahead, we are confident that our strategy, along with our solid financial position, will help us deliver an even more meaningful difference in the lives of our customers and delivering value to all our stakeholders, including providing attractive returns to our shareholders while enabling us to fulfill our vision to become a global leader in expanding access to investing, insurance and retirement security.", "Thank you again for joining us and for your time today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2019-11-05	[ { "description": "Head of Investor Relations, Senior Vice President", "name": "Darin Arita", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charles Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Robert Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Executive Vice President and Chief Operating Officer, International Businesses", "name": "Scott Sleyster", "position": "Executive" }, { "description": "Executive Vice President and Chief Operating Officer, U.S. Businesses", "name": "Stephen Pelletier", "position": "Executive" }, { "description": "CEO of Workplace Solutions", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Evercore -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "John Nadel", "position": "Analyst" }, { "description": "Dowling & Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "JP Morgan -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "Sandler O'Neill and Partners -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by and welcome to the Prudential quarterly earnings call. [Operator Instructions] I would now like to turn the conference over to Mr. Darin Arita. Please go ahead." ] }, { "name": "Darin Arita", "speech": [ "Thank you, Cynthia. Good morning and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey Chairman and CEO; Rob Falzon, Vice Chairman; Steve Pelletier, Head of US Businesses along with Andy Sullivan, our next Head of US Businesses; Scott Sleyster, Head of International Businesses; Ken Tanji, Chief Financial Officer; and Rob Axel, Controller and Principal Accounting Officer.", "We will start with prepared remarks by Charlie, Robin, Ken and then we will take your questions. Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and a discussion of doctors that could cause actual results to differ materially from those in the forward-looking statements. Please see the slide titled Forward-Looking Statements and Non-GAAP Measures in the appendix to today's presentation, which can be found on our website at investor.prudential.com.", "I'll hand it over to Charlie." ] }, { "name": "Charles Lowrey", "speech": [ "Thank you, Darin. Good morning everyone and thank you for joining us today on this call. Yesterday, we reported third quarter earnings per share of $3.22 cents. We also reported a year-to-date ROE of 13%. I'll begin by discussing our progress and executing our financial wellness strategy. We are committed to delivering a broader set of financial wellness solutions to more people in new ways, leveraging our scale across multiple distribution channels and drawing on our expertise, including product development and asset management. During the quarter, we took steps to expand our digital distribution capabilities through the announced acquisition of Assurance IQ, a fee-based and capital-light growth engine. Assurance is a leading direct to consumer platform for financial wellness solutions that enable us to serve a different demographic segment including the mass and middle markets. Over time, we believe we can expand these capabilities internationally.", "The Assurance acquisition, which closed in October, also provides attractive financial benefits and significant upside potential. Assurance shares our purpose of solving the financial challenges of a changing world, which is at the core of who we are. In that theme. I'm pleased to note that Fortune has named Prudential to its prestigious Change the World List for a second consecutive year. We also made progress in the quarter toward our margin expansion goals by evolving and transforming the way we do business across the organization. Along these lines, we launched a voluntary separation program in October for segments of our US workforce. These efforts are intended to better position us to meet the needs of our customers while driving greater speed and efficiency.", "Finally, we continue to advance our efforts to reduce the impact of market fluctuations and add transparency to our quarterly financial performance. As a result, beginning in the fourth quarter our corporate and other results will be less affected by changes in the equity markets and our own stock price. Looking ahead, we're taking a very disciplined approach to pricing to help offset the impact of rates on new business profitability, which will have an obvious effect on some of our sales.", "We're encouraged by our progress and are moving quickly and with conviction to implement the plans we have set forward to deliver meaningful solutions and long-term value to our customers and shareholders. With that, I'll turn it over to Rob for a closer look at our business performance for the quarter. Rob." ] }, { "name": "Robert Falzon", "speech": [ "Thank you, Charlie. I'll provide an update on how we're executing on our strategy to leverage our multi-channel distribution product and asset management expertise and scale to deliver financial opportunity to a wider demographic within our US Financial Wellness PGIM and international businesses.", "As shown on Slide 4, US Financial wellness currently represents our workplace and individual solutions division that produce a diversified source of earnings from fees, investment spread, and underwriting income. Beginning in the 4th quarter, it will also include fee-based earnings from the Assurance business, earnings, which are not correlated to equity markets, interest rates, or credit. We continue to execute our strategy to expand our addressable market.", "Our Financial Wellness proposition is resonating with our workplace customers and with the employees of those customers, driving higher participation rates in the employee benefit programs and increased engagement with our advice platform. The number of people who have activated our digital Financial Wellness platform has increased to 9 million as of September 30th. This platform provides a digital venue to address a variety of needs, including education on financial wellness topics and assessment of financial health.", "We're also growing individual relationships and expect to provide additional solutions to the employees of our workplace customers as well as other retail customers. One way we deliver these solutions is through link by Prudential, which is are highly interactive personalized online resource that enables people to create a path toward achieving their financial goals. Earlier this year, we began to deploy link on our workplace platform and we have already made it available to roughly 2.3 million people. We are on track to meet our goal of 2.5 million people by the end of the year. And notably with the October closing of our acquisition of Assurance, we have significantly expanded our addressable market with approximately 19 million individuals who are actively seeking insurance solutions. Assurance has direct to consumer platform an end-to-end engagement model, which includes over 3,000 agents, enables us to serve more people along the socioeconomic spectrum. In addition, this platform will enable us to expand our range of available solutions for our workplace customers by adding third party provided health and property and casualty insurance as well as Medicare coverage.", "We're also making progress streamlining our operations to increase agility while driving efficiencies and enhancing the customer experience. We are on track to achieve $50 million in run rate margin expansion by the end of 2019 and expect this to increase to $500 million by the end of 2022 this is being accomplished through a number of programs that we have under way. In the current quarter, we incurred about $20 million of implementation cost to support these programs.", "Shifting to a discussion of third quarter trends in the underlying fundamentals of our businesses, I'll start with flows in the US Financial Wellness this quarter, focusing on our Retirement and Annuities Businesses.", "Our Retirement business had net outflows of $2.7 billion driven by a single large client lapse in our full-service business. This was partially offset by strong sales in the quarter, as the market continues to be active including episodic large client activity. The Institutional Investments business had net inflows of $600 million, including $3.6 billion of longevity risk transfer transactions. Year-to-date we have closed $17 billion of longevity reinsurance transactions and we have a strong pipeline. This elevated deal activity is driven by our strong competitive positioning and innovation as well as by UK pension funds de-risking ahead of Brexit. While we did not close any funded PRT transactions in the third quarter and recent declines in interest rates have impacted the funding levels of these plans.", "The fourth quarter has started well and we have a solid pipeline of pending transactions. Our Annuities business experienced $1.1 billion of net outflows driven by normal accounts withdrawals roles as well as by elevated lapses, as certain contracts moved out of the surrender period. We expect this elevated level of lapses to persist through 2020. This was partially offset by an increase in sales, including the impact of launching our PruSecure Fixed Indexed Annuity last year and expanding into the IMO channel this quarter. However, we expect the current low interest rate environment to continue to pressure sales.", "Turning to Slide 5, our strategy in PGIM, our Asset Management Business, is to combine our multi-manager model with global distribution and affiliated flows to grow and higher value-added strategies that serves investors globally. PGIM is a top 10 global asset manager with $1.3 billion of assets under management. It ranks as the fifth largest investor in fixed income and the third largest investor in alternative investments with significant real estate and private investment platforms. As the investment engine of Prudential, it benefits from a symbiotic relationship with our US Financial Wellness and international insurance businesses. PGIM's asset origination capabilities and investment management expertise, provide a competitive advantage, helping our businesses to bring enhanced solutions and more value to our customers, both retail and institutional.", "And our businesses in turn provide a differentiated source of growth for PGIM for affiliated AUM flows that complements its successful third party track record of performance and growth. Generated $800 million of net third party flows during the third quarter. Our third party net retail flows were $3 billion. Strong investment performance in our growing ETF and usage platforms and record Mutual Fund sales delivered solid fixed income flows, partially offset by equity outflows and our third-party institutional outflows were $2.2 billion, mainly driven by a single institutional fixed income client withdrawal of $2.9 billion dollars due to management consolidation. We serve many of the world's largest institutional investors and as a result, experience large idiosyncratic inflows and outflows from time to time.", "Our Asset Management Fees benefited from record assets of the management due to market appreciation and continued robust fixed income flows. Strong investment performance and expertise across a broad range of asset classes has allowed us to continue to attract flows into higher return strategies. Approximately 80% or more of assets under management have outperformed their benchmarks over the last 3-year, 5-year, and 10-year periods. We continue to broaden and globalize our products and capabilities by developing and launching private and alternative investments expanding and retail and international markets.", "Our multi-manager model strong track record of private originations and demonstrated investment performance, as well as the investments we are making in our distribution capabilities will position us to generate positive flows over time and to grow our earnings even absent the Wells Fargo fee arrangement, which ends this year.", "Turning to Slide 6, our international business includes our world-class Japanese life insurance operation, where we have a differentiated business model with unique distribution as well as other operations in high growth markets like Brazil. Our Life Planner strategy is to grow our high quality distribution with a focus on needs based sales. In emerging markets, we look to combine Prudential strengths with local expertise to serve customers in a non-traditional way.", "Life Planner sales which were about half of the total international sales in the current quarter increased by 8% compared to the year ago quarter. This was driven by record Life Planner count and higher US dollar sales in Japan as well as by continued growth in our Brazil operations. Sales for Gibraltar, which represents the other half of international were 11% lower than a year ago.", "This primarily reflects lower single-pay US dollar fixed annuity sales in our life consultant channel, as we continue to focus on recurring pay protection products. In addition, the recent decline in US interest rates resulted in lower crediting rates, which also affected sales of US dollars denominated products. We also experienced lower production in our independent agency channel and lower bank channel sales due to continued heightened competitive conditions.", "We will continue to innovate new products and consider pricing actions while focusing on maintaining our target level of profitability and improve sales over time. Summary, in order to generate profitable growth and attractive returns, we are expanding our distribution and product solutions, leveraging our asset management expertise and focused on engaging more deeply with our customers.", "And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 7, which provides additional insight into our fourth quarter earnings. Relative to our third quarter results. We begin with our third quarter pre-tax adjusted operating income, which was $1.7 billion and resulted in earnings per share of $3.22 on an after-tax basis, then we adjust for the following items. First, we adjust a variable investment income to a normalized level, which is worth $65 million.", "Second, the fourth quarter will include seasonal expenses and implementation costs related to the acceleration of our Financial Wellness strategy. We expect this will lower results in the fourth quarter by approximately $280 million resulting in an expected loss in the corporate another segment of $475 million to $500 million inclusive of the cost of our Financial Wellness initiatives. There will also be additional costs in the fourth quarter related to the voluntary separation programs that Charlie mentioned. This is all part of this $600 million to $700 million of implementation costs to accelerate our financial wellness strategy, as we discussed on Investor Day.", "Third, there are other considerations that we expect will result -- will increase results by approximately $25 million on a net basis in the fourth quarter.", "And fourth, we anticipate a $10 million reduction in the quarterly net investment income from portfolio reinvestment, assuming reinvestment rates are held flat with the third quarter. Absent a change in interest rates, the $0.02 per share for one quarter would compound to $0.30 per share over the five-quarter period ending December 2020. This assumes a 7% annual turnover on $370 billion fixed income portfolio with new money yields 65 basis points below disposition, yields on average. Combined, this gets us to a baseline of $2.50 per share for the fourth quarter before including the impact of future share repurchases, business growth, and market impacts.", "This baseline includes a few items that puts it below our typical earnings level. First, we have seasonal expenses in the fourth quarter, we expect those expenses to be similar to prior years at about $125 million to $175 million. Second, we expect about $95 million of Financial Wellness implementation costs in the fourth quarter. And third, we expect $55 million of higher typical expenses -- higher than typical expenses in Life Planner.These three items total about $0.58 per share and explain the elevated level expense expected in the fourth quarter baseline.", "While we have provided these items to consider, there may be other factors that affect fourth quarter earnings per share. A few additional items to note. First, we issued 5.5 million shares in the fourth quarter for the Assurance acquisition. Second, as Charlie mentioned in his remarks, we have taken further action to reduce fluctuation of quarterly earnings by reducing the impact of movement in Prudential's stock in the equity markets on long-term and deferred compensation expenses.", "Also on Slide 17, we have provided updated information regarding seasonal items by business. We hope that you continue to find our new disclosures, including our baseline earnings per share information, helpful in understanding the earnings power of our businesses. We have indicated over the past few years, we are considering alternatives to how we approach guidance. With the new disclosure now in place and provided on a regular basis, we have decided not to provide annual EPS guidance or host an outlook call in December. We believe our enhanced disclosures and processes provide insightful information on a more frequent basis.", "Turning to Slide 8, I'll provide an update on capital deployment, liquidity, and leverage. We feel very good about the overall strength of our capital position. We returned $1.4 billion to shareholders during the current quarter through dividends and share repurchases. Our share repurchase authorization for the remainder of the year is $500 million as of September 30th and over the last 5 years, we've increased our dividend per share by 16% per year on average. Our current quarterly dividend of $1 represents a 4% yield on our adjusted book value. We also continue to maintain a rock solid balance sheet. Our regulatory capital ratios continue to be above our AA financial strength target levels and our financial leverage ratio remains better than our target. Our cash and liquid assets at the parent company was $6.2 billion at the end of the quarter and that was above our top end of our $3 billion to $5 billion liquidity target range.", "As shown on the Slide, we've provided a pro forma of the highly liquid asset balance that reflects the amount that funded the acquisition of Assurance in early October and brings the balance within our target range. We will look to continue to invest in the growth of our businesses, assess acquisition opportunities to build, scale, or gain capabilities and return capital to shareholders.", "Turning to Slide 9 and in summary, we are accelerating our strategy and positioning our businesses to deliver long-term growth. We remain on track to achieve $50 million in run rate margin expansion by the end of 2019 and $500 million by the end of 2022. We've generated a record high adjusted book-value per share and continue to generate strong cash flows that support consistent growth in dividends and other distributions to shareholders and we maintain a robust capital and liquidity position with financial flexibility.", "Now, I'll turn it over to the operator for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator Instructions] We'll go to the line of Alex Scott with Goldman Sachs. Your line is open." ] }, { "name": "Alex Scott", "speech": [ "Hi, good morning . So first question I had is on variable annuities and I guess here we're seeing the ROA, it's really starting to come down. And I just wanted to see if you could dimension for us. What's impacting that, is it sort of the spread you're making on the writers, is it just the fee levels coming down and how I think previously you talked about 115 or 116 bps or so. We're already below that. I mean should we expect significantly lower long-term sort of trend level at this point?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, this is Ken. I'll take that. First, our variable annuity business continues to be very profitable and that's although it's a bit lower, it still has a high ROA and a strong ROE. We've mentioned in the past that we'd expect the ROA trend over overtime as policies both move into lower fee tiers and as we continue to diversify our product mix to solutions with less equity market sensitivity. So that continues to play out. And while the ROA is a general -- generally a good benchmark for profitability, it will adjust when markets move significantly and interest rates have declined pretty significantly in 2019 down by about over 100 basis points year-to-date. So while the decline in rates increases the account value, it affects earnings by the combination of higher benefit ratios and and higher DAC amortization. So despite the decline in rates, again the business continues to be very profitable and generating a quarterly cash flow, we still like the profitability, albeit at a lower ROA." ] }, { "name": "Alex Scott", "speech": [ "Got it. Okay. And then my followup question is I guess more broadly on expenses, there is some acceleration in Life Planner, a little bit more next quarter, you've got the digital expenses going on, but I guess you've also got Assurance IQ coming on, which I think there were some synergies with some of the things you're doing on digital capabilities. So just -- just wondering if you could provide more detailed thoughts on how much you'd be looking to spend over the next year or so and what kind of offset there is from Assurance coming online. And if -- and if you have any more like big accelerations like there was a Life Planner for other segments like once you get past whatever you're focusing on Life Planner." ] }, { "name": "Charles Lowrey", "speech": [ "Let me just -- this is Charlie. Let me start in and then others others can join in. So, we said with Assurance that there would be -- there would be a certain amount of expense synergies. I think we said $25 million to $50 million next year and then additional after that. So you can expect those to come in over time. Those are separate and distinct from some of the other expenditures that we're making or some of the other savings we're seeing in the margin improvements." ] }, { "name": "Robert Falzon", "speech": [ "And then the other area for the quarter was international, where we did see the shift of some expenses and a higher level of expenses in the quarter." ] }, { "name": "Alex Scott", "speech": [ "So, is that really one time or are you going through any kind of process, where you might be assessing needs for other other segments that are outside of the digital initiative that's in corporate?" ] }, { "name": "Scott Sleyster", "speech": [ "Hi Alex, this is -- this is Scott. I think Darin gave some guidance on what will be recurring and non-recurring, but there is a couple of big things going on. First of all to the specific quarters, as I mentioned before, we see evolving regulatory oversight and we're trying to put the infrastructure in place to continue to be at industry best practices and some of that's rolling out actually not just in Japan, but around the world. As I mentioned at Investor Day, we also have been following some of the technology upgrades and the digital upgrades that occurred in the US. We kind of follow what worked well and we're rolling some of those out across the board. And then this quarter, we actually had some additional litigation and other reserves and finally some things we're doing on process improvement and automation.", "So I would say, it really falls into those two big buckets. We were playing a bit of catch-up on the improving regulatory best practices and then we had some significant initiative roll outs that we were doing in International that I would say lag the US by about a year. We're most of the way through that and so I think if you look at the -- if you look at the adjustments we have call it $55 million and accelerated additional spending in the fourth quarter that will disappear as we hit our run rate going into 2020, I think we would say that's -- that's largely our new baseline." ] }, { "name": "Alex Scott", "speech": [ "Got it. That's all very helpful Thank you." ] }, { "name": "Charles Lowrey", "speech": [ "And I'll just add, for the quarter, keep in mind, corporate was lower and there is sort of a couple of pieces there. We had lower long-term compensation expense related to the change in our share price that. As we mentioned will no longer occur going forward, as we've -- we've modified our long-term compensation program to no longer need to have that stock price flowing through our expense and then corporate expenses were also a little bit lower. So if you looked at corporate international, they were somewhat offsetting." ] }, { "name": "Alex Scott", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Erik Bass with Autonomous Research. Your line is open." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. So you've talked about the outlook for EPS in the fourth quarter, but it sounds like that includes a number of one-off expenses in addition to the normal seasonal impact. So it's not, I guess a real reflection of your earnings power. Therefore, can you help us think about a more reasonable earnings baseline for 2020 and is it really adding back the $0.54 of items, so thinking of something in kind of the low $3 range before buybacks and growth." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Erik, it's Ken. There's actually a number of ways that you can think about this and look at this. So I'll -- first, I'll start with the baseline that we gave at the end of the second quarter, going into the third quarter, which was about $3. So that was sort of where we thought in the middle of the year, our earnings power was. The third-quarter results came in at $3.22 and that was a little bit above that, because we had favorable variable investment income and favorable underwriting expense across our businesses and as I mentioned in our last comments the expenses kind of offset between corporate and other international.", "So if you adjusted that, you got to a number that was a little better than -- than $3. Now, in the fourth quarter baseline, you do have a number of items like I said in my -- in my opening remarks that make it a little bit below our typical earnings level. The first is our seasonal expenses that's unique going on this year, typical to what we see in the fourth quarter. We have the Financial Wellness implementation costs, again very consistent with what we articulated at Investor Day. And then third, we have expectation of little higher expenses in our international businesses. If you put those items altogether and you adjust it for that, you'd be back at a earnings level a little bit over $3. So I think that's the way we're thinking about, our earnings power over those time frames." ] }, { "name": "Robert Falzon", "speech": [ "And Erik, it's Rob. Let me just sort of pickup on that sort of looking ahead off that baseline, Ken mentioned in his commentary that we do have interest rate sensitivity going forward and we've given some guidance on that. So that's sort of updated and will be a headwind contrary to what would otherwise have underlying business growth and then obviously the very significant increase we have growth as a result of capital deployment from shares. The other piece to think about, with interest rates is that we'll have lower sales that that come out of that in a lower interest rate environment as well or at least that's -- that's what we're anticipating. Recognizing all of that, we are being very proactive, we're managing sales through product pricing, design, and mix, we're managing costs, so that includes implementing the previously announced Financial Wellness initiatives that Ken covered as well and we've been actively deploying capital for growth that was evidenced very clearly in the Assurance IQ acquisition, which is not sensitive to rates or equity markets, but also the things that we've done in PGIM and its investment capabilities and its distribution capabilities and the other global technology and distribution initiatives that we have, all of which we think will contribute to fundamental growth and then obviously, as I mentioned the share repurchases. So deploying capital for growth, all that we believe gives us the ability in combination with what's happening on international in terms of our continued ability to grow the in-force. It gives us confidence that we can continue to show a differentiated level or we can show going forward a differentiated level of of growth and ROE vis-a-vis the industry in light of the sort of the macro headwinds that we outlined." ] }, { "name": "Erik Bass", "speech": [ "Thank you. That's helpful detail. Maybe going on the interest rate comment, I mean it seems like your interest rate sensitivity has increased versus the $0.30 impact for 100 basis point move that you gave on last year's outlook call, just hoping you could give a little bit more color on why that's the case." ] }, { "name": "Charles Lowrey", "speech": [ "Yeah. Sure, I'll cover that. Again a year ago when we issued guidance, interest rates were in a different zone and our guidance a year ago assumed 2019 would have interest rates above 3% if you use the 10-year US Treasury as a benchmark. We were at rate levels that are now over 100 basis points below that, well I should -- and when we gave that guidance last year, we mentioned that our sensitivity to 100 basis point decline would be $0.30 per share and that's kind of what we've experienced as we've gone through the year and that's what we've experienced in our financial results as well. So the impact that we've experienced in 2019 is very consistent with what we provide is as sensitivities again, a year ago. But from here, the rates are at a lower start point and we also have more US dollar business in Japan. We have more business that's at crediting rate minimums. So there is -- and it's not linear as well and in which we do have a greater impact and you also have to consider there is an impact on the present value of claims at a lower discount rate. So those are the reasons that -- we have more interest rate sensitivity now and it all has to do with a lower rate environment." ] }, { "name": "Erik Bass", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Suneet Kamath with Citi. Your line is open." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. Just a follow-up on that, Ken, just as we're thinking about this rate pressure potentially compounding over time, the $0.02 eventually becoming a much bigger number. If rates don't move up, isn't this is going to pretty much offset some of the margin expansion that you are targeting as associated with the Financial Wellness initiatives." ] }, { "name": "Ken Tanji", "speech": [ "The interest rate impact again assuming rates don't change does build over time. Eventually, it does dissipate as the portfolio more fully turns over. And this is exactly the experience that we had, if you go back a number of years as we shift it from the then rate environment to what was the more recent rate environment, now we're going through that again. So that phenomenon is not new, it's how it plays out. And so, I think it will -- it will work its way through in multiple -- in multiple waves as you go out, but again dissipates eventually over time as the portfolio turns over." ] }, { "name": "Robert Falzon", "speech": [ "Suneet, just call out in the deck, it's Rob, in the deck that we provided, we gave you the sort of the sensitive rates based on what's the delta between our third quarter new money rates and the yield on the portfolio that will be turning over on a go-forward basis. That's about 65 basis points so vis-a-vis, where we are today, if rates modestly rise to something that's sort of in the mid-2's not very different from where we were just a little while ago, this phenomena begins to wear off." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. Okay. And then just on the decision to not host an outlook call I guess for next year. Typically, it would be on that call that we would get a sense of how you're thinking about capital return for the upcoming year and view or an outlook on year-end AAT reserves. So since you're not having that call, just wondering if you could provide some commentary on how you're thinking about those two things at this point?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. So first, I'll start with AAT, given lower rates, we would have a rise in asset adequacy testing reserves, but we do have derivative -- interest rate derivative hedges that would have gains as well to offset that. So, we still feel very good about the RBC level of our -- of Prudential Insurance Company of America. In terms of our capital returns, that's a decision that the Board will make in December and -- and we'll get that information out once the Board makes that decision and does its authorization.", "Our free cash flow profile has been very consistent and our capital management approach has also been very consistent, so for now you can factor that into your thinking." ] }, { "name": "Suneet Kamath", "speech": [ "Okay. Thanks guys." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Tom Gallagher with Evercore ISI. Your line is open." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. Ken, just going through the Slide that discusses the Corporate loss. If I take $475 million for the 4Q guide and then I strip out the $150 million sort of the mid point of higher seasonal 4Q expenses in the $95 million of one-time restructuring expenses that gets me to a Corporate loss of about $230 million. I think the guidance you guys have provided has been over $300 million a quarter as more of a normalized Corporate loss. I just want to know are you implying that you would expect the Corporate loss to be lower on a go-forward basis or is there -- is a little over $300 million still a decent quarterly loss expectation?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Tom, the one thing I think that I think you have a little bit off there is the $150 million of seasonal doesn't all occur in Corporate and Other, only about half of it does. So if -- I think if you -- if you make that consideration, you're more in line with where our Corporate and Other run rate has been." ] }, { "name": "Tom Gallagher", "speech": [ "Okay. Thanks for that clarification. The other -- the other question I had is on the , just a follow-up on capital return cash flow, the -- I think based on -- I understand there's been some GAAP earnings pressure here, but can you talk about how cash flow visibility is playing out as you head into 2020. Would you still expect a similar or call it 65% conversion ratio or will that be changing based on where interest rates are in both Japan and the US." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Tom, our cash flow engines are still very much intact. So first for the businesses that have been providing quarterly dividends, PGIM and our annuities business, as you can see those have been very consistent regular and paid quarterly and Japan paid a dividend this quarter in the third quarter as well, and we'll be filing for a dividend from PICA in the fourth quarter. So yeah rates will decrease net investment income and have some modest impact as we talked about with our sensitivities, but in general our cash flow picture is quite strong and quite consistent." ] }, { "name": "Tom Gallagher", "speech": [ "Got you. And then just one final follow-up if I could, the market related Experience Adjustment Factor, which was I think around the negative $300 million to net income this quarter, was that a just a one-time adjustment outside of the actuarial review to reflect macro or can you just provide some color on that? Thanks." ] }, { "name": "Ken Tanji", "speech": [ "Yeah, sure. No, that wasn't a one-time adjustment. So that adjustment occurs to update our discount rates related to our best -- best estimates of insurance liabilities and the amortization of deferred acquisition costs and it did lead to a charge for the quarter. Having said that, we had other gains as well and if you looked at GAAP net income, it was actually above operating income. So overall, our GAAP profile was pretty in line with our operating profile." ] }, { "name": "Tom Gallagher", "speech": [ "Okay. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of John Nadel with UBS. Your line is open." ] }, { "name": "John Nadel", "speech": [ "Good morning everybody. Maybe a question for Rob or Ken. It sounds like -- it sounds like this is more macro-driven and maybe you can correct me if I'm wrong, but it sounds like your expectations are that sort of given in particular sustained low rates, some insurance products are simply less attractive to customers. And as a result you know that your expectation is that sales in such an environment would be somewhat pressured, it maybe down. First question is, do I have that right or is there something else to that story and then the second or related question is should we expect that at least in the short term, as a result of that environment, your free cash flow could actually be better and maybe we ought to consider potentially at least some incremental capital deployment or capital return to shareholders." ] }, { "name": "Charles Lowrey", "speech": [ "Yeah, John, this is Charlie. Let me start and then some others will jump in too. Let me just philosophically about sales. So the answer is as As interest rates decrease, absolutely sales will -- may well decrease as we change pricing and as certain products become much less profitable for us and we've always talked about a sustained level of profitability over time and so what we have to calibrate between is making sure that our products meet our hurdle rates on the one hand and two, sustaining distribution on the other hand and we're always calibrating between that, but we will -- we have already and will continue to raise pricing, lower crediting rates, do whatever it takes in order to maintain a level of profitability that makes sense for the company and shareholders and at the same time, look at what a minimum level of sales would be in order to maintain what is a world-class distribution system as we go forward and that's what we're toggling and that's why we're toggling on those two issues, and you will -- you will see that as we go through, but we have already raised pricing and taken multiple pricing actions, both domestically and internationally." ] }, { "name": "Stephen Pelletier", "speech": [ "John, it's Steve. Maybe I'll amplify Charlie's comments and get a little bit more specific on what I think is a primary example of it, which is in the -- in the annuities business. Recently with the decline in interest rates, we have been active in making product changes that reduce the level of product benefits and effectively increased pricing, but that relates to over the past couple of months, reducing payout rates by 40 to 45 points in some of -- in our products by reducing roll-up rate on HDI by 50 basis points.", "This is something that we do, as Charlie mentioned in the normal course of business in order to manage the business for sustainable profitable growth, while certainly looking to maintain relevance with distribution partners and a competitive value proposition for customers. We've seen some competitors take some actions, but frankly we've made more changes than most and as a result, it's possible that we could see our sales trajectory decline in the near term and we'd simply see that as an outcome of how we manage the business and I would mention as how we manage that business foreign extended period of time. If you look over a multi-year period in the annuities business, we've certainly been active in the marketplace throughout, but we've been significantly more active during periods where capital market conditions were more supportive of product features and add issue returns and we've been relatively less active in periods, where capital market conditions were not so supportive, it's that over an extended period of time that has built the in-force block in that business that has the characteristics, pardon me, that Ken mentioned earlier of strong profitability, robust returns, and solid cash flow." ] }, { "name": "John Nadel", "speech": [ "Yeah. Listen, I appreciate the need to balance right maintenance or maintaining distribution versus profitability of sales. I was just wondering if you'd expect that sales would be down sufficiently such that maybe it has in near-term or a short-term impact on free cash flow. But we can take that offline." ] }, { "name": "Ken Tanji", "speech": [ "Hey, you know John, I can cover that real quickly, expect sales come down. Yes, naturally, you would expect that cash flow would improve because we're not -- we don't need to hold capital associated with new business, so the direction is as you described." ] }, { "name": "John Nadel", "speech": [ "Thank you. And Ken, I've got one quick housekeeping one, and this is in light of really no outlook for 2020 call, but any reason why your tax rate given the business mix, etc. should be any -- it should be meaningfully different next year than it is this year?" ] }, { "name": "Ken Tanji", "speech": [ "No. I don't -- I think our tax rate has been very consistent." ] }, { "name": "John Nadel", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Humphrey Lee with Dowling & Partners. Your line is open." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning and thank you for taking my questions. Looking at PGIM, the fee rate seems to be a little bit more pressure this quarter, especially in retail and general account assets. I was just wondering if you can talk about just kind of your overall fee rate expectation in the near term and especially the fees of the assets that have left versus those that came in?" ] }, { "name": "Stephen Pelletier", "speech": [ "Humphrey, it's Steve. I'll take your question. Well, Rob called out a specific Fixed Income institutional outflow this quarter, but general story throughout 2019 has been pretty strong inflows into Fixed Income and some other asset classes and a pressure on equity flows, negative flows in the equity space really experience across the industry, as I would say the active to passive the -- active to passive headwinds picked up again this year. Given the relative fee rates across asset classes that that migration of assets from -- of asset mix from from equities to Fixed Income has that impact that you -- that you noted on our average fee levels. Now, I should emphasize, we've been able to significantly mitigate that by drawing a lot of our flows and including our Fixed Income flows into specific strategy -- strategies that have a solid fee levels. But nonetheless, the cumulative impact is as you -- as you pointed out. I would say though that this gradual migration of assets from equity to Fixed Income -- of asset mix from equity to Fixed Income especially fueled by Fixed Income appreciation in recent quarters due to the declining interest rate environment, while that might be a source of pressure on fees, it's also highly supportive of margin in the business. Fixed Income -- we have scale economies throughout our Asset Management complex, but the Fixed Income business is where those scale economies are most attractive and the flows increasing contribution of Fixed Income to our asset mix will be supportive of margin expansion in the business." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. I appreciate the color. Just for clarification on the expenses in International. I think in response to Alex's question earlier, you talked about the $55 million in the fourth quarter in terms of the elevated expenses to kind of where you think would drop off. But I think from last quarter's call, you talked about in Gibraltar you expect some high expenses to -- to continue throughout 2020 and then especially given, it seems like Gibraltar was a little bit lighter expenses in the third quarter, should we still expect some elevated expenses in International throughout 2020 and then kind of coming off after that or how should we think about that in general?" ] }, { "name": "Scott Sleyster", "speech": [ "Hi, Humphrey, this is Scott. I'll take that. The $55 million really related to the Life Planner business and as you pointed out, we had a -- we actually had a -- we kind of overshot on what we thought our expenses might be in Gibraltar this quarter. We do still expect in Gibraltar a modest level of elevated expenses, I think where we guided you last quarter that that would continue to about mid-year. The really sizable amounts of that were picked up in 2019, so I'd say those are relatively de minimis. And I think in the -- in the guidance on expenses that were given on the overnight, we've captured that bleeding and I would say it's not really very significant in Gibraltar." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of Jimmy Bhullar with JP Morgan. Your line is open." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hi. So first, a question for Ken on the interest rate impact. I'm assuming that if you don't -- if rates do not change than that at least for the next 1 or 2 or 3 years compounds at a much faster rate than your normal earnings growth, so it becomes a bigger and bigger headwind in 2021 versus what you have outlined for potentially the next 12 months. Right?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. I think you should think of it as for -- we said $0.30 for five quarters, call it $0.28 for four and that's sort of the annual -- the annual drag." ] }, { "name": "Jimmy Bhullar", "speech": [ "But then beyond that, it should be considerably higher than the $0.28 in the next four quarters, just at the pace that it's building up. Correct?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Yeah. That's the way the math works. But I think over time it dissipates, but." ] }, { "name": "Jimmy Bhullar", "speech": [ "Yeah. But that's a few years out as you rolled the portfolio over assuming no change in rates again. Right?" ] }, { "name": "Ken Tanji", "speech": [ "That's right. That's right." ] }, { "name": "Jimmy Bhullar", "speech": [ "And then on your Japan sales at Prudential Japan, you -- there was a tax law change, you withdrew a term product. Should we assume that, at least in the near-term that sales will remain muted or and if you could just give us color on what drove that weakness if there is something besides that, that drove the weak sales this quarter And just some idea on sort of the trends in that market and what your expectations are for sales? Hi, Jimmy, this is Scott. Let me take that a couple of ways. One, the corporate tax law change did in fact impact everybody in the industry, but it touched us in both POJ and in the Life Planner business and so there was the national tax authority was reviewing the rules and there was a 4-5 month period, where you didn't know what they were going to look like and then an implementation period after that. In the case of -- in the case of POJ, I would say the effect was more modest because of the clientele being business owners and high net worth and some of the products that are coming back there will continue to sell some of the new corporate products.", "But more importantly, the Life Planner growth across our channel has been strong really -- really across the board. So that's favorable. I would say in the case of in Gibraltar, it's really a more significant challenge. We've been seeing more competitive -- we had the corporate product. We've also continued to see pretty intense competition in the bank -- in the bank channel market and we've also imposed some pricing discipline, where we've favored kind of recurring premium, mortality based products versus some of the more income-oriented products as rates came down. So when you combine those three effects, I would say in the case of Gibraltar the issues are more challenging. In the case of POJ and Life Planner generally, they're more transitory in nature. Again, then just lastly, any comments on what's going on in the Chilean market, just with all the political instability and the potential for pension reform at some point?" ] }, { "name": "Scott Sleyster", "speech": [ "Yeah. A couple of comments. Our business there with with Habitat actually has performed very, very well year-to-date and we actually had very, very favorable and [Indecipherable] performance based on the underlying markets this quarter. That being said, I would say we've been in touch fairly frequently with what's going on there, and I wouldn't really downplay what's going on there, it's, you know, it's relatively serious. I think the people there are concerned about the unrest. That being said, one of the -- one of the responses and one of the request if you will, the demands that are out there and the factors impacting insecurity relates to people being nervous about old age retirement and so there is actually proposals to materially increase the deposits and then call it the generosity of some of the systems, we may or may not benefit that much from that because sometimes when they increase the deposits, they don't allow fees on them and what have you.", "But in general, I would say, I think it's a serious situation down there. That being said, we're actually quite well positioned and we're in a space in the market, where the demands of those that are feeling disadvantaged are looking for government actions that would be supportive of our sector." ] }, { "name": "Ken Tanji", "speech": [ "And also don't forget, we have the -- we have the lowest fees and some of the best investment performance in the business and therefore within the pension sector, we're very well positioned as well." ] }, { "name": "Jimmy Bhullar", "speech": [ "Okay. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of John Barnidge with Sandler O'Neill. Your line is open." ] }, { "name": "John Barnidge", "speech": [ "Thanks. Another life insurer had a large writedown in the quarter and private equity position. Can you walk us through how many different private equity or venture capital positions you have, average investment size, and largest on carrying value please?" ] }, { "name": "Robert Falzon", "speech": [ "John, it's Rob. In our -- if you look at our alternatives portfolio, a couple of things to note. One is it's extraordinarily well diversified. There are in excess of 2,000 underlying companies invested through somewhere around 300 funds in that portfolio. So we do not have any particular concentration to the extent that we have direct investments in companies in that portfolio, which come about as they do and these kind of strategies by co-investment rights, they are primarily, if not exclusively in private equity, not in venture capital and therefore tend to have significantly less volatility and any of those underlying investments are relatively small. So we obviously in the context of our alternatives portfolio, we have out in order performance that's a reflection of markets and overall segment performance. We tend to have a little less of the idiosyncratic performance as a result of single investments, we're not entirely immune from it, but nothing to particularly call out there. Well-diversified and relatively conservatively positioned." ] }, { "name": "John Barnidge", "speech": [ "Great. My follow-up, most of them have been answered, but are you seeing any signs of early activity in flu season, it seems like everyone here is sick earlier?" ] }, { "name": "Stephen Pelletier", "speech": [ "John, this is Steve. I'll answer your question, I think, I don't know about the -- about the immediately present the state of the flu season. But I think that we did see in this quarter, our Life mortality in the Individual Life business have some -- have some experience that was counter to what we normally see as -- as the seasonal trends. Normally, the third quarter tends to be a positive experience in Life mortality, it didn't play out that way this quarter. We saw the unfavorable experience in this quarter in blocks that have really generally trended quite favorably over time and as a result, we believe that this quarter's result is more of a random fluctuation rather than indicative of any underlying issues or trends. I would say also in relation to the third quarter mortality experience being different from normal seasonal patterns in Life, we saw exact -- the similar phenomenon play out in the Retirement business, a business that normally has, in the third quarter, less favorable reserve experience and in this quarter because of similar mortality trends, the business was able to realize outsized reserve gains again kind of pushing away from the normal seasonal patterns. And I think this speaks to our complementary business mix working out, as we've -- as we intend to do and as we've designed it to." ] }, { "name": "John Barnidge", "speech": [ "Great. Thank you very much." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question will come from the line of Elyse Greenspan with Wells Fargo. Your line is open." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi, thanks, good morning. My first question. So I recognize you guys aren't hosting an outlook on anymore, but I guess is there a way that you can give us some kind of baseline EPS growth or maybe where you come in within your ROE band in 2020, just so we get a sense of kind of the forward base beyond just I guess you thinking about some of the items you called out in the Slides as well as ride the higher corporate expenses that do recur every fourth quarter." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Sure. I'll just sort of echo some of the things that Rob mentioned earlier and I sort of described how you can think about whether the baseline that we described coming out of the second quarter or -- or our results for the third quarter adjusted for the things that were a bit favorable or the fourth quarter baseline we provided adjusted for the elevated level of expenses, all kind of gets you to an EPS number that's a little bit better than 3 bucks. And then our businesses are growing. We articulated some of our growth thoughts at Investor Day and now we do have a lower interest rate environment, so that eats into that a little bit as we described and given sensitivities to, but then on top of that we have the margin improvement that we have under way, which again we've articulated and gaining measures for as well as the impact of Assurance IQ acquisition, which we expect to be accretive in 2020. So I think those are all the components that we think about as we look to 2020 and would encourage you to to think about for yourself." ] }, { "name": "Robert Falzon", "speech": [ "Elyse, it's Rob. Let me just sort of jump in on the ROE portion of your question. First, I'd note that in the -- in the third quarter we had an ROE in excess of 13%. So while we had headwinds associated with equity markets, we did have positive impacts -- headwind associated with interest rates, we had positive impacts with the -- with the movement in equity markets and if you think about the little better than $3 quarterly baseline number that Ken triangulated around. That would still represent an ROE that would be about 13%. And so, when we provided our outlook of 12% to 14% ROE, it was obviously in an environment where interest rates were much higher, but the expectation was that absent those interest rates, we would be in the mid-point of that -- the 13% as the midpoint, between 12% and 14% was more sort of a baseline expectation as opposed to the high end of our range. With the headwind and interest rates, we could put a little bit of pressure on that, but I think that the -- the statements we made with regard to that range of 12% to 14% have not changed materially by virtue of anything that's occurred since the point in time where we've -- where we won't give out that guidance, absent the recalibration for interest rates." ] }, { "name": "Elyse Greenspan", "speech": [ "Okay. Thanks. And then in terms of Assurance, that deal is now closed, is there anything in terms of modeling that you want to point out in terms of the seasonality, as we put that into our models. I believe you guys had previously said it was more weighted toward the fourth quarter, just anything that stands out, as we think about getting that into 2020 on a quarterly basis?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Sure. Elyse, this is Andy. I'll take your question and thank you for the question. There will be seasonal variability quarter-to-quarter and right now, a good portion of the revenue is driven by the Medicare Advantage product and the individual under age 65 product that are really driven by the open enrollment periods in the fourth quarter. So when you think about earnings pattern with the current mix of business that we have with Assurance and prior to us go executing on adding additional products to the platform, the fourth quarter will likely be our heaviest from both the revenue and earnings perspective." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. But keep in mind again, this is a young company and a growing company, and we didn't expect it to be material to the fourth quarter -- and but we feel good about the progress we're making and the outlook for 2020 and 2021." ] }, { "name": "Robert Falzon", "speech": [ "Yeah. Maybe just two add-ons obviously in this fourth quarter will experience transaction -- transaction and financing costs, also the core results are going to be net of the amortization of the intangible assets that are -- that weren't on the books so." ] }, { "name": "Elyse Greenspan", "speech": [ "Okay. Thank you very much." ] }, { "name": "Operator", "speech": [ "Thank you. And with that, I'd like to turn it back over to Charlie Lowrey for any closing comments." ] }, { "name": "Charles Lowrey", "speech": [ "Thank you. So as you heard, we're committed to delivering on our purpose of providing financial opportunity to more people, and we look forward to keeping you updated on our progress in the months ahead. But before wrapping up, I'd like to take a moment to recognize Steve Pelletier, who is retiring next month following an extraordinary 27-year career at the company. Thank you, Steve for your many contributions to Prudential throughout your career and for those of you who are not in the room here, but on the telephone, I wish you could see his grin, which is from ear-to-ear, as he participates in his last earnings call. And with that, I'd like to thank you again for joining us today and we look forward to more conversations in the future. Thank you." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
PRU	2021-02-05	[ { "description": "Senior Vice President & Head-Investor Relations", "name": "Darin Arita", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Controller and Principal Accounting Officer", "name": "Rob Axel", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Yaron Kinar", "position": "Analyst" }, { "description": "Head of U.S. Businesses", "name": "Andy Sullivan", "position": "Other" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Head of International Businesses", "name": "Scott Sleyster", "position": "Other" }, { "description": "J.P. Morgan -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Andrew Kligerman", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Dowling & Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Vice Chairman", "name": "Bob Falzon", "position": "Other" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Josh Shanker", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to the Prudential quarterly earnings call. [Operator instructions] I would now like to turn the conference over to our host, head of investor relations, Mr. Darin Arita. Please go ahead." ] }, { "name": "Darin Arita", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential in today's call are Charlie Lowrey, chairman and CEO; Bob Falzon, vice chairman; Andy Sullivan, head of U.S. businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-Looking Statements and Non-GAAP Measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.", "With that, I'll hand it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Darin. Good morning, everyone, and thank you for joining us today. As we approach the 1-year mark of the global pandemic, I hope that you, your families and colleagues remain safe and healthy in this continuing difficult environment. As before, we remain deeply focused on the well-being of our employees, customers, communities and other stakeholders and on addressing their evolving needs and challenges.", "Amid the extraordinary events of 2020, we continue to take steps to evolve our business for the future, while living up to our purpose. Turning to Slide 2. We successfully executed on a number of our strategic initiatives in 2020 to reduce our market sensitivity and increase our growth potential, including the expansion of our cost savings program, while further solidifying our already robust financial position. We're now focused on building upon our achievements over the past year to further accelerate our strategy.", "I'll speak to this next phase of our transformation in more detail momentarily, but we'll start by recapping our accomplishments in 2020. Turning to Slide 3. We realized $215 million in cost savings during the year, exceeding our $140 million target. Recall that last quarter, we increased our cost savings target to $750 million to be realized by the end of 2023.", "We also began to rotate our international earnings mix toward higher growth markets. During the year, we completed the sale of our Korea business and announced the sale of our Taiwan business. We also took significant steps to address the low interest rate environment with derisking actions, such as repricing products and pivoting to less interest rate-sensitive solutions. This pivot included discontinuing sales of variable annuities with guaranteed living benefits and launching a buffered annuity product, FlexGuard, which is less sensitive to market fluctuations while continuing to serve our customer needs.", "Turning to Slide 4. As we look ahead, we're building upon the actions we've already taken as well as our competitive strengths to significantly transform the company over the medium term. To achieve this transformation, we expect to deliver on our cost savings program and to reallocate $5 billion to $10 billion in capital over the next three years, as we pivot toward higher growth and less market-sensitive businesses. In parallel to this capital reallocation, we anticipate returning $10 billion of capital to shareholders over the next three years.", "This includes dividends as well as share repurchases that are returning -- that are resuming in the first quarter under our new $1.5 billion authorization. As a result of these efforts, Prudential should emerge as a higher growth, less market-sensitive and more nimble business that is positioned not only to deliver growth for shareholders, but also to make a more meaningful difference in the financial lives of more people around the world. Turning to Slide 5. As we transform to become a higher growth, less market-sensitive business, we expect to double our growth businesses to more than 30% of earnings and have our individual annuities business to 10% or less of earnings.", "We will change our business mix primarily through organic growth and programmatic acquisitions for both our global asset manager, PGIM, and in emerging markets within our international businesses. PGIM manages $1.5 trillion of assets, which we have grown both organically and through acquisitions of talent and capabilities. In emerging markets, we have expanded with joint ventures and acquisitions in regions with large markets and favorable demographic tailwinds, such as Asia, Latin America and Africa. We benefit from strong relationships with companies that have a large footprint and a significant local market expertise.", "In addition, we will remain focused on investing in our other businesses to expand our addressable market as well as continue to improve expense and capital efficiency. Additional actions to change our business mix include derisking and other transactions in conjunction with running off certain blocks of business. The $1.6 billion of capital generated from the sale of Korea business is included in the $5 billion to $10 billion we plan to reallocate into our growth businesses. Our change in business mix will obviously not be a straight line.", "But as we reallocate capital, we'll provide you with information to help you both understand and measure our progress. Turning to Slide 6. We are well positioned to execute this strategic plan with a rock-solid balance sheet. At the end of the fourth quarter, we had $5.6 billion in highly liquid assets.", "And our operating subsidiaries continue to hold capital to support AA financial strength ratings. Finally, let's turn to Slide 7. During this time of change in transformation, our commitment to our company purpose and to supporting all our stakeholders remains as fundamental as ever. The importance of this work is reflected in the multiple environmental, social and governance initiatives that we advanced over the course of this quarter and throughout 2020.", "Here are some of the noteworthy accomplishments. We became the first U.S. insurer to insure a green bond aligned with the United Nations Sustainable Development Goals. We furthered our commitment to environmental transparency and accountability by disclosing our environmental impact through CDP, the world's leading environmental disclosure platform.", "Prudential scored an A- on CDP's 2020 Climate Change Survey. We introduced nine commitments to advance further the work we've been doing on racial equity, spanning our talent practices, our design and delivery of products, our investments and public policy work and our support of community institutions working to remove persistent obstacles to black economic empowerment. I'm also pleased that we'll continue to tie inclusion and diversity with executive compensation. Three years ago, we added an inclusion and diversity performance modifier that factored into our 2020 compensation plan.", "Over this period, diverse representation among senior management has increased. We're including this type of modifier, again, to drive us to improve further our inclusion and diversity over the next three years. Before closing, I'd like to say thank you to all our employees around the world. It's through your hard work and dedication that we've been able to successfully help our customers and advance our transformation.", "With that, I'll turn it over to Rob for more specific details on our business performance. Thank you all for your time this morning." ] }, { "name": "Rob Axel", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results, and update on our strategic progress and highlights of our outlook for our U.S., PGIM and international businesses. Turning to Slide 8, I'll begin with our financial results for the year. On a pre-tax adjusted operating income for 2020 was $5.1 billion or $10.21 per share on an after-tax basis.", "In the fourth quarter, our pre-tax adjusted operating income was $1.5 billion or $2.93 a share. Earnings exceeded the year ago quarter as increases in our PGIM and international businesses as well as our corporate and other operations offset a decline in our U.S. businesses. Results of our U.S.", "businesses reflected heightened COVID-19 related mortality experience as well as lower fee income in our individual annuities business, primarily due to outflows. This was partially offset by higher net investment spread results, driven by higher variable investment income and lower expenses. In addition, we made a change in our individual life procedures that provides policyholders information to better manage their policies and premiums for certain flexible premium policies. Due to this change, we have revised the estimated premiums to be paid for these policies, resulting in an adjustment to reserves.", "We also established an incurred but not reported, or IBNR, reserve in our group insurance business for the expected increase in disability claims as a result of the lag effect from higher unemployment. PGIM, our global asset manager, reported record assets under management of $1.5 trillion, up 13% from a year ago as well as higher net asset management fees and record high other related revenues. And earnings in our international businesses increased 6%, reflecting business growth, lower expenses and more favorable underwriting results, partially offset by lower net investment spread. Turning to Slide 9.", "Our U.S. businesses produced a diversified source of earnings from fees, net investment spread and underwriting income, which includes the benefits from netting longevity and mortality experience. We continued to make progress this quarter, executing on our priorities, including implementing pricing and product actions to derisk our business mix while protecting profitability and expanding our addressable market. Our product pivot has worked well with sales of our buffered annuity, FlexGuard, doubling to $1.2 billion in the fourth quarter from $600 million in the third quarter.", "And the pandemic has increased awareness of the value of our broad set of life insurance and financial solutions as we continue to enhance our capabilities to reach people when, where and how they want. These capabilities include traditional agents and financial advisors, the workplace, where 40 million people have access to our financial loan club and assurance. With respect to assurance, we launched our Medicare business a little more than a year ago. As a result of investments in our distribution capacity, marketing capabilities, and development of new technology, we nearly tripled our fourth-quarter Medicare revenues versus the year ago quarter.", "We expect to continue to grow these revenues as we further expand distribution, utilize newly developed tools for data-driven consumer product recommendations and broaden our marketing. In addition, this gives us further confidence as we develop and launch additional product lines. Customer interest for our simply term life insurance product through assurance has been strong, although sales have been lower than expected. We continue to modify our underwriting processes to allow for more instant decisions.", "As we streamline this process and improve the customer experience, we expect our life revenues to grow. Total revenues are our primary financial metric for assurance as we concentrate on scaling the business, doubled versus the year ago quarter. We're adding more carriers in all of our existing markets and expanding into new product lines. To execute this expansion, we have increased our investments in marketing, distribution and infrastructure.", "We expect operating losses in the near-term and earnings to emerge as we reach scale. Now turning to Slide 10. PGIM continues to demonstrate the strength and resilience of its diversified platform as a top 10 active global investment manager. PGIM's strong investment performance and diversified global investment capabilities in both public and private asset classes across fixed income, alternatives, real estate and equities position us favorably to capture flows.", "PGIM's investment performance demonstrated resiliency, with more than 90% of assets under management outperforming their benchmarks over the last three, five and 10-year periods. This investment performance contributed $6.3 billion of third-party net flows during the fourth quarter, including $3.8 billion of retail and $2.5 billion of institutional flows, resulting in $20 billion of net flows for the year. Of note, PGIM investments achieved the second highest U.S. mutual fund franchise ranking based on net flows in 2020.", "PGIM's strong overall flows were driven by continued investor appetite for fixed income strategies, particularly higher-yielding strategies and for real estate. PGIM's asset management fees increased 12% compared to the year ago quarter, reflecting growth in average assets under management. In addition, record high agency loan production and the effect of strong investment performance on incentive fees as well as co-investment and seed investment earnings drove significant growth in other related revenues. These results contributed to an increase in PGIM's operating margin, which was in excess of 36% for the quarter.", "While PSM's operating margin will vary with market conditions, we expect to sustain a margin of approximately 30% across the cycle. Turning to Slide 11. Our international businesses include our Japanese life insurance operation, where we have a differentiated multichannel distribution model as well as other operations focused on high-growth markets. As anticipated, Life Planner sales in the quarter were reduced by the accelerated sales in Japan last quarter following the U.S.", "dollar-denominated product repricing in August. For the year, we were pleased that sales were about flat as our high-quality distribution overcame the effect of the pandemic-related shutdown. Similar to Life Planner, Gibraltar sales were reduced in the current quarter, and sales for the full year were about even with the prior year. While we do not report separately on our emerging markets businesses, we would note that Brazil's life insurance in-force grew by 10% from a year ago.", "And our Chilean pension business held its No. 1 ranking for market share, benefiting from continued favorable investment performance. On Slide 17 in the appendix, we listed some of the emerging markets that we're in and our local relationships that have significant market leadership positions. And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 12, which provides insight into earnings for the first quarter of 2021 relative to our fourth-quarter results. Pretax adjusted operating income in the fourth quarter was $1.5 billion and resulted in earnings per share of $2.93 on an after-tax basis, then we adjust for the following items. First, variable investment income outperformed expectations in the fourth quarter, which is worth $360 million.", "Second, we adjust underwriting experience by a net $65 million. This includes a placeholder for COVID-19 claims experienced across our businesses of $170 million based on 250,000 COVID-19 related fatalities in the U.S. during the first quarter. Third, we expect expenses to be $165 million lower in the first quarter, primarily due to seasonal items in the fourth quarter.", "Fourth, there are other items that may be $40 million more favorable in the first quarter. As Rob discussed, in the fourth quarter, we recorded a charge for the change in our individual life business practice, which was partially offset by strong other related revenues in PGIM. Fifth, we anticipate net investment income will be reduced by $15 million, reflecting the difference between new money rates and disposition yields of our investment portfolio. And last, we expect the first quarter effective tax rate to normalize.", "These items combined gets us to a baseline of $2.54 per share for the first quarter. I'll note that if you exclude items specific to the first quarter, earnings per share would be $2.90 per share. The key takeaway is that this is roughly in line with the prior quarter. While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the first quarter.", "As we look forward, I'd like to bring your attention to a few other items in the appendix. In addition to the seasonal considerations on Slide 25, we have included other considerations for 2021 on Slide 26. Notably, we expect to realize an increase in cost savings from $250 million in 2020 to $400 million in 2021. We also provided the expected net cost for Corporate and Other, the yen foreign exchange rate and the effective tax rate for 2021.", "On Slide 13, we've provided an update on the potential impact of the pandemic. The estimated sensitivity of operating income for $100,000 incremental U.S. deaths due to the pandemic is $85 million based on our updated outlook. This is up slightly from our prior sensitivity as the virus more broadly spreads across demographics and geographies, including the insured population.", "As I noted earlier, our first-quarter baseline includes a net mortality impact of $170 million due to COVID-19. The actual impact will depend on a variety of factors, such as infection and fatality rates, geographic considerations and the speed and effectiveness of the vaccine rollout. Turning to Slide 14. We maintain a robust capital position and adequate sources of funding.", "Our capital position continues to support a AA financial strength rating, and we have substantial sources of funding. Our cash and liquid assets at the parent company were $5.6 billion at the end of the quarter, which is greater than three times annual fixed charges and other sources of funds include free cash flow from our businesses and other contingent capital facilities. Turning to Slide 15. And in summary, we successfully executed our 2020 initiatives, and we are building on those initiatives to transform Prudential into a higher growth, less market-sensitive and more nimble business, and we continue to benefit from the strength of our rock-solid balance sheet.", "Now I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question comes from the line of Suneet Kamath with Citi. Please go ahead." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. I wanted to start high level, if I could. Charlie, at the 2019 investor day, I think you guys laid out a strategy around financial wellness. And that initiative was supposed to get you to double-digit EPS growth and a 12% to 14% ROE kind of over the long term.", "Based on what you're talking about today, do you need to take these additional capital reallocation steps to get there? Or should we think about these initiatives as potentially pushing you above what you guided to?" ] }, { "name": "Rob Axel", "speech": [ "Suneet, it's Rob. I'll jump in on that, if you don't mind. So a couple of thoughts. One, since our investor day, obviously, rates have declined quite materially.", "And given our current business mix, a low interest rate environment with a 10-year hovering around 1.1%, 1.15% presents headwinds to an improving ROE. I would note, nonetheless, that in a challenging year for the industry, 2020, we achieved an ROE of just under 11%. And I think that speaks to the strength and earnings potential of the mix of businesses that we have. I'd also add that our focus, Suneet, is on not just ROE, but also on cost of equity.", "And importantly, the spread between the two. And the strategies and initiatives that Charlie outlined, I think, around derisking, simplifying and reducing market sensitivity and changing the business mix I would look at as very much geared toward expanding that spread between our return on equity and our cost of equity." ] }, { "name": "Suneet Kamath", "speech": [ "OK. And then as we think about that $5 billion to $10 billion of capital that you're going to reallocate, is it fair to think about most of that coming from life and annuities? And can you give us the amount of capital that's currently being consumed by those two businesses?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah. Let me jump in on that, Suneet. As we've said in the past, I think, everything is on the table, right? But what we've also said in this call is that we're really focused on annuities, and one of our priorities is annuities and shrinking annuities to 10% or less of earnings. But in addition to that, what we're doing is that we're looking at all market-sensitive low growth businesses or blocks of businesses in terms of runoff, reinsurance or sales.", "So we're going to continue to look at those. Life will be one of the businesses we look at in addition to annuities, but not necessarily the only one." ] }, { "name": "Ken Tanji", "speech": [ "Hey. Suneet, it's Ken. I just -- you asked about the amount of capital. Our annuities business is predominantly within one company and one statutory company called Prudential Life Assurance Company and its statutory capital is a little bit more than $6 billion.", "Our life business is well capitalized, but it's across a number of companies, and I don't have that aggregate number handy here." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Thanks again." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Yaron Kinar with Goldman Sachs. Please go ahead." ] }, { "name": "Yaron Kinar", "speech": [ "Thank you. Good morning, everybody. I guess, my first question is around the reduction of earnings coming from individual annuities. Can you achieve that without a block transfer or reinsurance deal? And the reason I ask that is, I would think that there may be a bit more of a challenge to dispose of that given that it is more of a GLWB variable annuity block? And I just -- we haven't seen a lot of appetite for that in the market to date.", "So maybe you could address those questions?" ] }, { "name": "Rob Axel", "speech": [ "Yeah. Yaron, it's Rob. I'll jump in first and then maybe Ken or Andy might want to jump in after me. But just with respect to the first part of your question, as we think about our objective of getting our annuities business into -- to represent 10% or less of our overall earnings, I think as we indicated in our slides, a noninconsequential component of that comes from the runoff of the existing legacy block to the tune of about -- legacy block runs off at about $3 billion a quarter.", "And so that gets us to a range of 40% to 45% of our objective, just with respect to runoff. Why don't I ask -- to defer to Ken and Andy to talk a little bit about the multiples and deployment of capital in the market?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah, sure. Yaron, our variable annuity business is, as we've said in the past, very well capitalized. It has a good profitability, cash flow and risk profile. And we don't see the fact that it's a GLWB book to present any unique or difficult challenges." ] }, { "name": "Yaron Kinar", "speech": [ "OK. That's helpful. And then I guess on the flip side of that in terms of growth into the double growth markets. I'm assuming there's this large inorganic component there, just considering the $5 billion to $10 billion that you're looking to deploy.", "And in those markets, I would think the valuations there may be a little bit higher. So how do you go about determining the use of call it prioritization of capital between buybacks, inorganic growth and organic growth in those emerging markets, asset management and the like?" ] }, { "name": "Rob Axel", "speech": [ "Yaron, it's Rob. I'll start out with that, and then I'll turn it over to others to answer the second part of your question. Just in terms of the amount of inorganic versus organic, as you think about the businesses that are grouped together in that sort of area that we're trying to grow to in excess of 30% or more of our earnings, those are higher growth businesses. They're dominated by PGIM.", "And PGIM, as we've said before, is a business that is growing in the mid- to high single digits on an organic basis. And so as we think about that, combined with the emerging markets and assurance, which we think has the potential for quite high-growth rates, we think that an excess of a third of our objective can be accomplished simply by organic growth. So let me stop there and turn it over to others to answer the second part of your question." ] }, { "name": "Andy Sullivan", "speech": [ "So Yaron, it's Andy. Maybe I'll jump in. This is a good spot to talk about PGIM and our plans around PGIM and how to accelerate into programmatic M&A. But first, I'd reemphasize what Rob said, we've had great growth in that business, and we expect that great growth to continue.", "When we look at our M&A opportunities in PGIM, we're looking to do as we've termed programmatic, which we would frame as methodical and planful. Specifically leaning into new product and investment strategy capabilities, we feel very confident that when we do that, we can gain a leverage from our distribution might and strength. Obviously, anything we do has to fit with our multi-manager model because we don't want to be disruptive to that multi-manager model. And particular areas of interest are areas that are higher growth parts of the asset management business.", "So I would name alternatives as a key area as well as international." ] }, { "name": "Yaron Kinar", "speech": [ "Thank you. Good luck with the execution." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Erik Bass with Autonomous Research. Please go ahead." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. How are you evaluating potential acquisitions in the growth markets that you've highlighted? And are you focused on near-term earnings accretion? Or is the bigger priority finding scalable properties with large addressable markets that you can grow over time?" ] }, { "name": "Scott Sleyster", "speech": [ "This is Scott. Why don't I start with that on the emerging markets front? First of all, we expect to remain focused on Latin America, Emerging Asia and Africa, and primarily on those markets where we already have established operations and partners. And in some cases, I think that would include expansion into adjacent markets. For the most part, we've been looking at, if you will, expanding into the markets that we're already in.", "And so we might be adding a capability or a little bit of scale. I think in those situations, the valuations have been relatively attractive. But going back to Charlie's opening remarks, we're going to be a disciplined buyer and make sure that we're earning an attractive return over our cost of capital before we deploy any funds over a reasonable amount of time. Thanks." ] }, { "name": "Erik Bass", "speech": [ "Thanks. And then maybe another one on a similar topic, but as you consider annuity reinsurance transactions, how do you think about the challenge of replacing the lost earnings and potential for EPS dilution if you're selling with a relatively low multiple business and to potentially buy higher multiple businesses?" ] }, { "name": "Ken Tanji", "speech": [ "Hey. Erik, it's Ken. We are reallocating capital, as you suggest, to achieve better growth, to lower our market sensitivity and improve our quality of earnings. And the combination, again, will deliver higher growth and less market sensitivity.", "And that, we believe, will get recognized in terms of a lower cost of capital and expanded valuation that would offset the dilution." ] }, { "name": "Scott Sleyster", "speech": [ "Got it. Thank you. That's helpful" ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Jimmy Bhullar with J.P. Morgan. Please go ahead." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hi. Good morning. First, I just had a question on the assurance IQ results. It was a good quarter on revenues, but you generated loss.", "And it seems like at least from the outside, the business has done significantly worse than would have been expected when you announced the deal. So what are your impressions of how that transaction has gone now that you've had it for about a year -- a little bit over a year?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Jimmy, it's Andy. So I'll handle your question. And you're correct, we now have four full quarters of operating the business under our belt, and we are very encouraged and glad that we have assurance as part of our business mix and see it as an expansion extension of our business model.", "Pretty early on in 2020, we made an explicit decision because we saw market opportunity to both expand and broaden the assurance platform. And we did that from both a product and a distribution perspective. So if you think of -- from a product perspective, we began to add on additional product lines, product categories like Medicare and like property and casualty. On the distribution side, we determined that we would be more successful over the long-term if we added on to the on-demand agent model.", "So we now have an external BPO agent component, and we're building out a Prudential W-2 agent component. That's leaning in to organically growing the business and expanding the business has led to a pretty significant increase in opex, as you would expect. And that's why we're so focused on revenues because now it's about scaling up the platform. And we're very confident over the long-term about the growth potential, both from a revenue perspective, but also expanding margins over time.", "As we said in previous quarters, we don't intend to provide or update any assurance-specific guidance other than what Rob sort of said at the top of the section about in the near term, given our organic investment that I spoke to, we expect operating losses." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. And then just on your annuity business, sequentially, you saw an improvement in variable annuity sales. And I wanted to get an idea -- and a lot of that, I think, is being driven by the FlexGuard product. But just wanted to get an idea on, is that fully rolled out to your distribution? Or is there sort of still ramp up potential for sales in that product? And relatedly, should we assume that sales in 1Q and through the first half of this year would be weak because you're withdrawing the living traditional living benefit products?" ] }, { "name": "Andy Sullivan", "speech": [ "So Jimmy, it's Andy. I'll take the question. And let me start with FlexGuard. Yes, we've been very, very pleased with the success that we've had of the FlexGuard buffered annuity product.", "In essence, we rolled it out in May and through the -- May through December, we almost crossed $2 billion in sales. We think it's one of the most successful launches probably in the industry. And the strength there is really coming from the strength of our business, the fact that our brand is so strong, our distribution and our relationships are so strong and we came out with a very good product. To your question of around momentum, we still are rolling it out to additional third-party intermediaries.", "So we have some additional work to go there. And we also have a couple of states left that haven't rolled out. So we're seeing great momentum and expect that momentum to continue. To the second part of your question, given the pivot that we're doing in that business, it was a pretty assertive and material change to see selling of our highest daily income in Prudential-defined income products.", "They were a big part of our sales in the past. So that will have an impact on our overall sales and flows. And I think you could expect that we will see outflows from the business due to that change." ] }, { "name": "Jimmy Bhullar", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Elyse Greenspan with Wells Fargo. Please go ahead." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi. Thanks. My first question, I guess, is going back to some of the transactions you've been talking about on the annuity side. So depending upon how this is structured, you could potentially -- and how the sales or transaction takes place, there could potentially be some hits that I imagine you could potentially take the equity.", "So how do we think about the leverage within your capital plan? Can you just update us on where you would see leverage going? And I'm assuming as you think through kind of freeing up capital that you've taken this into account and that you could probably absorb some hits and still keep your leverage within target so the capital freed up, like you said, be used for some of this M&A within the growth market." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Elyse, it's Ken. As we look at these transactions, we'll be looking at a number of key metrics and making sure we keep them all in balance. That's whether it's potential charges or gains to our equity, depending upon the transaction terms, what it would do to our cash flow going forward, our earnings and our risk profile.", "And very importantly, we'll be focused and disciplined on looking at fair value as we conduct these things. So we've managed our leverage ratio over time within our objectives to maintain our AA credit rating, and we'll continue to keep that a priority." ] }, { "name": "Elyse Greenspan", "speech": [ "So how high could it go? How high could the debt with that go?" ] }, { "name": "Ken Tanji", "speech": [ "We have some room and some flexibility. I don't want to pinpoint a number. And we'll -- but we manage to make sure we keep our objectives with our credit rating." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. And then my second question, on the -- your slide deck, you guys talk about the growth market, doubling that to the greater than 30%. It does include -- you do mention that your growth markets do include assurance IQ. So I guess following up on one of the earlier questions, so they're obviously embedded within the three-year outlook.", "There is some assumption for the assurance contribution to earnings because it sounds like your margins improve as the business scales. So if you can give us a sense as you put this plan together over this three-year time period what you're kind of assuming assurance does ultimately add to earnings over time." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Elyse, it's Ken. As Andy mentioned, we are very focused on growing this business, and that includes expanding distribution, expanding product lines, and that's requiring that we make some investments to realize the growth potential that's in the business that will lead to a modest loss in the near term. But we -- as that business scales and gains efficiency, we would see that gaining profitability, that's what I'd add." ] }, { "name": "Elyse Greenspan", "speech": [ "OK, thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Ryan Krueger, please go ahead, with KBW." ] }, { "name": "Ryan Krueger", "speech": [ "Hi. Good morning. In terms of the $5 billion to $10 billion of capital reallocation, given that your -- the higher growth businesses are generally not -- wouldn't be very capital consumptive, is it fair to assume that $5 billion to $10 billion would also equate to the rough amount of programmatic M&A that you're anticipating to do?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah, Ryan. It's Charlie. I think that's a fair assumption. In other words, as we think about reallocating capital, we're reallocating capital from the lower growth, less market-sensitive businesses into the opposite, right, higher growth, higher market-sensitive businesses.", "So it really is -- it's a reallocation of that capital, if you will, between the businesses." ] }, { "name": "Ryan Krueger", "speech": [ "Got it. And then on the individual annuity business, can you give us a rough sense of what percentage of those earnings are generated from the blocks that you've now discontinued that have living benefit guarantees?" ] }, { "name": "Ken Tanji", "speech": [ "Right now our current earnings are driven largely by our legacy business. We're new in the FlexGuard space. We're gaining great traction, and it's going well, but the majority of our current earnings are from our legacy business." ] }, { "name": "Ryan Krueger", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Andrew Kligerman with Credit Suisse. Please go ahead." ] }, { "name": "Andrew Kligerman", "speech": [ "Thank you very much. So another question on your M&A approach. You've mentioned asset management, emerging markets. I haven't heard anything about retirement and group.", "And I'm wondering if there's -- I think these are growth businesses. And I'm wondering whether full-service and record-keeping and various group and voluntary businesses might be attractive M&As as well." ] }, { "name": "Charlie Lowrey", "speech": [ "Hey, Andrew, it's Charlie. Let me start, and then I'll turn it over to Andy and Scott to elaborate some. But I think it's important to start with what we're not interested in, right? So we're not interested in doing a mega transaction that expands over multiple businesses. What we've said and what we're going to stick to is really looking at our less market-sensitive, higher growth businesses.", "In this case, emphasizing asset management and emerging markets. And so that's where we're going to do. And we're going to do it in terms of programmatic M&A that really emphasizes a multi-manager model in PGIM and certain specific markets in emerging markets. But I'll turn it over to Andy and to Scott to elaborate on that." ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Andrew, it's Andy. I would just add, you specifically mentioned our institutional businesses. I'll frame it that way, in full-service and in group insurance.", "We've seen very good success, in particular with our financial wellness strategy, at strengthening our institutional value prop in general. And that has led to good growth in both of those businesses. So I would say our focus in those businesses is to lean into that organic growth and to continue to see net revenue growth that flows from the investment in financial wellness." ] }, { "name": "Andrew Kligerman", "speech": [ "That's very helpful. And then in the individual life segment, I saw a line item, $130 million from reserve refinement. And I think as I kind of very generally understand it, it was providing customers with information around options that they could have maybe in their UL policies. I'm wondering what are those options? What exactly was offered to the customers and just how did that $130 million reserve impact evolve?" ] }, { "name": "Andy Sullivan", "speech": [ "So Andrew, it's Andy again. I'll take your question. So this was a business practice change, where, in essence, we're giving more detailed communications to certain of our flexible premium product holders. The intention of that information is to help them proactively manage their policies and premiums.", "And we believe that it will lead to less premiums coming in over time, thus, the financial charge. It does not have a material impact from a go-forward perspective on earnings." ] }, { "name": "Andrew Kligerman", "speech": [ "So I'm just trying to understand what would it mean that they don't have to pay premiums, they could use their cash value and that might prompt them to think, well, I shouldn't have been putting cash into the product. I just would like to understand what behaviors will change as a function of that because $130 million is a significant charge." ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. So Andrew, it's Andy again. So in essence, on their annual statements and their payment notices, we're giving them more details around their premium flexibility, their requested premium amounts and their guarantees against lapsation. And we think the customers working with their advisors, that will lead to less premiums coming in over time." ] }, { "name": "Andrew Kligerman", "speech": [ "Thanks, Andy." ] }, { "name": "Operator", "speech": [ "Thank you. Next, we go to the line of Tracy Benguigui with Barclays. Please go ahead." ] }, { "name": "Tracy Benguigui", "speech": [ "Good morning. As you're in the market speaking with potential buyers of closed block sales, I'm wondering if PGIM third-party investors, maybe consortium, has expressed any interest or appetite? I mean that does not preclude other buyers. Just want to get a sense of PGIM's familiarity can reduce the bid-ask spread at all." ] }, { "name": "Andy Sullivan", "speech": [ "So Tracy, it's Andy. Thank you very much for your question. We absolutely think PGIM, clearly, is a net positive to this overall process. We see more and more capital that sees value in the types of things that we do.", "And we think that does enhance our opportunity in many different ways. We feel advantaged in that we own world-class origination capabilities, very strong asset liability matching capabilities and PGIM as a world-class investment manager, in particular, being very strong in alternatives. And as I said earlier, is that being one of the areas that we look to strengthen even further. So I do think that, that is a positive for us, and we're excited for the possibilities that could create over time." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Great. And then besides your motivation of reducing market sensitivity, is part of the motivation to complete a block sale from the upcoming accounting changes from LDTI? Another insurer is divesting their own life and annuity business and said that the reduction to equity under LDTI would have been worse than the book value lost from the sale. Now I'm not asking you to comment on that specific transaction, but just to get a sense of your willingness to sell at a loss and how LDTI may be a motivating factor." ] }, { "name": "Ken Tanji", "speech": [ "Hey, Tracy. It's Ken. First, TI is a few years away, but -- and I don't want to comment on someone else's deal nor do I have a specific transaction for us to comment on. But with respect to deals, like I said, we're going to evaluate things through a number of metrics.", "One will be its impact on book value, earnings, cash flow, capital risk, we'll take that all into consideration. And so I can't comment beyond there because it would be being too general." ] }, { "name": "Charlie Lowrey", "speech": [ "Well, maybe I'll just add, Tracy. Recall, our accounting that we use for our annuities is different than most others that are in the industry are using for their accounting. And under TI, there actually is not a significant change to the accounting of the living benefit in our book, vis-à-vis, the way in which we currently account for it. So that may be part of the explanation to your question as well." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Thank you for the color." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Humphrey Lee with Dowling & Partners. Please go ahead." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning and thank you for taking my questions. Just to follow-up back on assurance IQ, I understand that you don't want to provide any kind of updated guidance in terms of revenue or margin since the original announcement. But basically suggesting it will be in operating losses in the near term. Given the, I guess, where it has been trending, do you feel like you could turn to be profitable by 2022? And then also, how should we think about the impact on the additional earnout? Looking at it right now, it doesn't look like that may be achievable.", "So could there be any impacts to the key person retention issues given the changes -- the challenges on the earnout?" ] }, { "name": "Andy Sullivan", "speech": [ "So Humphrey, it's Andy. As we talked about, we are seeing progress. As we launch product lines, the process we basically go through is we need to become more efficient at marketing those products. And then obviously, as we build out the distribution end of things, we need to get to a place where we're getting better and better at conversion.", "We have seen quarter over quarter throughout 2020, our conversion rates get better. We have seen, and we won't get into specifics, but product lines that we've started to see start to get toward the levels of profitability that we would expect. We're still not going to comment on specific timing, but we do like the trajectory that we're on and we intend to continue investing. The operating losses near-term have everything to do with the decision we made to really accelerate our investment and now we have the job in front of us that we're confident in of scaling up the revenue." ] }, { "name": "Ken Tanji", "speech": [ "And Humphrey, it's Ken. On the earn-out, it's based upon variable profits, and it's over a three-year period, so it's still in place until the end of 2022. And it was designed to incent them to outperform our expectations. And right now, it's still -- it has two years to go, and it's still in place." ] }, { "name": "Humphrey Lee", "speech": [ "OK. Shifting gear, as you shrink the annuity business, how should we think about the overhead or kind of potential stranded costs related to shrinking that book of business? Especially given two years ago, when you talked about the financial wellness, part of the cost synergy was having all of the different businesses sharing the call center and the back office support and now you have a major part of that potentially shrinking and reducing your overall earnings contribution. So how should we think about the potential kind of overheads related to the that side of the business? And how are you going to address that?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. First, as we indicated with our progress in 2020, we're making a really good progress when we accelerated our progress and increased our objectives with our transformation program. And it's also given us capabilities that we'll be able to apply should, as we reallocate capital, we need to deal with stranded costs. Also keep in mind, we're reallocating that capital.", "So as we may shift it from annuities, we'll be redeploying it into new earnings opportunities as well." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of John Barnidge with Piper Sandler. Please go ahead." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much. Does it seem reasonable to think that there will be elevated administrative expenses and group disability to process COVID claims as long as the pandemic remains? I ask that in light of the 2-point increase for the year." ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. John, it's Andy. I'll take your question. Yes, your assumption is absolutely reasonable.", "I mean one of the most important things during a period of time like this as a disability carrier is properly investing in the disability claims staff. So some of what you saw in our admin ratio in the fourth quarter was us adding to staff. That's claims managers, that's nurses, that's folk specialists, to make sure that our claims personnel have the adequate time and space to properly help our customers and help them return to work. So it is reasonable to assume as incidents goes up, which typically happens during the recession -- we have not yet seen that on the LTD side but we are expecting to see it, that we would continue to invest and maintain the right level of claims teams, and that would be a higher level of investment." ] }, { "name": "John Barnidge", "speech": [ "Great. And then unrelated to that, Israel has been the country that has enacted the most aggressive vaccination program globally. Are there any markers that you've seen out of the country in the weeks since they began this? Just provide maybe some insight around timing of maybe COVID tapering off a little bit." ] }, { "name": "Charlie Lowrey", "speech": [ "So John, this is Charlie. I think we are encouraged by what we see in terms of the -- of both the introduction of the Pfizer and Moderna vaccines, but also the potential of Johnson & Johnson coming with a completely different kind of vaccine, right? It's a one-shot vaccine, it doesn't need cold chain storage. And we think that could have a large effect on the ability of this country to get vaccinations, if you will. So over the course of the next three to six months, we're not going to say it's going to happen overnight.", "But we think there's going to be a material change in the ability to vaccinate people as we go forward, and that can only enure to the company, to the country's benefit and to the reduction in the transmission of the virus." ] }, { "name": "John Barnidge", "speech": [ "Thank you for your answers." ] }, { "name": "Operator", "speech": [ "Thank you. Next, we go to the line of Tom Gallagher with Evercore. Please go ahead." ] }, { "name": "Tom Gallagher", "speech": [ "Hi. First question is, Bob, you mentioned that one-third of the $5 billion to $10 billion of capital deployment will come through organic growth. I guess that seems like a high number considering PGIM and assurance IQ shouldn't have much capital intensity. So is that largely coming from the EM side?" ] }, { "name": "Bob Falzon", "speech": [ "Yes. Let me clarify what I said, Tom. Apologies if I wasn't clear. What I was saying is that in excess of a third of the earnings growth that gets us from 18% of our total earnings to 30% of our total earnings comes from organic growth, not that in excess of a third of the capital is organic.", "So I hope that clarifies that point." ] }, { "name": "Tom Gallagher", "speech": [ "That does. The other question I had is just a follow-up on the broader M&A strategy. The -- I get like group benefits and retirement aren't high growth businesses, but they're capital efficient. And so just curious why these wouldn't be M&A areas?" ] }, { "name": "Charlie Lowrey", "speech": [ "So let me start with that. And Andy, you may want to join in afterwards. But the way we look at those businesses, and I think consistent with what Andy said before is it is not that we are not investing in those businesses, we will continue to invest in them for purposes of organic growth. But when you think about the areas in which we want to reallocate capital, if you will, to higher growth businesses with less market sensitivity, those are our priorities are certainly PGIM and emerging markets.", "And Andy, I don't know if you want to expand on that but." ] }, { "name": "Andy Sullivan", "speech": [ "No, nothing to add, Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "OK." ] }, { "name": "Bob Falzon", "speech": [ "OK, thanks." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question comes from Josh Shanker with Bank of America Securities. Please go ahead." ] }, { "name": "Josh Shanker", "speech": [ "Yes, thank you for taking my questions late in the call. If we go back to the investor day that we keep bringing up, I guess, the big difference is the parting ways of the annuities, or at least certainly the high capital consumptive annuities. If I want to -- like, are there other strategic changes that really come out? I just put numbers to things that were already in motion or are there other strategic changes embedded in those numbers that we really should focus on?" ] }, { "name": "Charlie Lowrey", "speech": [ "So I'll take a first stab at that, and then Rob, maybe you want to join in. But I think when you look at our strategy, we still have the wellness strategy. That still exists. It's still a very much part of what was our investor day presentation back then and is -- continues to be there.", "What we've done with a much lower interest rate environment and with a strategic review is, again, say where we want to reallocate capital. And that's new, and that's what we've come out with this quarter in terms of thinking where we want to be in three years with the higher growth businesses. So if I were to articulate a difference, it would be there. And Rob, I don't know if you have other things you can elaborate on." ] }, { "name": "Rob Axel", "speech": [ "Yeah, Josh. So thank you for the question. Just to elaborate a little bit on what Charlie's saying. I think, Josh, if you think about what we said in investor day, all of that is largely intact, as we described it.", "Around our organic growth opportunities, we have said that it's -- that our near-term aspirations around some of that are we're facing headwinds with regard to a much lower interest rate environment than we were in at the point in time in which we articulated that. But I think it's not just the pivot away from annuities, but as Charlie said, it's also, as contrasted to what we described at investor day, the reallocation of -- the active reallocation of capital more broadly and into those growth businesses. So I would call out not just the emphasis of annuities because of its -- not because we don't think, incidentally, it's a very good business. We think it produces tremendous cash flows.", "It's well capitalized. It's well hedged. We just happen to believe that it's a business that will get better value in private markets than how we're getting rewarded in the public market for that today. And that gives us an opportunity to arbitrage capital and to reinvest it into areas in which we can be rewarded in the public market, and those would be the growth areas that we've articulated." ] }, { "name": "Josh Shanker", "speech": [ "So in presenting the plan to the board, where we're going to -- it's going to be probably earnings dilutive, but we're going to get higher multiple earnings out of it and less market sensitivity. Is there any frame for the magnitude of the dilution that was presented in order to make this change?" ] }, { "name": "Charlie Lowrey", "speech": [ "So let me take a stab at that. And what we really -- what we present to the board and what we present externally is it's really a balance, right? It's a balance between the reallocation of capital into these higher growth businesses, but also a redeployment of capital. And in this case, we've articulated $10 billion to shareholders in terms of share repurchases and dividends. And so what we've attempted to do is balance the two, right? Say we're going into higher growth markets.", "And so therefore, hopefully, we will have a higher multiple as we go forward and yet return a significant amount of capital to shareholders as we have done in the past and will continue to do in the future." ] }, { "name": "Josh Shanker", "speech": [ "Well, I'm trying to do some math and maybe Darin will help me out down the line. Appreciate it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Now, we will send it back to Charlie Lowrey for his closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "OK. Thank you very much. In closing today, I'd just like to reinforce our commitment to creating a new and more nimble Prudential, one that remains deeply focused on its customers, that will have a higher growth potential and will be less market-sensitive in the future. We're excited and we're optimistic about this next phase of our transformation, and we look forward to keeping you updated on our progress.", "So thanks again for joining us today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2021-11-03	[ { "description": "", "name": "Bob McLachlan", "position": "Other" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Executive Vice President and Head of U.S. Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Dowling and Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Andrew Kligerman", "position": "Analyst" }, { "description": "Head of International Business", "name": "Scott Sleyster", "position": "Other" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Senior Vice President, Corporate Controller", "name": "Rob Axel", "position": "Executive" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to Prudential's quarterly earnings conference call. [Operator instructions] As a reminder, today's call is being recorded. I will now turn the call over to Mr. Bob McLachlan.", "Please go ahead." ] }, { "name": "Bob McLachlan", "speech": [ "Good morning and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman, and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of U.S. businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller, and principal accounting officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled forward-looking statements and non-GAAP measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.", "And with that, I'll turn it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Bob, and thanks to everyone for joining us today. As always, we hope you and your families remain safe and healthy. Prudential delivered solid financial results for the third quarter, reflecting our strong investment performance and high demand for the products we've introduced to support our customers as they solve their financial challenges in a changing world. We also made significant progress executing on our transformation strategy to become a higher-growth, less market-sensitive, and more nimble company.", "First, we reached agreements to divest our full-service recordkeeping business and to sell a portion of our traditional variable annuities, advancing our pivot toward less market-sensitive, and higher-growth businesses. Second, we continue to advance our cost-savings program and remain on track to achieve $750 million of savings by the end of 2023. And third, with the support of our rock-solid balance sheet, we are maintaining a disciplined and balanced approach to redeploying capital. I'll provide an update on each of these transformation initiatives before turning it over to Rob and Ken.", "Turning to Slide 3. In September, we reached an agreement to sell a block of our traditional variable annuities to Fortitude Re. This divestiture, which is expected to close in the first half of 2022, represents approximately 20% of our traditional individual annuities account values and significantly advances our goal of cutting in half the earnings contribution of legacy variable annuities products through a mix of strategic transactions and natural runoff. This transaction expands upon our prior divestiture activity, including the agreement we announced in July to sell our full-service recordkeeping business and the successful completion of the sales of our Taiwan and Korea insurance businesses.", "As a result of these divestitures to date, we expect to generate net proceeds of approximately $6 billion by the first half of 2022. And we continue to explore additional opportunities to derisk in-force blocks of business. With the pending sale of our full-service recordkeeping business and our annuities block transaction, we have combined our individual annuities and retirement businesses to better serve the retirement needs of both individuals and institutions and support our growth strategy. Turning next to our cost-savings program on Slide 4.", "We are progressing well and remain on track to achieve our $750 million cost-savings targets by the end of 2023 as we look to reduce expenses while improving both the customer and employee experience. To date, we have achieved $590 million in run-rate cost savings, exceeding our $500 million targets for the full year. These savings include 145 million achieved in the third quarter for a total of $385 million this year. Turning to Slide 5.", "We continue to demonstrate a disciplined and balanced approach to capital deployment by enhancing returns to shareholders, reducing leverage, and investing in the growth of our businesses, all supported by our rock-solid balance sheet. Year to date, we returned $3.5 billion to shareholders, including 2.1 billion of share buybacks and 1.4 billion in dividend payments, reflecting a 5% increase in our quarterly dividend compared to last year. And we're targeting to return $11 billion of capital to shareholders by the end of 2023. During the third quarter, we also took steps to enhance our financial flexibility by redeeming $900 million of outstanding debt.", "This reduced financial leverage and generated 30 million in annual interest savings going forward. We also continued to deploy capital in our businesses to drive long-term growth. For example, this quarter, we completed a $5 billion funded pension risk transfer transaction, which is the fourth largest transaction in the history of the PRT market and demonstrates our expertise, ability to execute at scale, and commitment to this market. We also deployed capital to support our ongoing pivot to less interest rate-sensitive and higher-growth products, including our FlexGuard and variable life products.", "Our capital deployment is supported by our balance sheet strength, including highly liquid assets of $3.8 billion at the end of the third quarter and a capital position that continues to support a AA financial strength rating. Turning to Slide 6. I'm pleased to report a meaningful expansion of our environmental, social, and governance commitments. Earlier this week, we announced our commitment to achieve net-zero emissions across our primary global home office operations by 2050, with an interim goal of becoming carbon-neutral by 2040.", "We're also carefully assessing the emissions impact of our investment portfolio. As an immediate action, we will restrict new direct investments in companies that derive a material portion of their revenues from thermal coal. Separately, on the social front, the Prudential Foundation achieved an important milestone during the quarter, reaching $1 billion in funding to partners aimed at eliminating barriers to financial and social mobility around the world since making its first grant in 1978. These investments include funding aligned with our racial equity commitments to support organizations, such as those supporting minority-owned small businesses and historically black colleges and universities that foster black economic empowerment and address the racial wealth gap.", "This milestone by the foundation follows the $1 billion investment mark achieved in our impact investing portfolio in 2020. We are confident these actions taken alongside of our strategic transformation will help us build a more sustainable company on behalf of all our stakeholders. Thank you for your time this morning. And with that, I'll turn it over to Rob." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results and business performance for our PGIM, U.S., and international businesses. I'll begin on Slide 7 with our financial results for the third quarter. Our pre-tax adjusted operating income was $1.8 billion or $2.78 per share on an after-tax basis and reflected the benefit of strong markets and business growth, which exceeded the net mortality impacts from COVID-19.", "PGIM, our global asset manager, had record-high asset management fees driven by record account values of over $1.5 trillion that were offset by lower other related revenues relative to the elevated level in the year-ago quarter as well as higher expenses supporting business growth. Results of our U.S. businesses increased approximately 29% from the year-ago quarter and reflected higher net investment spread, driven by higher variable investment income, and higher fee income primarily driven by equity market appreciation, partially offset by less favorable underwriting experience driven by COVID-19-related mortality. Earnings in our international businesses increased 14%, reflecting continued business growth, higher net investment spread, lower expenses, and higher earnings from joint venture investments.", "This increase was partially offset by less favorable underwriting results, primarily driven by higher COVID-19 claims. Turning to Slide 8. PGIM continues to demonstrate the strength of its diversified capabilities in both public and private asset classes across fixed income, alternatives, real estate, and equities as a top 10 global active investment manager. PGIM's investment performance remains attractive with more than 94% of assets under management outperforming their benchmarks over the last three-, five- and 10-year periods.", "Third-party net flows were 300 million in the quarter, including institutional net flows of 700 million, primarily driven by public fixed income flows. Modest retail net outflows of 400 million were due to equity outflows from sub-advised mandates and client reallocations due to rising rates and inflation concerns. As the investment engine of Prudential, PGIM benefits from a mutually beneficial relationship with our U.S. and International Insurance businesses.", "PGIM's asset origination capabilities and investment management expertise provide a competitive advantage by helping our businesses to bring enhanced solutions and more value to our customers. And our businesses, in turn, provide a source of growth for PGIM through affiliated flows that complement its successful third-party track record of growth. PGIM's asset management fees reached another record, up 13% compared to the year-ago quarter as a result of strong flows driven by investment performance and market depreciation. PGIM's alternatives business, which has assets in excess of 250 billion, continues to demonstrate momentum across private credit and real estate equity and debt, benefiting by our global scale and market-leading positions.", "As an example, PGIM's private businesses deployed almost $12 billion of capital this quarter, 28% more than the year-ago quarter. This strategic focus on expanding higher-yielding products has resulted in stable fee rates over time despite industrywide fee pressures. Now turning to Slide 9. Our U.S.", "businesses produced diversified earnings from fees, net investment spread, and underwriting income and benefit from our complimentary mix of longevity and mortality businesses. We continue to shift our business mix away from low-growth, capital-intensive, and interest rate-sensitive products and businesses, transform our capabilities and cost structure and expand our addressable markets. In addition to the agreement that we announced in July to sell our full-service retirement business, this quarter, we also announced the sale of a portion of our legacy in-force annuities block to reduce the overall contribution of traditional variable annuities. These transactions are significant steps forward in shifting our business mix and product portfolio to reduce market sensitivity and accelerate long-term growth.", "In addition, our product pivots have worked well, demonstrated by continued strong sales of our buffered annuity products, which were $1.3 billion in the third quarter, representing 88% of total individual annuity sales. Since the launch of FlexGuard in 2020, sales have exceeded $6 billion. These sales reflect customer demand for investment solutions that offer the potential for appreciation from equity markets combined with downside protection. We have also exercised discipline through frequent pricing actions, and our sales continue to benefit from having a strong and trusted brand and highly effective distribution team.", "Also, our Individual Life sales continue to be strong and reflect our product pivot strategy, with higher variable life sales compared to the year-ago quarter. Our retirement business reflected strong sales in the quarter, including a 5.2 billion funded pension risk transfer transaction and 1.6 billion of international reinsurance transactions, demonstrating our market-leading capabilities. With respect to Assurance, our digitally enabled distribution platform, total revenues, our primary financial metric as we concentrate on scaling the business, were up 47% over the prior-year quarter. During the third quarter, we increased the number of agents to prepare for the seasonally higher expected demand of the Medicare annual enrollment period that occurs in the fourth quarter.", "Turning to Slide 10. Our international businesses include our Japanese life insurance operation, where we have a differentiated multichannel distribution model, as well as other operations, focused on high-growth emerging markets. Sales across both Life Planner and Gibraltar operations were higher than last quarter amid the state of emergency in Japan that ended on September 30th. However, sales were lower than the prior-year quarter's, which were elevated ahead of the U.S.", "dollar-denominated product repricing in Japan that we implemented in the third quarter of last year. We also continue to see sales momentum in Brazil, particularly within the third-party distribution channel. We remain encouraged by the resiliency of our unique distribution capabilities, which have supported the continued growth of our in-force business. And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 11, which provides insight into earnings for the fourth quarter of 2021 relative to our third quarter results. Pretax adjusted operating income in the third quarter was $1.8 billion and resulted in earnings per share of $3.78 on an after-tax basis. To get a sense for how our fourth quarter results might develop, we suggest adjustments for the following items.", "First, variable investment income outperformed expectations in the third quarter by 570 million. Next, we included a placeholder for COVID-19 claims experience in the fourth quarter that is a similar level to our experience in the third quarter. While we have provided this placeholder for COVID-19-related claims experience, the actual impact will depend on a variety of factors, such as infection and fatality rates, geographic and demographic mix, and the continued acceptance and effectiveness of vaccines. Third, we expect seasonal expenses and other items will be higher in the fourth quarter by 140 million.", "Fourth, we anticipate net investment income will be reduced by about 10 million, reflecting the difference between new money rates and disposition yields of our investment portfolio. And last, we expect the fourth quarter effective tax rate to normalize. These items combined get us to a baseline of $2.27 per share in the fourth quarter. I'll note that if you exclude items specific to the fourth quarter, earnings per share would be $3.05.", "The key takeaway is that our underlying earnings power has increased from last quarter, driven by the benefits of business growth, our cost-savings program, and market appreciation. While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the fourth quarter. Turning to Slide 12. We continue to maintain a robust capital position and adequate sources of funding.", "Our capital position continues to support a AA financial strength rating and have substantial sources of funding. Our cash and liquid assets were $3.8 billion, which is greater than three times annual fixed charges, and other sources of funds include free cash flow from our businesses and contingent capital facilities. Turning to Slide 13 and in summary. We are executing on divestitures.", "We are on track to achieve our targeted cost-saving initiatives. And with the support of our rock-solid balance sheet, we are thoughtfully redeploying capital. Now I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our first question today is coming from Erik Bass from Autonomous Research. Your line is now live." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. So we've recently seen asset managers, such as T. Rowe and Franklin, announce sizable deals to acquire private and alternative asset capabilities and transactions that were generally well received by investors.", "Wondering if you see more properties like these available in the market? And would this be the type of programmatic M&A that you might consider for PGIM?" ] }, { "name": "Andy Sullivan", "speech": [ "So thanks, Erik. It's Andy and I'll take your question. So let me start by reiterating that PGIM is a business that has demonstrated incredibly strong ability to grow organically year after year. And that's really due to the success of our multi-manager model and the team's very strong execution.", "We've seen 55 billion in net flows over the last five years, and we've seen 11 billion in year-to-date flows. As we've talked about in the past, though, we do want to build upon that track record with programmatic bolt-on M&A. And we've been very assertive in making sure that we're both in the now and in the flow, and we are aware of these transactions in the marketplace. We're leaned into areas that are higher-growth and higher-fee-oriented areas.", "Three I would mention: we're looking to continue to globalize the business, specifically in Europe and Asia. We're looking to continue to build on our already strong alternatives business, where we have 250 billion in assets under management. And our acquisition of Montana Capital Partners is a great example of that. And we're looking in the area of real assets.", "As always, we're going to be disciplined in what we do and in how we deploy capital. To your question about sizable deals, we very much feel, if you look across our managers in PGIM, we are at scale. So it's unlikely that you would see us do what I would call a big pure-play scale deal. But to the degree that we would look and potentially do something larger, it would come with a key capability or strengthen us in a material way in a key geography and also bring along with it synergies." ] }, { "name": "Erik Bass", "speech": [ "Got it. That's helpful. Thank you. And then was hoping you could talk a little bit or provide some more color on your group claims experience this quarter, and particularly, the trends you're seeing in both Group Life and disability." ] }, { "name": "Andy Sullivan", "speech": [ "Sure, Eric. It's Andy. I'll take that one again. And let me start on the Group Life side.", "So as I'm sure you know and you've seen in the press, Delta has had a large impact on the country. The deaths in 3Q were three times what were expected. We were expecting 30,000 deaths, and we saw 95,000. We are a top-three life and disability carrier, so -- and because of that, we have a very big and broad book of business.", "And there's really three effects that I would point to that we saw in the quarter. First, U.S. deaths in the age group between 35 and 54 tripled from a percentage perspective. And we cover a lot of younger workers.", "The average age of our group block is in the neighborhood of 46 years old. Second, as you probably know and expect, we have a large national account book of business and have a very strong share in healthcare, in retail, and in manufacturing. These are areas where frontline workers are out and about by the definition and nature of their job, and therefore, more exposed. And then the third thing I would mention is about 50% of the pandemic impact we saw on the life side came from claims in the Southern United States.", "So clearly, this is very unfortunate that we keep experiencing this, but we're proud that we're able to deliver on our promises and help these families. As I flip to the group disability side, I would frame it as we're seeing what we expected to see, and we're seeing what we prepared for as an organization. And as I frame this, this impact on the disability side was not the predominant impact on Group Insurance. It was the Life side but having said that, the disability benefit ratio was somewhat elevated at 85.9%.", "There were really two effects that were at play. In our fee-based STD and absence business, we are continuing to see a higher level of absence in STD claims. That really leads to more expense in the business, and you see that show up in the admin ratio. On the LTD side, as we talked about in previous quarters, we had both put up IBNR, but also we had built claims staffing to be able to -- be ready to handle what we expect it to come, which we thought we would see enhanced incidents due to both the morbidity impacts of the pandemic but also the impacts from the unemployment -- the subsequent unemployment.", "And we are seeing that. Our incidents on LTD was up about 10% in the quarter, and our severity was up as well, about 10% in the quarter. But again, this is what we expected to see, and this is what we prepared for. So we're handling it well.", "And we would expect, obviously, for this to improve and subside over time." ] }, { "name": "Erik Bass", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from Ryan Krueger from KBW. Your line is now live." ] }, { "name": "Ryan Krueger", "speech": [ "Hey. Good morning. First question was, what areas are you focused on additional derisking? Does that include more potential variable annuity transactions? And then is Individual Life also part of the consideration?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah. Hi, Ryan. It's Charlie Lowrey. I'll take that.", "As we stated in our opening remarks, we're making significant progress on executing to become a higher-growth, less market-sensitive, and more nimble business. And this includes, as you rightly point out, the sales of our full-service recordkeeping business and our block of traditional variable annuities as well as the completed sales of what we've talked about in Korea, Taiwan, Italy, and Poland. We have also noted, to your point, that in the past, we're looking at other blocks of business that may include the areas that you spoke about. So we're accomplishing a significant amount, but we still have a lot of work to do.", "I would note that in terms of our overall goals, we have -- which we stated is between five and $10 billion of capital that we wanted to free up to reposition, we're already $6 billion into that, right? So we don't need to do other deals at this point. We are very happy with the economics of the deals we've done as we think it reflects the high quality of the businesses we have, but we'll only transact other deals if they make sense for all our stakeholders as we go forward." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks. And then a bit of a follow-up on M&A. So you've done a few deals, but they've been on the pretty small side, I think, in terms of capital, and you have a fair amount of capital coming in next year from the transactions you've announced. Do you still anticipate ultimately redeploying that additional capital freed up into M&A transactions over time? Or if not, would you consider upping the buybacks again?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah. I think what we've always said in the past, Ryan is that if we can't find good uses for that capital, we will return that capital to stakeholders. But what I would also say is that we are looking both organically and inorganically at ways of redeploying that capital, and organic investment is another way of doing that. So we'll be very disciplined as we go forward in looking at potential acquisitions.", "The M&A is going to focus on, again, asset management and emerging markets as we increase the percentage of earnings from growth areas and reduce the percentage of our legacy traditional variable annuities. But we'll continue to focus in a very disciplined way on those two areas. Andy mentioned in his previous comment the acquisition of Montana as a capital partner as an example of that, but we'll look at the pipeline that's out there and see if there are good deals to do. If they're not, we'll return capital to shareholders as we have in the past." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks, Charlie." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from Humphrey Lee from Dowling & Partners. Your line is now live." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning and thank you for taking my question. My first question is regarding the fourth quarter outlook for Assurance IQ. Can you talk about the preparation you've done so far in terms of -- for the enrollment period? And how confident are you in terms of kind of generating the necessary level of activities to support the breakeven AOI?" ] }, { "name": "Andy Sullivan", "speech": [ "Humphrey, good morning. It's Andy, and thanks for your question. So as you know and as we've talked about in the past, we do expect our revenue at Assurance IQ to be strongest in the fourth quarter given the annual enrollment season. Medicare Advantage remains a very strong opportunity for us.", "If you look, last year, we had a little under 1% share in that marketplace, and that marketplace is growing at 10% per year. So there's a lot of space to operate. As you saw in the quarter, we continue to invest in the platform, both in the business overall, but specifically in the quarter, we invested in building out our W-2 Prudential agent force. And what we saw is coming into the annual enrollment period season, we came in with more agents than we had last year, and those agents were operating at a higher level of productivity right out of the gate.", "So we're encouraged versus last year. As I've said before, we're confident in what the platform can do for us in the long term and its ability to scale." ] }, { "name": "Ken Tanji", "speech": [ "Humphrey, it's Ken. Just if I could add, as Andy said, we're well prepared. For the purposes of the baseline for the fourth quarter, we just simply put in a placeholder for Assurance at a breakeven because we wanted to neutralize for the seasonality, but it's not a forecast. It's just a placeholder to neutralize the earnings for the fourth quarter." ] }, { "name": "Humphrey Lee", "speech": [ "OK. Got it. I see. Yes, because I was just thinking like what type of revenue level would you need to have in order to get to that break-even target, but it seems like this is just more of a placeholder as opposed to anything." ] }, { "name": "Ken Tanji", "speech": [ "That's right." ] }, { "name": "Humphrey Lee", "speech": [ "OK. All right. My second question is regarding PGIM, especially on the retail side. The flow seems to be -- kind of have softened a bit over the past couple of quarters.", "Can you provide some color in terms of what you're seeing there and what kind of actions that you have taken to improve retail flows?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Humphrey, it's Andy again. Thank you for your question on PGIM. So as we've discussed in the past, we will see natural variability and variation quarter-to-quarter when it comes to flows.", "This quarter, in aggregate, we saw modest inflows driven by a positive result on the institutional side, thanks to our work at fixed income and real estate. We did experience modest outflows on the retail side as a result of client reallocation out of equities and in the fixed income space into shorter-duration strategies. What I would say is, in any given quarter, you could experience client reallocations, and that can go either way. What we think is very important to keep your eye on is the long-term track record.", "And as I've said, this is a business where we've experienced a lot of flows over the long term and $11 billion year-to-date. That really comes from both outstanding capabilities and strong execution. We have a broad and diversified product portfolio in PGIM. And we -- as you've seen in the release, we continue to have exceptional investment performance with 94%-plus outperforming benchmarks in the three-, five- and 10-year period.", "So we're confident that while there'll be variability quarter-to-quarter, potentially in the near term, we will be a net winner over time." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. So assume this quarter so far is an early glimpse on LDTI with some company disclosures. There was one that was quantitative, another more qualitative. Your 10-Q is not out yet, but are you planning to add any disclosures there, like either now this quarter or in the near future?" ] }, { "name": "Ken Tanji", "speech": [ "Hey, Tracy, it's Ken. We continue to evaluate the new standards and refine our methods. And we continue to adjust as we move toward the effective date, and the effective date is still over a year away. And the impact also will be subject to rates at the time of the effective date as well as the actions that we have been taking and will continue to make to shift our business to be less market-sensitive.", "And that will have an impact obviously at the time of the effective date. So overall, we're making good progress on implementing the new standards, but it's too early to provide estimates, and that's where we are." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Maybe just one question on that, on your Japanese business. To the extent that there are dollar-dominated products, does that act like a mitigant at all in your view when those liabilities have to be marked to market?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. We've had a long-standing capability and competitive advantage in U.S. dollar business in Japan. And again, our Japan business is focused on sort of the lifetime needs of our customers with a primary focus on death protection, including those that are denominated in U.S.", "dollars. It does have a long duration profile, and it's supported with robust reserves and a high-quality investment portfolio, and is very financially resilient. Again, we're not -- it's too early for us to provide estimates. But overall, although the accounting will be modified, we feel very good about the overall profitability of the business, the risk profile and the financial strength of our Japan business, including the U.S.", "dollar business." ] }, { "name": "Tracy Benguigui", "speech": [ "All right. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from Andrew Kligerman from Credit Suisse. Your line is now live." ] }, { "name": "Andrew Kligerman", "speech": [ "Hey. Good morning. I guess the first question is a follow-up on your capital management. Charlie, you made a comment -- two comments that you would look at the pipeline and that organic investing is a way to deploy the capital.", "So could you clarify what you meant by organic investing and the amount of money that might require? And then with regard to the pipeline, color on that. Is there -- because the two deals you did were rather small, is it possible that there might not be anything that really intrigues you, and you might have other uses for that capital?" ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. So a couple of comments, taking them in order. In terms of organic growth, if you look at FlexGuard as an example, so we have pivoted away from the variable annuities with guaranteed living benefits and then started with new products and are investing in those and supporting those as they grow. And that really ties into becoming a less market-sensitive company, and frankly, a higher-growth company.", "So that's an example. So we'll look at the product pivots that we do as an example of organic growth. In terms of inorganic growth, I think there are going to be plenty of opportunities as we go forward, especially in the areas that we want to invest in, namely asset management and emerging markets, some of the growth areas. So over time, I think we will find good places to put the capital.", "And as always, if we don't find places to put that capital to the extent that we don't have attractive opportunities that meet our strategic and financial criteria, we'll return the excess capital to shareholders as we've done in the past." ] }, { "name": "Andrew Kligerman", "speech": [ "Got it. That makes sense, Charlie. And then with regard to your international businesses in Japan, Gibraltar, and the Life Planners, sales were off pretty sharply in the 30-plus percent range. And in the press release, you cited the dollar-denominated product repricing that went on in the year-ago quarter, that the people wanted to catch these products.", "Could you clarify for us whether those products written a year ago were adequately priced and adequate returns? Was there a possibility for anti-selection? And now going forward, with an emergency act and kind of that getting out of the rearview, is there a possibility that as COVID subsides, these sales could really jet upward?" ] }, { "name": "Scott Sleyster", "speech": [ "Thanks, Andrew. This is Scott. I'll go ahead and take that one. As you recall, we took significant crediting rate actions last August on our U.S.", "dollar products. And that's really just part of our ongoing effort to maintain strong profitability on all of our new business activity. And that's across Japan, but across all of our other operations. And as is typical, that does create a sales surge ahead of the crediting rate, which typically pull sales forward from a quarter or two.", "And then additionally, I would say the impact of COVID emergency states, as well as the Olympics in Japan, also dampened sales for a period. But we are happy with the recovery that we've had in sales. And if you look at the third quarter over quarter, it looks good. In Japan, we benefit from having multiple distribution channels.", "We've got life planners, life consultants, the affinity channel, bank, and third-party distribution. And further, I would say that we've made significant progress in using and enhancing technology and new strategies to support both our customers and our distribution channels. So I think all of that put together says we feel pretty good about the sales momentum that we have. And we maintain a strong discipline and a continuous watch on our pricing actions.", "And where we're priced now, quite frankly, we don't foresee any material repricing actions on the horizon in Japan. And I think we made the actions that we took a year ago in a timely manner. Ken, were you going to say something?" ] }, { "name": "Ken Tanji", "speech": [ "I'd just say, our Japan business has consistently written business above its cost of capital. We are happy with the returns last year, and it's these pricing actions that keep us in good position from both a profitability but a customer value proposition. So it's been a pretty consistent story." ] }, { "name": "Charlie Lowrey", "speech": [ "And Andrew, it's Charlie, if I could just add one -- Andrew if I could add one other thing, and that is what Scott alluded to, which is that we have been extraordinarily disciplined in looking at the pricing of all our products around the world, not just in Japan, but as Scott said, in all the other countries, including the U.S. And we've been really pleased as we've increased the pricing, as we've had to with the low-interest rates, the strength of the sales, and I think that comes from three points of view. One is the strength of our brand. Second is the strength of the solutions we provide, such as -- with the new introduction of FlexGuard in this example.", "And third is the quality of our distribution, which is both in-house distribution and through third parties. So we have plenty of different ways of distributing the product, and I think that enures to our benefit." ] }, { "name": "Andrew Kligerman", "speech": [ "Thanks, Charlie." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from Tom Gallagher from Evercore ISI. Your line is now live." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. Individual mortality held up pretty well this quarter despite the increase in COVID mortality and also by some measures, there was elevated non-COVID mortality also this quarter. In terms of describing why you think your block only had minor sensitivity, can you comment on what that might be? Is it just vaccination levels, older age, demographics, and geography? Or anything you could share on that?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Tom, it's Andy. I'll take your question, and thanks for the question. So when you think about our Individual Life in the third quarter.", "I'd go through a series of items here. I think we did see a lift. Third quarter, I think, as you're aware, is our highest underwriting gain quarter. So there's definitely seasonality that's showing in the results.", "We also saw in the quarter fewer large face amount claims. And again, that's the type of thing that will vary quarter to quarter. This quarter, we happened to just see fewer of those. I guess the -- when it comes to the pandemic effect, in particular, I would say that our block tends to be more oriented toward the Northeast as far as geographic distribution.", "And I think it's pretty clear that from a U.S. death perspective, it was heavier in the Southern region of the United States. And then, yes, you mentioned this, but the average age of our ILI block tends to be older, and those older-age demographics tend to have higher vaccination rates." ] }, { "name": "Tom Gallagher", "speech": [ "Gotcha. OK, thanks. And then for my follow-up, just curious, any updates on economic solvency regime in Japan? Is that still -- I think last I heard, it was like 2025. Is that still the timing? And if so, how do you feel that you're positioned to adopt that?" ] }, { "name": "Rob Axel", "speech": [ "Hey, Tom, it's Rob. I'll take a shot at that. To our knowledge, there's not been any change in the timing of that. The JFSA has been well synchronized with the broader international -- ICS, or the International Capital Standard, that's being rolled out.", "And so it's -- their plan has always been to sort of be slightly behind the implementation of that as their new solvency regime is closely aligned to that. And with respect to our Japan business, I think as both Ken and Scott have pointed out, the underlying economics to our Japan business are incredibly strong. And so we would hope that under both accounting and regulatory constructs that ultimately is visible. Having said that, we would -- we have articulated some concerns, as others in the industry have, with regard to both the international capital standard that's being proposed in terms of some fundamental flaws that continue to persist there.", "And then to the extent that those carry over into Japan's economic solvency regime, that would be a concern that we would have. But we continue to be in an active dialogue both on the international front and in Japan, along with a number of our peers. And we're optimistic that through that continued engagement, we can ensure that the economics of the underlying business get appropriately reflected in the regulatory constructs." ] }, { "name": "Tom Gallagher", "speech": [ "OK. Thanks, Rob." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from Elyse Greenspan from Wells Fargo. Your line is now live." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi, thanks. Good morning. My first question, on the PRT business. You guys had some pretty good activity in the third quarter.", "Can you just talk about the pipeline there for the fourth quarter? I know that tends to be heavy toward the end of the year. And any initial outlook for 2022?" ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Elyse, it's Andy. I'd be happy to take the question. So we think the market in 3Q was in and around 17 billion, and that's very consistent with what communicated on the previous couple of calls, that we felt the back half of the year would be very healthy.", "The average funded status for plans is around 97%, which is the best level in 10 years, and they still have a very strong desire to transact. We think the total market size for the year will be in the neighborhood of 40 billion, and we think that level of momentum will continue in the near term. This is a space that, in many ways, we're a pioneer in and very much a leader in the space. As we've said in the past, we are very committed to it, and we are going to pick our spots.", "We're very confident that the strength of our brand and our capabilities and our track record. We're going to gain more than our fair share over time. But in the near term, we do think the market is going to be healthy." ] }, { "name": "Elyse Greenspan", "speech": [ "OK, thanks. And then my second question, going on to your Group Life book. You guys gave some good color on what you'll be elevated COVID boxes there in the third quarter. As we think about the fourth quarter in 2022, do you expect that you would see losses in line with kind of that same elevated severity that you've been seeing? And then how much of your losses that you've set up so far for COVID or IBNR?" ] }, { "name": "Andy Sullivan", "speech": [ "So Elyse, maybe I'll start and then Ken could follow up. So I kind of went through the dynamics of what's causing the elevated mortality, the three predominant things being the average age, the predominance of our book in certain segments, and the distribution of the claims being in places where the vaccination rates are lower. We would expect those underlying drivers to continue near term into the fourth quarter." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. And Elyse, in terms of IBNR, the -- it's -- we stayed pretty current on claim activity. So the lag is measured in weeks. And we have a pretty established process to measure that.", "And so that continues. In terms of an outlook for 2022, we have not provided an outlook beyond the current quarter. And based upon, as Andy described, just sort of the continuation of current trends, we think that's the most reasonable approach. The situation is very unique and very dynamic, a lot of variables at play, whether it's social distancing or other preventive measures or vaccines and treatments and variants.", "So we've -- in our baseline, we've extrapolated the current trends, and that's what that reflects." ] }, { "name": "Elyse Greenspan", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from John Barnidge from Piper Sandler. Your line is now live." ] }, { "name": "John Barnidge", "speech": [ "Thank you. Just thinking about the group business, given the enduring nature of the pandemic, unfortunately, is there a need to build more administrative expenses to support that effort?" ] }, { "name": "Andy Sullivan", "speech": [ "So, John, it's Andy. I think as we've talked about in the past, we actually have a higher level of both call and claims staff across our product lines. We hired out ahead of what we expected to see. So we were well prepared as it was coming in.", "But we think that level is already reflected in the admin ratio that you see." ] }, { "name": "John Barnidge", "speech": [ "That's great. Thank you. And then maybe my follow-up, just wanted to touch on that comment around LTD incidence increase in frequency and severity. How should we be thinking of this maybe in light of vaccine mandates? There's headlines about Boeing and Raytheon in percentage of workers there.", "I'm just trying to think through that in light of PRU's focus within the group market. Thank you." ] }, { "name": "Andy Sullivan", "speech": [ "So it's Andy, again. I guess I'd say two things. Our expectation for the number of deaths in the quarter takes into account what we think the current approach is in the employer marketplace and the current landscape of mandates. To the degree, our book tends to be more of a national account book of business, and there are more mandates in that segment, I think that would be a help to us and a tailwind." ] }, { "name": "John Barnidge", "speech": [ "Great. Thank you for your answer and best of luck." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is a follow-up from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thanks for taking another question. I just want to touch on your upcoming combination of individual and institutional retirement business. Is this just to simplify your operational model after the pending full-service sale? Or should we expect anything strategic coming out of that either on the expense or revenue side?" ] }, { "name": "Andy Sullivan", "speech": [ "So, Tracy, it's Andy. Let me take your question of -- about the drivers. So first and foremost, this is really a statement about our commitment as a firm to helping solve the retirement needs in America. And we continue to see a real need in the pension derisking area.", "We continue to see the need to lean in and help individuals in the retirement accumulation and de-accumulation journeys. This was really about taking two businesses that had great momentum, that were market leaders in their space, and combining together the market-leading talent market and market-leading capabilities. The benefits we expect to see is it will accelerate our decision-making as we go -- as we continue to go after the retirement need and sharpen our focus on the retirement space. So that was really the driver, and it's an important step in how we're transforming our business mix and system." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question is coming from Jimmy Bhullar from J.P. Morgan." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hey. So just a follow-up question on, Charlie, your comments around dispositions and/or derisking reinsurance-type transactions. I think you mentioned annuities potentially and Individual Life as well. But how do you think about long-term care in that context? And is that a business where you're seeing counterparties emerge? Or is it still like the bid ask as to why to expect a transaction in the near future?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah. I'll start and then maybe Ken can add to that, Jimmy. I think what you observed is exactly correct. So it is something that we would obviously look at if the market was there, but I think the market is extraordinarily thin at this point for bidders on blocks like that.", "I would also observe that we have a very -- a relatively small block of business and a relatively young block of business. And as a result -- and one, frankly, that we feel reasonably good about, in fact, quite good about. So if we are, as we've said, going to be very disciplined about the divestitures we make and with an eye toward creating shareholder value, we need to get -- make sure that the -- if we did transact something that it would be a transaction that was in the economic interest of our shareholders. And given the young block that it is, the bid-ask spread, if you will, can be quite large.", "So we'll continue to evaluate options if they come up. But at this point, we are continuing to run the book, and the book is going quite well. Ken, anything --" ] }, { "name": "Ken Tanji", "speech": [ "No. I think that covers it well, Charlie. Nothing to add from me." ] }, { "name": "Jimmy Bhullar", "speech": [ "And then just on the -- can you talk about the operating environment in your two largest international markets, in Japan and in Brazil? Obviously, different stages in terms of COVID in both markets. But how are those businesses faring? And what your outlook is for sales given the pandemic and economic conditions in Latin America?" ] }, { "name": "Scott Sleyster", "speech": [ "Well, why don't I start, Jimmy, with Japan, which I think I covered a little bit before. But I would say that the combined impact of the states of emergency and then the Olympics really did slow things down, and the effect of that really ran through September 29th with the state of emergency. We've come out of that nicely. And we really feel that our channels have benefited from our use of technology, as have our customers during this period.", "So we really feel like our sales organizations have adapted well to the new environment. And now that we see things out of a state of emergency and returning to a more normal state, you've seen a good sequential quarter. I would also say that recruiting has been somewhat challenged during a COVID environment. We've also learned how to recruit and bring people on board in a more remote environment.", "But I think as we come out of COVID, both the actual sales activity and the ability to recruit will continue to improve, and we see that as a positive sign. In Brazil, our sales have been improving from the combination of having a strong Life Planner model. But more importantly, we've been building our third-party distribution. And most recently, that's now exceeded a third of our sales.", "And just a few years ago, that was closer to 10%. So we've seen positive momentum from the channels that we sell in. COVID hit harder -- quite frankly, a bit harder in Brazil than it did in Japan. And again, we're really happy with the resiliency that our sales force has shown there.", "So overall, we feel good about the trends in both markets. And I think the most recent quarter is indicative of why we maintain that confidence." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Lowrey for any further closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you. And thank you all for joining us today. Our performance this year and the progress we're making on repositioning our business mix and advancing the cost-savings program, along with disciplined capital deployment, reinforces our confidence in our strategy to transform Prudential, and generate substantial growth. We remain optimistic about the opportunity to continue to deliver strong financial outcomes to all our stakeholders.", "Thank you again for joining us today and for your time." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2018-08-01	[ { "description": "Head of Investor Relations", "name": "Darin Arita", "position": "Other" }, { "description": "-- Chairman and Chief Executive Officer", "name": "John Strangfeld", "position": "Executive" }, { "description": "-- Vice Chairman", "name": "Mark Grier", "position": "Other" }, { "description": "-- Chief Financial Officer", "name": "Rob Falzon", "position": "Executive" }, { "description": "-- UBS -- Analyst", "name": "John Nadel", "position": "Analyst" }, { "description": "-- Head of Domestic Businesses", "name": "Steve Pelletier", "position": "Other" }, { "description": "-- Evercore -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "-- Citi -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "-- Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "-- Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and Gentlemen: Thank you for your patience in standing by and welcome to the Prudential second quarter of 2018 earnings call. At this time, all of your participant phone lines are in a listen-only mode and later there'll be an opportunity here for your questions. Just a brief reminder, today's conference is being recorded and I would now like to turn the conference over to Head of Investor Relations, Darin Arita." ] }, { "name": "Darin Arita", "speech": [ "Thank you, Justin. Good morning, everyone, and thank you for joining us. Representing Prudential on today's call are John Strangfeld, Chairman and CEO, Mark Grier, Vice Chairman, Charlie Lowrey, Head of International Businesses, Steve Pelletier, Head of Domestic Businesses, Rob Falzon, Chief Financial Officer, and Rob Axel, Principal Accounting Officer. We will start with prepared comments by John, Mark, and Rob, and then we will take your question.", "Today's presentation may include forward-looking statements. IT is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements please see the section titled forward-looking statements and non-GAAP measures of the materials for today's presentation. These can be found on our website at investor.prudential.com.", "You will notice that we made changes to the format of our slide presentation. We hope this provides you with more color on the strategic direction of our company and the key priorities of our businesses. Also, as a reminder, we will be hosting an investor day in Tokyo on the morning of September 27th. The focus will be on international businesses with an emphasis on Japan. We hope that you will be able to join us. And with that, let's turn to slide two and I will hand it over to John." ] }, { "name": "John Strangfeld", "speech": [ "Thank you, Darin. Good morning everyone and thank you for joining us. We are pleased with the momentum of our business in the first half of the year. We continue to bring financial opportunity to more and more customers around the world in new, exciting, and compelling ways. I will expand on our US financial wellness initiative in a few moments. We generated an attractive operating return on equity and double-digit growth in both adjusted earnings per share and adjusted book value per share. And, with our strong capital position, we returned approximately $760 million to shareholders as well significantly strengthened our long-term care reserves. We expect to continue a robust level of capital return and to utilize the remaining $750 million of our share repurchase authorization by the end of the year.", "Turning to slide three, I will provide some additional financial highlights on the second quarter. We produced an annualized operating return on equity of 13.5%, which was above our near to intermediate term objective of 12% to 13%. Our second quarter adjusted earnings per share of $3.01 grew significantly from the prior year. This increase was driven by growth in the business, tax reform, and assumption updates. Adjusting for notable items, earnings per share grew 16%. Our current quarter net income was also affected primarily by the significant strengthening of our long-term care reserves as I noted earlier. Rob Falzon will discuss this in more detail.", "Our adjusted book value per share of 92.60 is up 14% over the prior year. This increase reflects the earnings we generated as well as the impact of tax reform and accounting changes the start of 2018. Partially offsetting these items were the payment of $3.30 per share of common stock dividends and about 1.4 billion of share repurchases over the past year. With respect to our business segments, here are some highlights from the quarter. PGIM, which is our investment management business, continued to produce positive net flows with 7.3 billion in the quarter.", "Our retirement business had record account values of 433 billion, including net flows of 2.8 billion driven by pension risk transfer and full-service sales. The third quarter has started well with our recently announced pension risk transfer transaction with Raytheon, totaling close to $1 billion. Our individual annuities business produced sales of 2.1 billion, which were 37% higher than the prior year and up 20% sequentially. And, in international, we continue to produce steady in force growth.", "Turning to slide four, I'm extremely excited about our potential to accelerate earnings growth as we continue to unlock value through our unique business model. Not only does our model allow us to manage risk and deploy capital in a way that is attractive to shareholders, our model and business mix also allows us to design and deliver integrative solutions at scale to bring financial security more into reach for a growing base of customers. By combining our competencies across disciplines, we generate outcomes that other companies simply cannot replicate.", "There are three key points I'd like to make regarding our financial wellness initiative in the United States. First, we have built up significant experience since launching this initiative three years ago and have continued to innovate. Second, we believe our integrated holistic solutions, which are available in person or online, provide meaningful differentiation in the market. And third, our value proposition is resonating with employers and individuals and this is resulting in commercial success. We view financial wellness as a way to help people drive behaviors that allow them to effectively manage their day-to-day finances, achieve their most important financial goals, and protect themselves against key risks.", "As a reminder, we launched financial wellness with the introduction of Prudential Pathways. And in this program, our Prudential advisors provide education for employees of our workplace clients. Should these employees want more information and solutions for their needs, they can follow up with our advisors. Customers can also receive education and solutions in digital form since the launch of our digital financial wellness platform. Employers also find significant value in this digital platform, as they can better understand the financial wellness of their overall employee population.", "We have critical ingredients to deliver integrative solutions that address the holistic financial needs of individuals and these include our own financial advisors, workplace access to over 20 million people via our retirement and group insurance businesses, income and protection solutions via our individual annuities and individual life businesses, and investment management solutions via PGIM. All of this is built on our own technology platform. This integration creates value in several ways.", "First, institutional customers only need to work with one party. Second, we can enhance customer experiences and solutions and these experiences are personalized with solutions tailored to each person's needs. We have the flexibility to adapt and refine the experiences and solutions by having all of the capabilities I previously mentioned. And this is further enabled by our digital and data analytics expertise.", "And third, having all the parts of the value chain will allow us to lever sustainable value to our shareholders. Our solutions that I'm describing are resonating. Since launching financial wellness, over 350 employers representing more than 4 million employees have signed up with Prudential Pathways. When people attend the educational seminars, many schedule follow up meetings with our financial advisors. The types of employers that have signed up represent a broad spectrum and include several well-known brands from among the largest and fastest growing companies in the country.", "Also, approximately 200 employers are using our digital financial wellness platform. We're very excited about how our business has come together to make a meaningful difference in the financial health for people. And innovations like Prudential Pathways and our digital financial wellness platform don't happen without an inclusive, empowering culture, that promotes internal partnerships. We've witnessed the power of bringing together different perspectives, experiences, and expertise to gain deeper insights, develop new offerings, and enter new markets.", "Our own pension risk transfer business was born from this type of an entrepreneurial culture and partnering capability and financial wellness is another great example. I continue to believe that Prudential's culture is a competitive advantage and I'm excited to see how our talented people continue to push the company into new areas for growth; areas that are consistent with our mission and our purpose. With that, I'll turn it over to Mark who will provide an update on how our businesses are executing on key priorities." ] }, { "name": "Mark Grier", "speech": [ "Good morning, good afternoon, and good evening. Thank you, John. I'll be going through comments on each of our businesses in a few minutes but let me start off by reminding you that we've often talked about ourselves as a very good story around developing thoughtful strategies, executing well, building good business fundamentals, and realizing attractive financial results. And in fact, we often start our earnings calls by talking about the attractive business fundamentals reflected in sales and flows for example that we're experiencing in our businesses.", "So under that umbrella of the themes; strategy, executive, fundamentals, and results, I'm going to make a few comments on each of our businesses. I won't be going through that whole equation for everything we do everywhere but there are things that are worth highlighting in the context of each of our businesses. Before I get into a business-by-business discussion though, let me mention a few common themes that run across our businesses. And these are themes that are not necessarily so visible. These are things that are in the heart of our execution processes that are making differences to us in our markets and with our clients.", "The first common theme and its part of a lot of what John talked about is the notion of enhancing our value propositions. The practical consequence of that is that we are able to compete on a basis other than just price because of the attraction of the value proposition that we put in front of our clients. Importantly, this is not a theoretical aspiration for us. We're seeing real results in the marketplace reflecting differentiation and reflecting the attraction of a value proposition that goes beyond price competition.", "The second common theme that runs across our businesses relates to what we're doing to impact the front end, our customer-facing activities. And almost everywhere, we're doing things that are changing our client experiences folding into the notion of enhanced value propositions and again, having concrete results with respect to either individual or institutional businesses. And then finally, technology runs across so many of the things that we're doing that it's worth highlighting the idea of digital, mobile, and data in a number of aspects of our businesses.", "John mentioned how important technology is to the financial wellness proposition but technology runs through a lot of the things that we're doing in the context of that front-end impact and also in the context of the enhanced value proposition. So a big deal there, and each of these impacting what we do in the markets every day are things that are driving the attractive business fundamentals that you're seeing. I want to now comment on the individual businesses. I'm gonna start with slide five. This one is titled PGIM -- and again, I'm not gonna go through the whole equation for everything everywhere but I want to make some points that tie things together around our themes.", "With respect to PGIM, our headline for a while has been net flows. Every year we've counted one more year of consecutive positive flows, up now to 15 years of consecutive, positive net flows in our institutional business. Thirteen consecutive years of positive net flows in our retail businesses. But the story isn't just arithmetic. These net flows tie specifically to the key priorities that are mentioned on the right-hand side of this slide. I guess if there's a leading indicator of future flows, it's the first bullet under key priorities, which is investment performance.", "You see metrics there that provide extremely attractive messages and signals about the prospects where future flows in this business. As our performance ages, we'll see three-year records becoming five-year records, and five-year records becoming 10-year records, and you see very attractive performance relative to benchmark. That has been one of the anchors over time driving our flows in the institutional and retail investment businesses. Then you see some strategy bullets and we've talked about these.", "Leveraging scale, realizing the benefits of operating leverage, especially as we've highlighted in public fixed income. But also expanding our global footprint. We are getting mandates from around the world. We are receiving recognition as an asset manager in publications in Europe, for example, and in publications in Asia, for example. So the global footprint story really is working. I think the PGIM brand has been very helpful to us in that regard.", "And then, diversification with respect to products and capabilities. We've talked about strategy initiatives and I've highlighted PGIM over and over as a great story over the past five or six years that relates strategy execution and results and so those flows do tie back to exacting the things that are listed under priorities to grow. I comment finally, on the lower right-hand side of this, our overall fee rate is holding up very well in PGIM. And we've talked about the mix changes that are helping to offset some of the dynamics of product changes within asset management. And those mix changes continue to serve us well.", "Turning to the next slide that's on retirement. The big story here, I think, is probably across the board flows. You see on the bottom institutional investment product flows and full-service net flows in institutional investment products. We did about $1 billion of PRT deals in the second quarter. John mentioned a big deal that's been done since then. And we did about $2.4 billion in two jumbo longevity swaps during the quarter. So we continue to see robust business flows on the institutional side.", "On the full-service side, in the first half of the year, we had $16 billion in sales and deposits and that resulted in the $3 billion net positive full-service flow for the first half of the year. On the point I made earlier about differentiated value proposition, I would highlight the first bullet under key priorities to grow, which is the potential impact on our retirement businesses, especially full service, of the thing that we're doing in financial wellness and how important that can be as part of our value proposition to clients. And as I said, it's not just a theoretical aspiration, it's happening. We see business coming in because of what we can do in the wellness arena.", "Turning to the next slide group insurance. I guess the highlight here is to tie again back to the idea that our value proposition is resonating. We're closing, as John's slide mentioned, marquee business, not just on the basis of price but on the basis of the wellness proposition and other dimensions of service. Under key priorities here, we mentioned financial wellness again, but the third bullet also mentions improved organizational and process efficiencies.", "And we're doing things there that are impacting our customer experience and impacting our value propositions and these things are paying off. The way in which we're approaching customers goes beyond the inclusion of the wellness initiative in our overall package to some specific aspects of how we deal with and how we treat clients. How we service customers, both at the individual level as beneficiaries, for example, but also at the institutional level as group insurance clients.", "Turning to the next slide individual annuities. I want to highlight three things. On the bottom left, you see that sales are growing. And what I would say about sales is that they're growing, they're well diversified, and we're selling at prices that are achieving or exceeding our target returns. So it's a good, solid, attractive sales picture reflecting efforts we've made in the product arena but also reflecting our pricing discipline with respect to meeting profit targets.", "The second thing I want to highlight is on the bottom right and that is the flow of dividends from our annuity business 2PFI. We have promised you as we structured and talked about the potential in this business that we would generate healthy cash flows from our variable annuity business to the parent. And we are realizing that as you see in that slide.", "And then finally, the third bullet under key priorities to grow reflects part of what variable annuities can do to be part of the integrated solutions that John mentioned, that we're delivering across businesses, particularly with respect to secure retirement income in the workplace as it relates to individual annuities. We've launched a product called guaranteed income for tomorrow. The short phrase for that is GIFT. And this is a specific extension of secure retirement income products into the workplace market in a way that we feel is very attractive and is an important complement to what we're doing overall in financial wellness.", "Let me turn now individual life in the next slide. I want to talk about two things here. One is the broad sales picture, which we would describe as very solid. But then this is an area where we're doing things that are impacting value proposition and impact on our client interfaces that are extremely important. We've added a capability that we call PruFast Track, which is an end-to-end solution that combines policies in as quickly as 48 hours. This compares to a traditional issue process that may take several weeks. This process eliminates the need for health examinations.", "This capability is unique in the marketplace coming from Prudential in several dimensions. One is, we're selling our own products and our binding. We offer a broad array of products, including term, variable universal life, fixed universal life, and indexed universal life. We sell face amounts up to $1 million for age ranges between 18 and 60. We anticipate fully rolling this out in our third-party channels by the end of August and we're optimistic that processes like this, which make life easier for people to do business with an insurance company, can have a significant positive impact on sales. The analogy generally is the whole digital world where things are just easier and we're making things easier in our individual life business.", "Let me turn now to international and there are two slides. And I want to highlight common themes and then a couple of specifics on each. There are three drivers of our international story at this point and they're probably familiar. One is the importance of dollar products overall but particularly in Japan. Our ability to sell dollar products because of the quality of our sales forces has allowed us to maintain strong sales results and strong profitability even in an environment in which some of the local currency products. Again, especially referring to yen, have been challenged in terms of both attractiveness in the marketplace as well as profitability.", "Headline number one is the importance of dollar products. And you see graphs of sales mix by currency on both of the pieces of the international picture. Second key bullet; the management of our life planner and life consultant forces. This includes growth, it includes quality, and I just referenced quality in talking about dollar sales, and it also includes productivity, all of which are strong and improving for us and terrific assets in terms of the way we do business.", "And then finally, a new one for us to talk about in international, which is digital, mobile, and data analytics initiatives. And I would describe this as something below the level of total international, thoughtful, market-by-market, tailored to the circumstances in our individual markets. But a package of initiatives that we'll be talking more and more about as we mature both in terms of our front-end initiatives and in our back office and other capabilities.", "So just quickly on life planners. We've been through a couple of experiences, which we've talked about where we've had a blip in sales manager growth followed by better results in terms of life planner growth. We're kind of nearing one of those blips right now. We have appointed a lot of sales managers and we're anticipating that there will be some reflection of that sales manager growth in life planner hiring over the next couple of years. It doesn't happen the next day but there's a strong basic dynamic around the second bullet under priorities, which is growth life planners. And that important dynamic relates to appointing sales managers. And then I mentioned sales mix by currency just to highlight that on the bottom of that slide on the right.", "And then turning to Gibraltar Life. Two comments here, one is the currency results. And again, how important US dollar products are and tying that back to the quality of our sales force and what they can do in the market that many others can't do. But I also want to highlight the multi-channel approach that's reflected in Gibraltar's results. Looking at the sales mix on the left where you see distribution, we have life consultants. We also have independent agents and we also have the bank channel.", "And so we continue to optimize across those channels with respect to both product design and ultimately, volume and price. Good attractive results there. That said, as I said, I've highlighted some pieces under the strategy executive fundamentals and results equation. Good stories everywhere for us and some things that may not have been so visible that we're happy to be able to talk about. And with that, I'll hand it over to Rob." ] }, { "name": "Rob Falzon", "speech": [ "Thanks, Mark. I'm gonna pick it up beginning on slide 12 by highlighting the notable items, which have impacted the current quarter adjusted operating results. We have combined what we previously called market driven and discreet items with trend considerations into a single list of notable items. These items consist of the impact on results from our annual reviews, including assumption updates, and other refinements, the quarterly updated estimate of individual annuities profitability driven by market performance, and the impact attributable to variances from our expectations for selected variable revenues and expenses. We highlight these items because their contribution to current quarter results may not be indicative of future performance.", "This year's actuarial review included economic and insurance assumption updates and other refinements and resulted in a net unfavorable pre-tax adjusted operating income impact of $160 million on our ongoing businesses. We expect no meaningful change to our run rate earnings across our businesses from these updates and refinements. Current quarter returns on non-coupon investments and prepayment fees were about $10 million below our long-term expectations.", "In addition, the current quarter underwriting experience was approximately $85 million better than our average expectations, including favorable pension transfer case experience in retirement. And finally, our group insurance business incurred elevated expenses in the current quarter including the costs to terminate a third-party underwriting service provider contract. These services will be performed internally, which should reduce future underwriting costs. In total, these notable items reduced earnings by $102 million or $0.19 per share. Excluding these notable items, earnings per share would be $3.20 up 16% from the year-ago quarter.", "Turning now to slide 13, I'll spend a few minutes discussing our long-term care business. We entered the long-term care business in the 1990s and actually issued our first individual long-term care product in 1999. In 2012, we discontinued all sales of long-term care products, classified this business as a divested business, and strengthened reserves by $700 million. We currently have approximately 211,000 policies in force with about 2% of these policies currently generating claims. We have been actively managing our long-term care bloc by enhancing our claims manager programs, optimizing our cost structure, and successfully pursuing rate increases.", "Our experience of applying for and receiving approvals for rate increases is consistent with the assumptions in our reserves. Included in our reserves is $1 billion of combined future rate increases and benefit reductions in lieu of rate increases, which have not yet been approved. During the quarter, we strengthened our GAAP reserves by $1.5 million as a result of updating our actuarial assumptions. We removed our morbidity improvement assumption of a 1% reduction in claims cost per year over a 20-year period, which increased our best estimate reserve by $1.4 billion. In addition, there were a number of other changes to our assumptions, the net effect of which was largely offset by the margin in our reserves that existed prior to the update. These changes align our assumptions with experience and industry data.", "Although we removed our morbidity improvement assumption, we retained our mortality improvement assumption. If we also removed this latter assumption, our best estimate reserve would've been reduced by about $850 million. While strengthening our reserves, we continue to maintain a strong capital position and do not anticipate any change through our capital deployment plants, including the level of dividends and stock repurchases.", "For additional detail, we have included the key assumptions and sensitivities to changes in these assumptions in the appendix of this slide deck. We've also included in the appendix additional details about the bloc. Here are a few of the highlights from that data. Our average attained age is 65 years old, which is relatively young and therefore likely to provide more time to collect premiums. About two-thirds of our book is group issue, which tends to have lower benefits than individual policies. And as a result, less than 10% of our total policies have lifetime benefits and less than 30% contained compound inflation features.", "Now, turning to slide 14, I will provide an update on key balance sheet items and financial measures. Our cash and highly liquid assets of the parent company amounted to $4.7 billion at the end of the quarter. The sequential quarter decline of about $400 million was driven primarily by our redemption of high coupon junior subordinated note partially offset by cash inflows, which were in excess of shareholder distributions during the quarter.", "Shareholder distributions included dividends of $382 million and share repurchases of $375 million. The share repurchase authorization for the remainder of the year was $750 million as of June 30th. Our domestic and international regulatory capital ratios are above our AA financial strength targeted levels. And our financial leverage and total leverage ratios remain within our targets as of the end of the second quarter. In addition, we do not expect material impacts to capital for the proposed variable annuities statutory framework changes adopted by the NAIC variable annuities issues working group last week.", "In summary, we are executing on our strategies and generating strong returns in growth in our adjusted earnings per share and adjusted value per share while maintaining a robust capital position. Now, we'll turn it to the operator for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. So, ladies and gentlemen, it is *1 if you'd like to queue up here for any question. First, we'll go to the line of John Nadel of UBS. Your line is open." ] }, { "name": "John Nadel", "speech": [ "Hey, good morning. So this has been a long day and there's a lot going on. I guess the first question I have is when I think about the morbidity improvement in the removal of that assumption from your long-term care reserves, was that something that was an internally motivated decision or was there any external influence on that decision, whether from regulatory bodies or rating agencies or any other constituents?" ] }, { "name": "Rob Falzon", "speech": [ "John, it's Rob. That decision was entirely an internally motivated decision. It was done with the benefit of consulting with industry experts and others in the industry from which we were able to glean insides as to trends that were occurring within the industry. But was not done in reaction to any regulatory stimulus. If I expand on that a little bit, perhaps, and perhaps a little redundant with what I might've stated in my opening remarks. We discontinued the business back in 2012 and we took a $700 million strengthening of our reserves at that point in time.", "As I mentioned, we incorporated our reserve estimates for the morbidity improvement, which means people living healthier, which reduced our required reserves. As well as mortality improvement, which meant that people living longer, which conversely increases our reserves. Given the lack of the statistically significant experience in our book at that point in time, we relied on guidance from consultants, academic research, and industry practice. Since then, neither our experience, which now has sort of more statistical significant associated with it or any of that consultation or survey within the industry has indicated that there's been any morbidity improvement trend.", "At the same time, we're seeing the mortality improvements in this business and in other businesses. Based on that, we elected to remove the morbidity improvement assumption and that gave rise to that $1.4 billion charge while maintaining the mortality improvement assumption. And as I indicated in my remarks, that's about an $850 million addition to reserves, or attribution to reserves as a part of our assumption update process. Recognizing that that's a more conservative approach that others in the industry have taken but it's consistent with our updated view of best estimate." ] }, { "name": "John Nadel", "speech": [ "That's really helpful, I really appreciate that. And then, just following up on that; is that change applied to both the individual and the group long-term care bloc? Did you have that assumption in both places? And if so, can you give us an estimate on how to allocate that piece of it?" ] }, { "name": "Rob Falzon", "speech": [ "So yes, the assumption was pertained to both blocs of business group and individual. And the old assumption and in the update, so it's been removed by both. The impact on either of those blocs in any given assumption actually is gonna be variable so there's not a consistent rule of thumb that you can use. With regard to this particular assumption, roughly what I would say is about 60% of it would've been driven from the individual bloc and about 40% of it from the group bloc." ] }, { "name": "John Nadel", "speech": [ "Okay, and then just one quick follow-up on an actual business question. Within investment management or PGIM, results really stepped up in terms of the pre-tax operating income contribution. Looks like that was -- I mean, revenues were sort of in line. You continue to grow very nicely. It looked like the biggest driver of the jump was the reduction in spending. Is that sustainable? And if so, what is driving that? Is it just sort of the runoff of some of the investment spending you've been making?" ] }, { "name": "Steve Pelletier", "speech": [ "John, this is Steve, I'll address your question. There's going to be some variability in relation to timing of expenses. For example, on a sequential quarter, our first quarter expenses were ordinarily be elevated by how we account for our long-term incentive compensation in the asset management business. And you're not seeing that show up in the same way in the second quarter.", "Also, as you note, looking at a longer-term time trend some of the investments that we've been making in the business are reaching maturity and are yielding very, very significant benefits. But I would say that the main drivers looking at a year timeframe or a multi-year timeframe in the asset management business and the growth and earnings there have been continuing to attract very strong and robust flows; attracting those flows into areas where we already have existing strategies so therefore we're able to onboard the flows in a very effective way and expand our margins and our ability -- our ability that we've spoken about before, which we think is pretty distinctive in the industry to maintain a stable average fee structure across the entire book of business at about 22 basis points. So all of those factors together we see as really being the underpinning of positive earnings flow in positive earnings trends in PGIM." ] }, { "name": "Operator", "speech": [ "Next, we have the line of Tom Gallagher of Evercore. Your line is open." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. Hey, Rob, first just to follow-up to John's question. Removing the morbidity improvement assumption with only 2% of your book now on claim, do you really have enough experience in terms of your own data to see that you're not seeing the emergence of morbidity improvement? Or did you have to rely pretty heavily to that assumption change on the third party consulting advice as well? Or was it a mix? Any help on that would be appreciated." ] }, { "name": "Rob Falzon", "speech": [ "So, Tom, I would say it was a balance between the two. I would say, well when we initially took this we had very little experience. We've now got five, six years worth of experience that statistically you would call significant. As we look at that data, there's noise and it clearly, as you would think given it still is a relatively shorter measurement period and as we indicated the number of claims that we have is small relative to the overall book and to the population of claimants that are across the industry.", "So we complemented that with looking externally and talking with consultants that we know have insights into what's happening across the industry to confirm that what we're seeing isn't any different than what others are experiencing across the industry. And based on what we got from those conversations and looking at our own book, felt that there was no discernable trend toward morbidity change.", "And so, our best estimate there for recognizing that it could go either way. So it's something that you're trying to get, as a midpoint is that there is no morbidity improvement occurring in our book or across the industry that would cause us to think that our book would ultimately behave in a different way than it has been. And if you don't mind, let me just sort of add-on further thoughts on that. I think that this was, as we noted, it was somewhat unusual vis-a-vis peers in the industry we recognize that. And while the charge associated with it at $1.4 billion is in excess of what street expectations might've been as we're beginning to look at this.", "But I would emphasize that we have a very strong capital position and it is largely unaffected by our across the board second quarter assumption updates. We continue to have the flexibility to finance our growth, including investments in our new business initiatives while redeploying capital. Including, as I mentioned in my opening remarks, to our shareholders through dividends and stock repurchases. It's completely consistent with our existing plans. And all of that incidentally includes absorbing fuller the impact of the tax act while maintaining our targeted AA solvency ratios. Currently still at a 400% FICO ratio. And remaining within our targets for liquidity and leverage as well." ] }, { "name": "Tom Gallagher", "speech": [ "Thanks for that. And then, just a question about the trends you're seeing in the long-term care bloc. I know in 2017, there was sort of this spike in incurred claims up around 50%. As that trend continued into 2018, was that also part of the upsizing of the charge here or has that calmed down in terms of the actual trend?" ] }, { "name": "Rob Falzon", "speech": [ "So let me try taking a stab at that this way, Tom. When we did our assumptions, our assumptions now reflect our full historical experience through 2017 and based on that, our actual to expected is running at 100% over that period of time. And as we look at our 2018 experience as it's emerging, it is entirely consistent with those revised set of assumptions. You sort of think about as an average over that period of time and 2018 being reflective of what that average is, recognizing that in any given period, be it quarter or year, you can get noise, as we saw during 2017." ] }, { "name": "Tom Gallagher", "speech": [ "Thanks. And just one other quick one. The statutory charge you took, the 600 million, was that just on claim reserves or did you adjust active life reserves at all?" ] }, { "name": "Rob Falzon", "speech": [ "No, that was the ALR. That was the active life reserve adjustment, Tom. So the $600 million -- there was a small adjustment in GAAP and stat for the disabled life. The driver in both statutory and in GAAP was on our active life reserve. The 600 million was significantly less than the GAAP reserve because we had more margins in our reserves on a statutory basis relative to GAAP. But the same set of assumptions are used in the adjustments that we made in GAAP in stat with the only difference being that stat, as you can see in the total reserves, they're slightly larger as a result of the pads that you have in stack relative to our GAAP results." ] }, { "name": "Operator", "speech": [ "Next, we have the line of Suneet Kamath of Citi. Your line is open." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. Just wanted to go back to the morbidity improvement. You've removed the 1% assumption but could that go the other way? In other words, if claims costs go up by 1% over 20 years would that essentially, based on your sensitivities require and other 1.4 billion of reserves?" ] }, { "name": "Rob Falzon", "speech": [ "Let me try, Suneet, to answer that question this way. We removed the morbidity improvement assumption, as you indicated. We did provide to you sensitivities with regard to claims costs. And so, if you think about the potential variability in our claims cost, we said; a reasonable, stressed kind of sensitivity around that, we put in there at plus or minus 5%. If our assumptions are that morbidity improvement -- not only is there not morbidity improvement but that we experience some level of morbidity deterioration. If there was a 5% deterioration, not a 5% per year for forever, but a 5% holistic deterioration in that, that would be about a $500 million adjustment to our reserves recognizing over the fullness of time with health innovation, et cetera, there might be an upward bias to that.", "But if it were to be downward, that would be the order of the magnitude to that. We've provided similar assumptions across the rest of what we believe to be the primary drivers to the reserves that we hold for this business. I think I would characterize what we've done and the sensitivities being provided there in the following way.", "One, it is comprehensive and so we've looked holistically at all of the assumptions underlying our business and tried to reflect in those assumptions the experience that we've been seeing and what we can glean from what's happening across the industry. Our desire was to put this issue to bed in the eyes of investors and to allow investors to focus on the strong fundamental and growth that we have in our operating businesses." ] }, { "name": "Suneet Kamath", "speech": [ "Okay, got it. And then, just on the same slide 21. If we look at the $1 billion of future rate increases assumed in your reserves, is that the same number for GAAP and stat? And separately, what was the prior assumption? In other words, what did you have built in before you did your second quarter of '18 reserve and review in terms of benefit from future reaction?" ] }, { "name": "Rob Falzon", "speech": [ "The first part of your question, yes, the same assumption being used in both GAAP and statutory reserves as I'd indicated before. The second question, let me try approaching it a little differently to see if I can actually get at what I think you want to understand with respect to that $1 billion. Think about that as being in three traunches. The first is, about 10% of that we've already filed for.", "First, actually, let me also start with, put that in the context of we've actually already received about $0.9 billion worth of rate increases on this bloc over time from the point at which we impaired it back in 2012. So hopefully, that adds some perspective in terms of balancing this $1 billion against almost $1 billion that we've already achieved to date. And the assumption is driving the $1 billion that we have in there are consistent with our experience in the first rounds of price increases that we sought. And incidentally, is subject to very robust underwriting in order to quantify that number, to begin with.", "And so going back to sort of thinking about those in buckets. 10% of what's already been filed. About 30% of that actually represents instances where we've already had filings with the states where we've implemented a price increase but where we have agreed to come back to the state and do it in multiple steps as opposed to do it in a single rate increase.", "We implemented a rate increase but we've agreed to come back and seek approval for a further rate increase in order to make it a more palatable outcome for consumers at the end of the day. And then the remaining 60% would be new filings. And within those new filings, that would represent both some of our legacy -- adverse experience that we've had. As well as the new adverse experience that we updated as a result of this update. And think about that as being roughly evenly split between where we expect to get price increases and where we expect to actually come out in the form of benefit reductions in lieu of price increases." ] }, { "name": "Suneet Kamath", "speech": [ "Lastly, on the same topic. The assumption to get rid of the morbidity improvement. It seems like that's what your third party actuarial consultants are recommending as a best practice. I'm just trying to think through where the range is of these assumptions are across different companies." ] }, { "name": "Rob Falzon", "speech": [ "To be clear: We did not engage any consultants in the evaluation of the process that we went through. We consulted with outside parties but there's no consultants that recommended to use this as the best estimate. Obviously, our accountants who have actuarial expertise have weighed in on this and they have confirmed that they believe that our approach to this is a reasonable approach to take with regard to establishing the best estimate." ] }, { "name": "Operator", "speech": [ "Next, we have the line of Alex Scott of Goldman Sachs. Your line is open." ] }, { "name": "Alex Scott", "speech": [ "So my question is around just the cash flows and Rob, I think you mentioned that you were able to absorb a good amount here and how you maintain the capital of deployment plans. What are the parts of the business that are driving free cash flow? And as we kind of think out to next year and beyond, is there upside as maybe you have some of these things that have been a drag fall away and kind of have continued acceleration in cash in some of the businesses like variable annuities and maybe others?" ] }, { "name": "Rob Falzon", "speech": [ "A couple thoughts on that. First, as I mentioned before, we start from a position of having a very robust capital structure that's able to absorb a lot of the changes that are going through in the industry. So you have the Q2 assumption updates that we've been through. You have the impact of the tax law change. You'll also have certain regulatory changes occurring that are occurring at the NAIC that are net chewing away that the RBC ratios of companies.", "And despite all of that, where we are at the end of the day is pro forma for all of it, including the full year anticipated impacts of the tax act. We're able to maintain above our currently targeted RBC ratio of 400%. So we start out at a very strong position. We also have the benefit of continuing to generate strong cash flow and capital. And so in the course of the second quarter just by way of example, what was a statutory charge for long-term care business was actually the increase in the strengthening of reserves in our long-term care business was about $600 million. In other parts of RBC calculation, we actually generated incremental capital that almost entirely offset that reserve strengthening.", "And so, we see that dynamic. If you look at sort of the fullness of this year and even what we experienced to date this year, what you're gonna find is we have diversified businesses, each of which provides robust cash flow and diversified sources of cash flow. In a current year, while we're strengthening PICA's reserves in order to respond to the impact from the tax law changes, we are getting from our international business, significant free cash flow we are getting from our PGIM business, a very high free cash ratio relative to the strong earnings that we're generating from that.", "And as we've highlighted in the deck through the bar charts that we provided, our annuities business at the current levels of sales is throwing off a significantly high level of free cash flow. We're able to continue to generate free cash flow through the portfolio of businesses that we have and absorb the variety of reserve strengthening initiatives that we in the industry are facing during the course of this year." ] }, { "name": "Alex Scott", "speech": [ "That's really helpful, thank you. Maybe just a follow-up on the 12% to 13% ROE. How should I think about that near to intermediate term ROE just in light of maybe the move up in interest rates and sort of the environment? Are we at a point where maybe you revert back to the 13% to 14% that you guys have targeted historically? Or sort of where do we need to get in terms of rates to achieve that?" ] }, { "name": "Rob Falzon", "speech": [ "I think about it this way. I think first, as you see in our results and observe in the market, interest rates have been rising and that's been beneficial to us and to others in the industry. If you look at what I'll call our adjusted portfolio yields, so adjusting it for taking out the impact of alternatives and for where we've invested in treasuries as we've waited to take the premiums and reinvest them into corporates.", "In the first quarter, our portfolio yield was about 4.3%. If you look at our new money rates in the first quarter, it was about 4.25%. So we're at the time now where we're investing is crossing over to our portfolio rate, whereas in the past you would've seen a very large gap between those two numbers. And so I think the interest rate environment is rapidly ceasing to be a drag. And we'll be pivoting over toward being actually a positive to earnings growth on a go-forward basis.", "Now, it took a compounding of several years for us to drag us down from 13 to 14 to our intermediate range of 12 to 13. And we'll need to see some compounded period of being in that better interest rate environment before you'd expect on a sustainable basis our ROE to be in a 13% to 14% range. I would note, that if you look at our ROE this quarter adjusted for the notable items that we've called out, it's 13.5%. So while we've provided guidance of 12% to 13%, the reality is in this current environment with the robust performance we're getting out of our businesses, we're actually exceeding that range that we've provided." ] }, { "name": "Operator", "speech": [ "And next, we have the line of Ryan Krueger of KBW. Your line is open." ] }, { "name": "Ryan Krueger", "speech": [ "Hi, good morning. On the annuity ROA, it's been 121 basis points the last two quarters. How much more near-term downside do you expect from the additional hedging actions? Or are we mostly complete with that at this point?" ] }, { "name": "Steve Pelletier", "speech": [ "Ryan, this is Steve, maybe I'll jump in and Rob can add on. If you look at the annuities ROA on a year-over-year basis, there was a decline. I'd attribute that to three factors consistent with what we saw before. First, lower non-coupon earnings driving lower spread results. Second, the aging of the book of business and fee compression that gradually results from that.", "And finally, amortization of hedging costs as you mentioned. The first of those three factors varies from quarter to quarter. The second and the third I would say, they're obviously real impacts but they emerge very, very gradually over time over an extended time period. So if you're talking about near-term ROAs, I would say there's sustainability of our ROAs for the near-term at our current level." ] }, { "name": "Rob Falzon", "speech": [ "The only thing I'd add to that, and Ryan, this may be obvious by virtue of how you asked the question but just to make sure that it's very clear. Our expected hedging costs are entirely in ALI today. And so, that's built into our ALI. We include the cost of hedging in that.", "Secondly, that when we have variances against that expected hedging, so what we call hedge breakage, that works its way into our benefit ratios and therefore also is amortized into our ALI. So full cost of hedging is reflected in ALI over time. That hedge experience has been generally on the positive side but calls it around neutral and what you're seeing as a result of that is still a robust level of ROA as Steve just walked through." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks. And then, the corporate segment I know is volatile but been pretty favorable for a couple of quarters. Has anything changed there or should we expect it to revert back to a higher loss over time?" ] }, { "name": "Rob Falzon", "speech": [ "Our guidance for that, Ryan, has been that -- think about it as being as an average of $350 million a quarter subject to seasonality. So obviously, we get the fourth quarter seasonality that we've walked through a number of times in the past. If you look at the actual average of the last four quarters, it's been slightly below that. So it averages out around $340 million. And in the first and second quarters are driving that because they've been below our run rate expectations. Each of those quarters benefited by somewhere in the range of $15 million to $20 million of lower than expected compensation costs, both long-term and deferred that are associated with market experience, including incidentally, our own stock price performance.", "The remainder of the variance came from lower net expenses across a whole variety of activities. So, while that experience can be sustained, we don't believe that that experience would change our view going forward of what the run rate and seasonality would be. So we've benefited from it but not to the point where we would take a different view toward what we stated in the past with regard to sort of the going forward run rate of the business of the segment." ] }, { "name": "Operator", "speech": [ "Our last question comes from the line of Erik Bass of Autonomous Research. Your line is open." ] }, { "name": "Erik Bass", "speech": [ "Hi, thank you. I guess following up on Alex's question. If we look at the dividends paid from PALAC year to date it's been about 70% to 75% of AOI. Is this a reasonable way to think about the sustainable cash generation of the annuities business? And how sensitive is this to the level of sales volumes?" ] }, { "name": "Rob Falzon", "speech": [ "So I would say that the annuities business is a positive contributor to our overall targeted free cash flow. So think about our free cash flow, as we've articulated as being around 65% of earnings. And at current levels of sales, we would expect the annuities business to actually be reasonably materially in excess of that. And we believe that that's a sustainable level.", "We don't believe that it's particularly volatile on a go forward basis either. The changes that would occur there would be, as Steve has expressed before, things that would be reflected over a fairly long period of time. We're very well capitalized within that business and so changes in market conditions and/or other drivers to the reserves would not alter the level of distributions from free cash flow that we anticipate and are currently getting from the business." ] }, { "name": "Erik Bass", "speech": [ "Thank you. And then, yesterday Fidelity got a fair amount of press coverage for eliminating fees on certain of its index products. Do you see this having implications for pricing in the asset management or defined contribution retirement businesses more broadly?" ] }, { "name": "Steve Pelletier", "speech": [ "Eric, it's Steve, I'll address your question. For some time, we've been very acutely aware of the fact that the most rapid fee compression in the asset management business has really been taking place over multiple years within the passive space. You saw the press coverage yesterday referring to yesterday's move as the race to zero and this being the logical conclusion of it. It's a race that we're not participating in.", "Several years ago, we made the strategic decision that we were not going to compete in the passive space. But even back then, it was a space well spoken for by a handful of competitors. And instead, we would focus on the long-standing value proposition of our investment management business, which is alpha generation. Alpha that our clients can use alongside the index exposure that they can draw from passive managers on a cost-effective basis. But really focusing on our ability to generate alpha through active management.", "And the result of that decision over multiple years has been that passive assets represent less than 2% of total AUM and well under 1% of total fees. Our fees are based on our generation of alpha, based on the foundation of strong investment performance, and strong distribution capabilities generating attractive flows at stable fee levels. That 22 basis points I mentioned, which has been stable for us now over an extended period of time and we expect it to remain so." ] }, { "name": "Operator", "speech": [ "At this point, I will be happy to turn it back to John Strangfeld for any closing remarks." ] }, { "name": "John Strangfeld", "speech": [ "Thank you very much. I'd just like to bring this back and close it with just a few final thoughts. The bottom line of this whole discussion is our businesses are performing very well. They're supported by a strong balance sheet. We're very confident in our ability to both innovate and execute and our talented employees who embody our purpose-driven culture are ultimately at the core of who we are and what we do and collectively, we deliver sustainable value for our customers, our community, and our stakeholders. And I'd like to thank you very much for your time and attention today and have a good day." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen still connected, that does conclude the presentation for this morning. Again, we thank you very much for your participation and using our executive teleconference service. You may now disconnect." ] }, { "name": "Erik Bass", "speech": [ "More PRU analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
PRU	2022-05-04	[ { "description": "Vice President, Investor Relations", "name": "Bob McLaughlin", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Executive Vice President and Head of U.S. Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Head of International Business", "name": "Scott Sleyster", "position": "Other" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; and Rob Falzon, vice president, chairman; Andy Sullivan, head of U.S. businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared remarks by Charlie, Rob and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements.", "Please see the slides titled forward-looking statements and non-GAAP measures in the appendix of today's presentation. And the quarterly financial supplement, both of which can be found on our website at investor.prudential.com. Now I'll turn the call over to Bob McLaughlin. Please go ahead." ] }, { "name": "Bob McLaughlin", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of U.S. businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slides titled forward-looking statements and non-GAAP measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.", "Now I'll turn it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Bob, and thanks to everyone for joining us this morning. We delivered solid operating earnings for the first quarter, including strong variable investment income that more than offset the impact of elevated mortality from COVID-19. We have also recently achieved multiple significant milestones in our transformation process to become a higher growth, less market-sensitive and more nimble company. These milestones included continued execution on our plans to reposition our businesses.", "We completed two key divestitures and announced another programmatic acquisition. We continue to invest in our businesses to further enhance the customer experience and expand solutions to support sustainable long-term growth. And we also further advanced the progress on our $750 million cost savings program. We are pleased with the pace of these initiatives, which are well supported by our rock-solid balance sheet and help us expand access to investing insurance and retirement security for our customers and clients around the world.", "I'll provide an update on each of these areas before turning it over to Rob and Ken. Moving to Slide 3. At the beginning of April, we successfully completed the divestiture of our full service retirement business and the sale of a significant portion of our legacy variable annuities block. Together, these dispositions reduced the overall market sensitivity of our businesses by approximately 20%, while enabling us to further sharpen our focus on higher growth opportunities, including programmatic M&A and asset management and emerging markets.", "To that end, we agreed during the quarter to acquire a minority stake in Alexander Forbes, a leading provider of financial advice, retirement, investment and wealth management in South Africa. This deal provides access to essential financial tools and further expands our footprint in a strategically important market. We also continue to focus on enhancing customer experiences and creating solutions to drive sustainable growth across our businesses and to address the evolving needs of our customers. For example, FlexGuard continued to build momentum, and we are excited about its future and our broader suite of complementary annuity products, including FlexGuard Income.", "In Individual Life, we continue to expand our reach to a broader range of customers and further address the $12 trillion life insurance coverage gap with the introduction of a final expense product. And we are also making similar growth investments to further enhance customer experience and expand solutions across our international businesses. In Japan, we are focusing on evolving our product suite to meet the increasing retirement and inheritance needs of the aging Japan population. In Brazil, we are diversifying our customer offerings with the introduction of a new stand-alone accident and health product.", "And in China, we introduced Grow Partners, a digital sales platform that we are extending to distribution partners and directly to consumers, beginning with a medical cash benefit plan. Turning to Slide 4. We continue to make steady progress toward achieving our cost savings target of $750 million at the end of 2023, while improving customer experience. During the first quarter, we realized $170 million in cost savings for a total of $680 million of run rate savings to date since 2019.", "Turning now to Slide 5. Prudential's rock solid balance sheet provides significant financial flexibility to execute on our transformation strategy while returning substantial capital to shareholders. Our robust financial position includes: a high-quality, well-diversified investment portfolio; a capital position that supports a AA financial strength rating; and $3.6 billion in highly liquid assets at the end of the first quarter, as well as over $4 billion of additional proceeds from divestitures that we have already received in the second quarter. In addition to supporting our strategy for sustainable, profitable growth, we remain committed to returning $11 billion of capital to shareholders between 2021 and the end of 2023.", "As part of this program, we have increased our dividend by 4% in the first quarter of 2022, our 14th consecutive annual dividend increase. Before turning it over to Rob, I'd like to update you on a few of our recent ESG initiatives, which we consider integral to our purpose of solving the financial challenges of our changing world. First, relating to the war in Ukraine. In addition to providing financial assistance to humanitarian and nonprofit organizations supporting people impacted by the war, we divested our modest level of Russian financial assets in our investment portfolio.", "Closer to home, we've adopted a hybrid working model that combines the benefits of in-person collaboration and remote work flexibility to support our employees and help us attract and retain talent. Our hybrid work model will enable us to reduce our total home/office properties in the U.S. by approximately 50% over time as we invest in the redesign of 600,000 square feet of office space that will be optimized for collaborative and hybrid work, most of which was completed during the past two years. In addition to helping us achieve our cost savings targets, our real estate and hybrid work strategies are one of the several factors that will contribute to a 2050 net zero emissions target.", "Alongside these efforts, we are also finding new opportunities to support our home city in Newark, New Jersey, including new investments in local commerce, live workspaces for resident small business owners and additional opportunities to foster local home ownership. We look forward to continuing to support the city's revitalization. With that, I'll turn it over to Rob for more specific details on our business performance." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results and business performance for our PGIM, U.S. and International businesses. I'll begin on Slide 6 with our financial results for the first quarter of 2022.", "Our pre-tax adjusted operating income was $1.6 billion or $3.17 per share on an after-tax basis and reflected a benefit from variable investment income, which exceeded the net mortality impact from COVID-19. PGIM, our global investment manager had higher asset management fees than the year ago quarter. However, these were more than offset by lower other related revenues as well as investments made to support business growth. Results of our U.S.", "businesses increased 12% from the year ago quarter and reflected higher net investment spread, including benefits from variable investment income and rising interest rates, more favorable underwriting, primarily due to declining COVID-19-related mortality experience and lower expenses, primarily driven by our cost savings initiatives, partially offset by lower fee income resulting from the runoff of our legacy variable annuities. Earnings in our International Businesses decreased by 8%, reflecting lower net investment results, less favorable underwriting results and lower earnings from joint venture investments, partially offset by continued business growth. Turning to Slide 7. PGIM, our top 10 global investment manager has diversified capabilities in both public and private asset classes across fixed income, alternatives, real estate and equities.", "PGIM's long-term investment performance remains attractive with more than 84% of assets under management outperforming their benchmarks over the last 3-, 5- and 10-year periods. PGIM experienced third-party net outflows of $4.3 billion in the quarter as institutional net inflows, driven by fixed income and real estate, were more than offset by retail outflows, driven by mutual fund investors rebalancing out of fixed income due to rising rates and inflation expectations. As the investment engine of Prudential, the success and growth of PGIM and of our U.S. and international insurance and retirement businesses, are mutually enhancing.", "PGIM's asset origination capabilities, investment management expertise and access to institutional and other sources of private capital or a competitive advantage, helping our businesses bring enhanced solutions, innovation and more value to our customers. And our insurance and retirement businesses, in turn, provide a source of growth for PGIM through affiliated flows and unique access to insurance liabilities that complement its successful third-party track record of growth. PGIM's asset management fees increased by 2% compared to the year ago quarter, reflecting positive third-party flows and a continued shift toward higher fee-yielding strategies, including the benefits from recent acquisitions over the past year, partially offset by the impact of rising rates. As rates rise in the near term, investor demand for some fixed income strategies could continue to moderate.", "However, over the longer term, a stabilized higher rate environment would be a positive for fixed income demand and PGIM's business. We continue to grow our alternatives in private credit business, which has assets under management of approximately $240 billion, across private credit, real estate equity and debt and private equity secondaries, and benefits from our global scale and market-leading capabilities. Notably, across PGIM's private platform, we deployed nearly $10 billion of capital, up 20% from the year ago quarter, reflecting the continued strong environment for both real estate and private credit. Now turning to Slide 8.", "Our U.S. businesses produced diversified earnings from fees, net investment spread and underwriting income and benefit from our complementary mix of longevity and mortality businesses. We continue to shift our business mix toward higher growth and less market-sensitive products and businesses to transform our capabilities and cost structure and to further expand our addressable markets. Our product pivots have worked well, as demonstrated by strong sales of recently launched simplified solutions.", "Our FlexGuard and FlexGuard income products represented $1.4 billion or over 90% of total individual annuity sales in the first quarter. We continue to exercise pricing discipline informed by changing market conditions and our sales benefit from having a strong and trusted brand and a highly effective distribution team. Our Individual Life sales also reflect our earlier product pivot strategy with variable life products representing approximately 70% of sales for the quarter. We also successfully completed the national rollout of our Individual Life Express term plus product with a large national distributor and recently launched a final expense product continuing to expand our middle market presence.", "And we are focused on enhancing customer experience through digital tools, including automated underwriting, resulting in more than 90% utilization for eligible policies in the first quarter of 2022. Our retirement business has market-leading capabilities, which drove funded pension risk transfer sales of $700 million in the quarter. And our group insurance business reflected sales growth of 5% compared to the prior year quarter driven by an increase in supplemental health sales. Turning to Slide 9.", "Our International Businesses include our Japanese life insurance companies, where we have a differentiated multichannel distribution model as well as other businesses aimed at expanding in high-growth emerging markets. In Japan, we are focused on providing high-quality service and expanding our geographic coverage and product offerings. Our needs-based approach and mortality protection focus continue to provide important value to our customers as we expand our product offerings to meet their evolving needs. We continue to enhance customer experience and agent support, including through digital tools.", "The value we provide customers was recently recognized by the 2022 J.D. Power life insurance customer satisfaction survey. Prudential of Japan was ranked #1 in all three categories: contract; servicing; and claims. In emerging markets, we are focused on creating a carefully selected portfolio of businesses in regions where customer needs are growing, where there are compelling opportunities to build market-leading businesses and partnerships and where the Prudential enterprise can add value.", "In the first quarter, we continued to focus on expanding product and business capabilities in emerging markets to meet the evolving needs of our customers. We launched a new accident and health product in the large and growing Brazil market, and continue to expand our wellness platform across Latin America. In addition, as Charlie discussed earlier, we are pleased to expand our presence in Africa with the announcement to acquire a minority interest in Alexander Forbes through our existing partnership with LeapFrog investments. As we look ahead, we're well positioned across our businesses to be a global leader in expanding access to investing, insurance and retirement security.", "We plan to continue to invest in growth businesses and markets, deliver industry-leading customer experiences and create the next generation of financial solutions to better serve the diverse needs of a broad range of customers. And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 10, which provides insight into earnings for the second quarter of 2022 relative to our first-quarter results. Pretax adjusted operating income in the first quarter was $1.6 billion, and resulted in earnings per share of $3.17 on an after-tax basis. To get a sense of how our second quarter results might develop, we suggest adjustments for the following items: first, variable investment income outperformed expectations in the first quarter by $275 million; next, we adjust underwriting experience by a net $165 million.", "This adjustment includes a placeholder for COVID-19 claims experienced in the second quarter of $40 million for our U.S. businesses based on 25,000 COVID-19-related fatalities in the U.S. and a placeholder of $25 million for our International Businesses. While we have provided this placeholder for COVID-19-related claims experience, the actual impact will depend on a variety of factors such as infection and fatality rates, geographic and demographic mix and the effectiveness of vaccines; and last, we expect other items to be $95 million lower in the second quarter, primarily as a result of completing the sales of both our full service retirement business and a block of legacy variable annuities.", "These items combined get us to a baseline of $2.75 per share for the second quarter. I'll note that if you exclude items specific to the second quarter, earnings per share would be $2.91. A modest decline from recent quarters, primarily from the completed sales of businesses. And the proceeds from these sales will provide flexibility for future capital deployment.", "I would also note a few other items: first, due to the rise in interest rates, we no longer anticipate a reduction in net investment income from portfolio reinvestment. The benefit from a rising rate environment on our investment income compounds over time as we reinvest our portfolio. However, the reductions in assets under management and related income and our fee-based businesses occurs more immediately. In addition, as a result of our derisking actions, the sensitivity of our adjusted operating income to markets will be reduced by approximately 20% on an annual basis.", "We also expect to report a gain on the sale of the legacy variable annuity block and adjusted operating income in the second quarter. Impacts from the annual review of actuarial and economic assumptions will also be reported in the second quarter. In accordance with our established practice, we have a comprehensive process that will include, among other things, the review of long-term interest rates, inflation, COVID mortality experience and updated industry data that may impact our assumptions. And finally, as a result of new foreign tax credit regulations, we are expecting an effective tax rate in the range of 21% to 23% for 2022.", "While we have provided these items to consider, please note there may be other factors that affect earnings per share in the second quarter. Turning to Slide 11. We continue to maintain a robust capital position and adequate sources of funding. Our capital position continues to support a AA financial strength rating, and we have substantial sources of funding.", "Our cash and liquid assets were $3.6 billion and within our $3 billion to $5 billion liquidity target range. And other sources of funds include free cash flow from our businesses, proceeds from divested businesses and contingent capital facilities. Turning to Slide 12 and in summary. We are executing on our plans to reposition our businesses.", "We are on track to achieve our targeted cost savings and our rock solid balance sheet provides financial flexibility to execute on our transformation and thoughtfully deploy capital. Now I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question today is coming from Erik Bass from Autonomous Research." ] }, { "name": "Erik Bass", "speech": [ "Can you provide some more color on the net flow drivers for PGIM in the quarter? And with interest rates continuing to move higher, can you talk about how this is affecting fixed income demand from both retail and institutional clients?" ] }, { "name": "Andy Sullivan", "speech": [ "Sure. Erik, it's Andy. As we've discussed in the past, PGIM flows are going to vary from quarter to quarter, and we're very focused and stay focused on our long-term track record. We're very proud of the fact that 18 of the last 19 years, we've had positive third-party flows.", "In the first quarter, we did experience $4.3 billion in net outflows. It was a challenging quarter for the fixed income U.S. mutual fund industry in general, and we were similarly affected. We saw $4.6 billion of retail outflows, almost entirely driven by retail investor repositioning out of fixed income.", "On the Institutional side, we saw a positive $300 million driven by flows into public fixed income and real estate. We continue to think this is a good proof of our diversification. And on the Institutional side, we see algorithms actually positioning into fixed income given the rising rate environment. As we step back, our long-term track record remains very strong.", "We saw $55 billion in flows between 2017 and 2021, with $27 billion of that being on the retail side. That being said, we do think it's fair to expect continued pressure on the retail fixed income industry as the rates and spreads continue to rise, but that's a near-term effect. As Rob said upfront, higher rates are good after the transitory period for the fixed income business. We're very confident in the fact that we have the right products, the right strategies, exceptional long-term investment performance and great distribution and will be a net winner over time.", "One thing I wanted to add today, when we talk about flows is more around the private business that Rob talked about given that those are higher fee rate businesses. We continue to benefit from a very strong market for real estate and private credit. We were able to put $9.6 billion to work in the first quarter across real estate at PGIM private capital raise another $1.8 billion. So we are confident in PGIM and confident in a long-term track record." ] }, { "name": "Erik Bass", "speech": [ "I appreciate all the color there. And then I was hoping that you could talk about the implications of the weaker yen for your Japan business in terms of earnings, capital and the demand for foreign currency-denominated products. And I realize that you're hedged for 2022, but can you just remind us what percentage of your earnings are in yen?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Erik, it's Ken. I'll start off on sort of the financial implications. And you're right, we do have a pretty established and, we think, a very effective hedging program.", "But first, it's important to know that of our -- because of the success of us in the Japan market with U.S. dollar products, a substantial portion of our reserves and our assets backing those reserves are U.S. dollar-denominated. And that in combination with the fact that as a Japanese company, our expenses are almost exclusively denominated in yen.", "The combination of that results in our income from our Japan business being mostly -- nearly all of our U.S. -- our income in Japan is U.S. dollar denominated. What income we have denominated in yen, we hedged over three years.", "And we have a net equity capital hedge position as well. So it's a long-established hedging approach, and we think it performs well, both from an accounting and economic standpoint." ] }, { "name": "Erik Bass", "speech": [ "Got it. And for the product demand with just -- you sell a lot of foreign currency denominated products [Inaudible]." ] }, { "name": "Ken Tanji", "speech": [ "I'll hand that over to Scott." ] }, { "name": "Scott Sleyster", "speech": [ "Erik, this is Scott. Yes, in the -- it's a little bit of a mixed bag or a dislocation if you, if you will. But for the most part, the higher U.S. interest rates, which I think are related to the currency is good for demand, as Rob said, and I think it's good for Prudential overall.", "But as investors in Japan are looking for more attractive yielding products, that's good. In the short run, though, and when the currency moves, it does make the price tag of the purchase a little more expensive. And we have found in the bank channel where there's an intermediary in there. You may see slightly higher surrenders because of the run-up in the dollar.", "But net-net, we think it's generally a positive for us." ] }, { "name": "Operator", "speech": [ "[Operator instructions] Our next question is coming from Tom Gallagher from Evercore." ] }, { "name": "Tom Gallagher", "speech": [ "Ken, a question on the holdco cash and just overall capital generation in the quarter. If I look at the -- it looks like you issued $1 billion of junior debt in the quarter, so that would be an inflow, and you got $300 million of cash from the dispositions, and I guess, $4 billion-plus is still closed after the quarter, but that's $1.3 billion. And then I look at your holdco cash balance, it didn't change versus 4Q. So just curious how I should think about that.", "It doesn't -- looking at it that way, it doesn't look like there were much in the way of dividends that came up during the quarter. Were there capital needs that came up in the subs? Or is it a timing issue? Can you help us think through like the capital generation in the quarter and what that should look like going forward?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Thanks, Tom. Yes. We did issue $1 billion of hybrid debt is actually early in the quarter and before the rise in rates and before the spreads widened out.", "So we're happy with that execution. And that's part of our process to prefund upcoming debt that we would like to either -- that's either maturing or we're going to call. And we do have about $1 billion of hybrid debt that's going to be callable in September. So we sort of earmarked that $1 billion for that purpose.", "Liquid assets at the holding company will fluctuate due to timing. Typically, that's within our $3 billion to $5 billion target. But in the first quarter, as is in typical with most first quarters for us, subsidiary dividends and cash flow were low, and then they tend to be greater in the second part of the year. And so part of that is just timing.", "But we also did make a capital contribution to a new reinsurance subsidiary that we have -- that we've established in Bermuda in the first quarter. And that will give us the ability to reinsure policies from PICA, our U.S. insurance company, to that new subsidiary, to give us more economic reserving and greater capital efficiency over time. So over time, it was -- it did require some capital to initially fund -- but over time, we feel good about that in terms of giving us much more balance sheet efficiency going forward? And then also, just keep in mind, we did receive $4 billion from the sale of full service and PALAC in April." ] }, { "name": "Tom Gallagher", "speech": [ "Gocha. And just a follow-up there, Ken. Can you comment on the size of the new reinsurance vehicle that's, I guess, ranged on the captive that you referenced?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. We initially capitalized it with $800 million. So that was the amount of initial capital that we put in. And although it's a requirement now, it's actually going to provide capital efficiency in the future.", "So you can think about that as a net positive to our capital efficiency over time." ] }, { "name": "Operator", "speech": [ "Our next question today is coming from Suneet Kamath from Jefferies." ] }, { "name": "Suneet Kamath", "speech": [ "Great. First question just on strategy. I guess, Charlie, we've been talking about this objective of improving the earnings contribution from growth businesses to, I guess, over 30%. And we're a year into the strategy and haven't really seen that move all that much, at least based on the way we're calculating it.", "So my question is, is the plan to still sort of get there over the next couple of years? And is it going to take something more than programmatic M&A in order to accomplish that?" ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. So we can't control the markets, but this is -- we look at it as both a numerator and a denominator issue. And we're continuing to make progress on both -- through both the acquisitions we've made, the four acquisitions we've made over the past year and the dispositions that we just completed. And so you've seen that we've made progress with the four acquisitions and the two major dispositions.", "And we'll continue to execute on the strategy. We have a sense of urgency. We're going to make progress as we go forward, and we'll make progress in both ways." ] }, { "name": "Suneet Kamath", "speech": [ "And can you give us a sense on the timing of the use of the $4 billion of proceeds? Obviously, we could think about a couple of different buckets, right, M&A and/or capital return to shareholders. But now that these deals have closed, sort of over what time frame would you like to use that capital?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yes. Sure. So as I hope you've seen, we are operating with a sense of urgency, right? Speed is important, but we don't have a specific time ban per se. So we're going to remain prudent stewards of capital, as we've said, and continue to evaluate programmatic acquisitions.", "But as we've also said and as we've done in the past, we'll return capital to shareholders if we can't find the appropriate opportunities over time. So we're going to continue on our process. But as you've seen, we have returned capital to shareholders, and we'll continue to operate in that fashion." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. If I could just sneak one more in for Ken or Rob. When we think about the individual annuity business, I think in the past, specifically thinking about the highest daily value product, I think the commentary you guys gave in the past is a rising interest rate environment, coupled with a falling equity market environment is generally not great for that business, which is the environment, obviously, we're sitting in today. So can you just talk about from a risk management perspective, how that business is holding up in this environment?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Suneet, this is Ken. We've very well capitalized and reserved our business, and we have a highly effective hedging program. And that has been very effective of mitigating market impacts, both from equity markets and interest rates.", "And so -- and it continues -- it was continued to be very effective in the quarter. So no change there." ] }, { "name": "Operator", "speech": [ "Your next question today is coming from John Barnidge from Piper Sandler." ] }, { "name": "John Barnidge", "speech": [ "Expense ratios in both group disability and group life insurance decline. I know that some of the source of the expense saves programs, but you're also building the service COVID claims. Can you maybe dimension some of the improvement in admin expenses there between those two?" ] }, { "name": "Andy Sullivan", "speech": [ "Sure, John. It's Andy. So our admin expense ratio for the quarter was 15.6%. That was almost a 4% improvement from Q4, but was basically flat from Q1 of last year.", "I would just keep in mind, fourth quarter was elevated by some one-time compensation expenses, so there's some seasonality effects going on. We are starting to see the beginnings of our core expense improvement of impacting our businesses. When I think about that, I would say the expense saves are more attributable to the overall expense work. The incidents and severity in the business remain elevated, even though they have started to come back toward normal, they remain elevated, and we maintain the higher level of staffing in both our claim and our call centers.", "So we would expect that the admin ratio will stay elevated for the remainder of the year." ] }, { "name": "John Barnidge", "speech": [ "Great. And then my follow-up question. Can you talk about maybe how higher rates have changed the conversation around pension risk transfer activity with potential counterparties?" ] }, { "name": "Andy Sullivan", "speech": [ "So, John, it's Andy. So we -- maybe let me talk about the current quarter and then I'll go into looking forward. So as you're aware, this is a very transaction-oriented business. And first quarter tends to be light, and that's kind of what we saw with the industry.", "We think the first quarter was somewhere around $5.3 billion. We were very pleased, as Rob said, that we did two deals for $700 million. Overall, as we look forward for the rest of the year, we believe it's going to be a strong year, and I think the overall industry level should clock in around $40 billion. The fact is, funded status hit a record high in February of 102%.", "And if you add on top of that, the rise in rates and then the volatile environment that we're in, all of that bolsters sponsors' desire and proclivity to transact. So this is a big market that it has become more competitive, but we know that we could pick our spots and be disciplined and net-net, will grow over time." ] }, { "name": "Operator", "speech": [ "[Operator instructions] Our next question is coming from Tracy Benguigui from Barclays." ] }, { "name": "Tracy Benguigui", "speech": [ "I'm wondering if your intolerance of interest rate sensitive business changed at all considering the 10-year is nearly 3% may go up from here? Like are you thinking at all about increasing the portion of spread-based business going forward?" ] }, { "name": "Rob Falzon", "speech": [ "Tracy, it's Rob. Let me take a stab at that. First, to your point, yes, rising interest rates are a good thing. They're a good thing for the industry and they're a good thing for us as a company, both because it allows us to be more competitive in providing a value proposition to our customers and our products and also because it has a positive impact on our portfolio yield.", "Having said that, it is our desire to have a mix of businesses and products that are less market-sensitive and less market-sensitive across market cycles. So our focus is on trying to operate at the intersection of both shareholder and customer value propositions that are sustainable throughout cycles. If you're asking about how we think about the impact of higher interest rates on the long-term reversion rate that we have in our assumptions, obviously, that drives pricing and valuation. We do our assumption updates in the second quarter, probably not something -- anything specific we can say about that.", "But maybe I'll turn it over to Ken and he can comment more generally." ] }, { "name": "Ken Tanji", "speech": [ "Yes. Thanks, Rob. Yes. The long-term interest rates and our assumptions are something that we do look at in our assumption updates annually.", "We do that by looking at multiple perspectives sort of from an array of economists and banks and asset managers. We also look at the forward curve, which as you know, has increased recently. And we set our assumption kind of close to the median of that. And also with our assumption update, inflation has risen.", "We factor near-term inflation into our reserve setting as well as for long-term inflation as well. And then part of our assumption update will obviously cover mortality and other policyholder behavior as well, including not just our own experience, but anything we get in terms of new data from other sources in the industry. We did recently receive a new industry study that indicates experience is more adverse in some of our assumptions of our U.S. life insurance business.", "We're evaluating this information and its applicability to our business. And to the extent that it would cause an increase in reserves or a decline in earnings. So that -- all that work is underway. It will conclude later in the quarter, and that will be part of what we report in the second quarter." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Great. I'm also wondering as unfavorable FX impacts change your view right now on increasing international business through M&A." ] }, { "name": "Scott Sleyster", "speech": [ "Tracy, this is Scott. I'll go ahead and take that one. I guess in the short answer, I'd say, not really. We're seeking to build out a well-diversified emerging markets portfolio of businesses.", "And we see local currency weakness as an opportunity to improve our U.S. dollar purchase economics, if you will. But that being said, we do factor in the potential for currency risk over time by using risk-adjusted discount rates in our valuation estimates when we think about these businesses. So I would say if you take a step back, we'd actually say, it's a net positive." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Sorry, if I could just sneak one quick one, that mention of that reinsurance entity established in Bermuda for the type of business. I'm just wondering, is that reinsurance flow or the back book? Is that being reinsured?" ] }, { "name": "Ken Tanji", "speech": [ "Initially, we're going to use it for reinsuring some of our in-force business, but we are gaining experience in Bermuda and our ability to use it -- we will be considering strategies, potentially, for flow in the future." ] }, { "name": "Operator", "speech": [ "Your next question is coming from Alex Scott from Goldman Sachs." ] }, { "name": "Alex Scott", "speech": [ "I had a follow-up just on Suneet's question and the answer there. And when you mentioned that the business mix shift, part of it's the denominator, I guess -- I think part of that is also being communicated is the runoff of the annuities business over time or at least the sort of more legacy piece of the annuities business. And now that, that transaction is closed, I was just wondering if you could give us a more firm way to think about how we should expect the earnings power to run off or whether some of the new product growth can offset that?" ] }, { "name": "Ken Tanji", "speech": [ "Alex, it's Ken. Yes, our traditional -- we've -- we're no longer issuing traditional variable annuities. So it is running off. And after our -- the sale of about 20% of our block of business with PALAC, it will continue to run off at about $3 billion a quarter is what you saw in the quarter.", "So you can kind of think about that as kind of $12 billion to $15 billion a year, and that's about an 8% runoff a year. So that, combined with the PALAC business that was 20%, that over time will get us very close to our objective to reducing our income from traditional variable annuities. And having said that, we would think about other ways to do that as well." ] }, { "name": "Alex Scott", "speech": [ "Got it. And then I had one more follow-up to the response on the impact of interest rates, particularly your comments on the actuarial review. The inflation impact that you mentioned, I assume that's probably long-term care and the reimbursement style policies. Could you help us think through the sensitivity to that? I mean, you've provided a lot of sensitivity around long-term care.", "And so we have all of that around changes in discount rates and new money yields and so forth. But the inflation one, I've struggled to put my finger on. So even if it's just relative to rates, which is the bigger factor, any kind of commentary you can provide to help us think through that would be useful." ] }, { "name": "Ken Tanji", "speech": [ "Yes, Alex. Yes. Long-term care is probably where that's most relevant in terms of inflation. We have factored in inflation, obviously, into our reserves including increases in near term, it's -- long-term inflation would be where it's more sensitive.", "We have provided some of those sensitivities. So -- and overall, we think it's very manageable for us." ] }, { "name": "Operator", "speech": [ "Your next question today is coming from Elyse Greenspan from Wells Fargo." ] }, { "name": "Elyse Greenspan", "speech": [ "My first question is on Assurance IQ. You guys took a goodwill impairment there in the fourth quarter. And I believe at the time, you mentioned that part of the rationale for that was the lower valuation of the public peers. I noticed you didn't take another charge this quarter, and the peers have rerated subsequently lower from a few months ago.", "Was that to contemplate it when you took the charge in the fourth quarter? Or any update you can give us there?" ] }, { "name": "Tom Gallagher", "speech": [ "Yes. The charge that we took in the fourth quarter was relevant to the environment at the end of the fourth quarter. We again did a qualitative review of our -- the value of our insurance goodwill in Assurance, and we did not need any further impairment. So that's where that stands." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. And then my second question, the group disability loss ratio was pretty strong in the quarter. Can we just get some more color there and just how you expect that to trend over the balance of the year?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Elyse, it's Andy. We very much obviously like the improvement that we saw in the disability business this quarter. It was our best benefit ratio since 2018 at 73.4%.", "I would frame this as what we've seen in disability, it continues to behave as we would expect and what we have been preparing for. And you always need to split this into the two different impacts. The one impact on the absence and STD side. On that side, we do continue to see a very high level of COVID-related claims.", "That, in general, turns into the need for the elevated staffing and claim and call. And because those are fee-oriented businesses, it shows up in our more from an elevated admin ratio perspective. We're going to stay the course on that staffing because being there for our customers is critically important and job one. On the long-term disability side, as I mentioned earlier, we are beginning to see both incidents and severity trend back downward in the business.", "You'll recall the previous two quarters, both of those were up about 10% in Q3 and Q4. But on top of that, our claims teams are also experiencing very good claims resolutions. And what we're hearing from our claims managers is the combination of very low unemployment at 3.8% and wage inflation accelerating, there's a strong desire for claimants to get back to the productive workforce. So in all, we're very pleased with the claims team's performance, and we're obviously happy to see the beginnings of an improvement in the environment." ] }, { "name": "Operator", "speech": [ "We reach end of our question-and-answer session. I'd like to turn the floor back over to Charlie for any further closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "All right. Thank you very much, and thank you all for joining us today. We continue to make significant progress on repositioning our business mix and advancing our cost savings program to transform Prudential into a higher growth, less market-sensitive and more nimble company. We're confident this strategy will help us deliver an even more meaningful difference in the lives of our customers and sustain value for our shareholders, while enabling us to fulfill our vision of becoming a global leader in expanding access to investing, insurance and retirement security.", "Thanks again for your time today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2023-02-08	[ { "description": "Vice President, Investor Relations", "name": "Bob McLaughlin", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Head of US Business", "name": "Caroline Feeney", "position": "Other" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Alex Scott", "position": "Analyst" }, { "description": "Executive Vice President and Head of International Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Andrew Kligerman", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Mike Ward", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to Prudential's quarterly earnings conference call. [Operator instructions] Later, we'll conduct the question-and-answer session. Instructions will be given at that time. [Operator instructions] As a reminder, today's call is being recorded.", "I will now turn the call over to Mr. Bob McLaughlin. Please go ahead." ] }, { "name": "Bob McLaughlin", "speech": [ "Good morning and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of international businesses and PGIM; our global investment manager; Caroline Feeney, head of U.S. businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from those predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slides titled Forward-Looking Statements and Non-GAAP Measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.", "And now, I'll turn it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Bob, and thanks to everyone for joining us today. As we look back on 2022, I am proud of the progress we've made executing against our strategic priorities. During the year, we continued to transform our business to be less market-sensitive and better positioned to deliver sustainable long-term growth. We exceeded our $750 million cost-savings target one year ahead of schedule, and our rock-solid balance sheet provided the financial strength to navigate the evolving macroeconomic environment.", "I'll provide an update on each of these areas, beginning with our business transformation. Turning to Slide 3. During 2022, we reduced the overall market sensitivity of our business by completing the sales of the full service retirement business and the PALAC block, as well as the run-off of traditional variable annuities. We simultaneously continued to invest in the long-term sustainable growth of our business through programmatic acquisitions and partnerships in emerging markets.", "In Africa, we acquired a minority interest in Alexforbes, a leading provider of financial advice, retirement, investment, and wealth management in South Africa. We also continued to grow our third-party distribution network in Latin America, particularly in Brazil, where third-party distribution now accounts for about 50% of sales and complements our strong life planner channel. Additionally, we advanced our vision to be a global leader in expanding access to investing, insurance, and retirement security. For example, we completed the second-largest pension risk transfer transaction in U.S.", "market history with IBM and closed several major longevity risk transactions, including the $8 billion transaction we completed in the fourth quarter with the Barclays Bank UK Retirement Fund. These transactions underscore our leadership in these markets, as well as the strength of our interconnected business model. Our IBM PRT transaction provided PGIM with more than $8 billion in additional assets under management and is a good example of how we leverage synergies across our businesses. We see a strong pipeline of opportunities in these markets in the year ahead.", "We continue to expand our product offerings to meet the increasing customer needs for financial solutions. For example, building on the success of our FlexGuard annuity products, we introduced during the fourth quarter FlexGuard Life, an index variable universal life product. In PGIM, we expanded our private loan capabilities through PGIM Private Capital, including our direct lending capabilities. This broad proprietary origination platform provides our insurance businesses and our institutional clients with unique investment opportunities and is another example of our self-reinforcing business model.", "We also invested in enhanced customer experiences that blend human touch with advanced technology. In Brazil, for example, we expanded our digital sales application to expedite same-day policy delivery and processing with greater automation. In addition, as the administrator for the IBM PRT transaction, we introduced new technology capabilities to expedite the onboarding experience for 100,000 IBM pensioners. And as part of our continued efforts to refine customer experience, we implemented a companywide initiative to better understand the evolving needs of all our customers around the globe and, in turn, deliver the most effective products and solutions to meet their needs.", "Moving to Slide 4. We achieved $820 million of annual run rate cost savings, exceeding our target of 750 million, one year ahead of schedule. We reached this milestone by streamlining and automating the way in which we operate while improving the customer and employee experience. We leveraged new systems and technologies to enhance our digital underwriting, claims, and fund processing capabilities, improving efficiency while reducing customer wait times.", "For example, for many of our individual life customers, we reduced the underwriting time from 22 days to 22 seconds. Our group insurance claims processing is now three times faster. And fund verification to process new annuity sales now takes two to three days, down from two to three weeks. We also implemented a hybrid work model for our employees that reduced our U.S.", "real estate footprint by 50%, equating to approximately $50 million in annual run rate savings. And finally, we adopted a continuous improvement mindset that helps us proactively identify and execute on cost-saving opportunities that enhance customer and employee experiences and continue to improve our competitiveness going forward. Turning now to Slide 5, our rock-solid balance sheet and disciplined approach to capital deployment have helped Prudential navigate financial and macroeconomic challenges for nearly 150 years. And 2022 was no exception.", "Our financial strength, including our AA ratings, is supported by $4.5 billion in highly liquid assets at the end of the fourth quarter, as well as a high-quality, well-diversified investment portfolio. We continue to balance investments in the growth of our businesses with returning capital to our shareholders. During the fourth quarter, we returned more than $800 million to shareholders through dividends and share repurchases for a total of over $7.5 billion since the beginning of 2021. For 2023, our board has authorized up to $1 billion in share repurchases, as well as a 4% dividend increase beginning in the first quarter.", "This represents our 15th consecutive annual dividend increase. Looking ahead, our strategic progress, financial strength, and self-reinforcing business system, coupled with the higher interest rate environment, position us well to be a leader in expanding access to investing, insurance, and retirement for our customers across the globe. Now, before turning it over to Rob, I'd like to extend a special thank you to all our employees for their dedication to our customers and our communities. Together, we have made significant progress on our transformation and are fulfilling our purpose of making lives better by solving the financial challenges of our changing world.", "And now, over to Rob to talk about the fourth quarter financial results and to provide an update on our business performance." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results and business performance for our PGIM, U.S., and international businesses. I'll begin on Slide 6. Pretax adjusted operating income was 4.7 billion, or $9.46 per share, for 2022; and 1.2 billion, or $2.42 per share, in the fourth quarter.", "These results reflect lower variable investment and fee income, partially offset by improved mortality as COVID has transitioned to an endemic phase, an increase in spread income due to rising interest rates, and underlying business growth. In addition, full year results include the strengthening of reserves from our annual assumption update and the gain on the sale of the PALAC legacy variable annuity block. Our GAAP net loss for the quarter was $1.53 per share and included net realized investment losses and related charges and adjustments of $800 million, largely reflecting the impacts of rising interest rates. This loss also included a $700 million goodwill impairment due to the reduction in the estimated fair value of Assurance.", "While Assurance is making good progress in many areas and had a profitable fourth quarter, the impairment reflects lower growth expectations; a higher discount rate applied to future cash flows, reflecting macroeconomic conditions; and lower publicly traded peer valuations. Turning to the operating results from our businesses compared to the year-ago quarter. PGIM, our global investment manager, reported lower fees, primarily due to lower assets under management resulting from higher rates and equity market declines. Results of our U.S.", "businesses primarily reflected less favorable variable investment income, partially offset by the impact of higher rates on spread income and more favorable underwriting. The decrease in earnings in our international businesses primarily reflected lower spread income, largely due to less favorable variable investment income and less favorable underwriting, including elevated surrenders in Japan due to the depreciation of the yen. Turning to Slide 7. PGIM, our global investment manager, has diversified capabilities in both public and private asset classes across fixed income, equities, and alternatives, including real estate and private credit.", "PGIM's investment performance remains attractive, with more than 79% of assets under management outperforming their benchmarks over the last three-, five-, and 10-year periods. For 2022, PGIM experienced positive institutional net flows that were more than offset by retail outflows, primarily in fixed income, consistent with industry trends due to the rising rate environment. In the fourth quarter, PGIM experienced third-party net outflows of $11.7 billion, driven by public fixed-income strategies across institutional and retail clients. Institutional net outflows were driven by a few large client redemptions, while retail net outflows reflected the impact of the rising interest rate environment on retail flows across the industry.", "As the investment engine of Prudential, the success and growth of PGIM and of our U.S. and international insurance and retirement businesses are mutually reinforcing. PGIM's asset origination capabilities, investment management expertise, and access to institutional and other sources of private capital are a competitive advantage, helping our businesses bring enhanced solutions and create more value for our customers. Our insurance and retirement businesses, in turn, provide a source of growth for PGIM through affiliated flows that totaled $13 billion during 2022, as well as unique access to insurance liabilities.", "In addition, we continue to grow our alternatives business, which has assets in excess of $230 billion across private credit and real estate equity and debt and benefits from our global scale and market-leading positions. Notably, PGIM's private businesses deployed nearly $43 billion of gross capital in 2022. Turning to Slide 8. Our U.S.", "businesses produced diversified earnings from fees, net investment spread, and underwriting income and benefit from our complementary mix of longevity and mortality businesses. We continue to shift toward higher growth and less market-sensitive products and markets, enhance our customer experience while reducing costs by amplifying the use of e-capabilities and self-service tools, and further expand our addressable markets. Retirement strategies achieved robust sales in fourth quarter and full year 2022 across its institutional and individual lines of business. Our institutional retirement business has market-leading capabilities, with full year sales of almost $32 billion, driving record account values at the end of the year.", "This includes being selected for a 50% participation in a $16 billion pension risk transfer transaction and our fourth-largest international reinsurance transaction of $8 billion in the fourth quarter. In individual retirement, product pivots have resulted in continued strong sales of more simplified solutions like FlexGuard and FlexGuard Income, representing over $12 billion of sales since inception, as well as increased fixed annuity sales. Our individual life sales were consistent through the year and reflect our earlier product pivot strategy, with variable life products representing approximately 70% of sales for the year. And our group insurance benefits ratio has improved during the year from lower COVID mortality.", "Turning to Slide 9. Our international businesses include our Japanese life insurance companies, where we have a differentiated multichannel distribution model, as well as other businesses aimed at expanding our presence in high-growth emerging markets. In Japan, we are focused on providing high-quality service and expanding our geographic coverage and product offerings. Our needs-based approach and protection product focus continue to provide important value to our customers as we expand our product offerings to meet their evolving needs.", "In emerging markets, we are focused on creating a carefully selected portfolio of businesses in regions where customer needs are growing, where there are compelling opportunities to build market-leading businesses, and where the financial enterprise can add value. Our international businesses experienced their highest sales since the third quarter of 2020, including record sales in Brazil. Compared to the prior-year quarter, Gibraltar sales were up 20%, mainly driven by the life consultant channel, primarily from higher U.S. dollar sales.", "Life planner sales were also up 17%, driven by continued momentum in Brazil's third-party distribution channel, as well as higher sales in Japan. As we look ahead, we're well-positioned across our businesses to be a global leader in expanding access to investing, insurance, and retirement security. We continue to focus on investing in growth businesses and markets, delivering industry-leading customer experiences, and creating the next generation of financial solutions to better serve the diverse needs of a broad range of customers. And with that, I'll now hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 10, which provides insight into earnings for the first quarter of 2023 relative to our fourth quarter results. As noted, pre-tax adjusted operating income in the fourth quarter was $1.2 billion and resulted in earnings per share of $2.42 on an after-tax basis. To get a sense of how our first quarter results might develop, we suggest adjustments for the following items.", "First, variable investment income was below expectations in the fourth quarter by 125 million. Next, we adjust underwriting experience by a net 60 million as we normalize for fourth quarter experience and expect seasonality in the first quarter. And last, we expect other items to increase adjusted operating income by 91 million, primarily due to seasonally elevated expenses in the fourth quarter. If these items combine, get us to a baseline of $3.01 per share for the first quarter.", "I'll note that if you exclude items specific to the first quarter, earnings per share would be $3.07. The key takeaway is that our underlying earnings power has improved due to business growth and the benefit of higher interest rates. While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the first quarter. As we as we look forward, we have included other considerations for 2023 in the appendix.", "Turning to Slide 11. I'll now provide an update on the adoption of the new accounting standard for long-duration insurance contracts, which went into effect on January 1st. The new standard applies to our GAAP financial statements and will have no direct effect on our statutory financial statements, cash flows, or dividend capacity. We estimate that as of September 30, 2022, GAAP equity will increase by approximately 15 billion comprised of two components.", "Accumulated other comprehensive income, or AOCI, will increase by approximately 17 billion, primarily due to the remeasurement of long-duration liabilities, with higher discount rates in our Japan business. Retained earnings will be reduced by approximately 2 billion, reflecting the reclassification of nonperformance risk gains from retained earnings AOCI and other changes in reserves. Also of note, GAAP equity will continue to exclude certain unrealized insurance margins from products subject to LDTI. As of September 30, 2022, the estimated after-tax unrealized insurance margins related to those products are approximately 50 billion, primarily in our Japan business.", "These margins are an important factor in determining financial strength and assessing profitability. And finally, we do not expect significant impacts from LDTI on our total underlying earnings power as impacts across our businesses will largely offset. Turning to Slide 12. Our capital position continues to support our AA financial strength rating.", "Our cash and liquid assets were 4.5 billion, at the high end of our liquidity target range. We have substantial off-balance sheet resources, including contingent capital and liquidity facilities. We remain thoughtful in our capital deployment, balancing the preservation of financial strength, investment in our businesses, and shareholder distributions. Turning to Slide 13, and in summary, we are transforming our businesses for sustainable growth.", "We exceeded our targeted cost savings one year ahead of plan, and we'll maintain our disciplined and continuous improvement mindset going forward. We continue to navigate the current macroenvironment with the financial strength of our rock-solid balance sheet. Now, I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We'll now be conducting a question-and-answer session. [Operator instructions] Our first question today is coming from Erik Bass from Autonomous Research. Your line is now live." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. Just hoping you could talk a bit more about how you're viewing excess capital. If we look at the pieces you provide, the PICA RBC ratio is below the 400% level where it's run historically.", "I think the SMR ratio looks in line, and holdco liquidity is within your target range but at the low end if we adjust for the planned debt call that you talked about on the last call. So, I guess this suggests a little excess capital, but are there other pieces or sources that we should be considering?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Erik, it's Ken. Overall, we do feel good about our overall capital picture in multiple parts, as you suggest. But I thought it might be helpful to give a little bit of an overall context for our capital management.", "You know, we've had a very well-established and consistent approach, and we observed this very well, particularly last year as we look to shift our business to be less market-sensitive and grow while also maintaining financial strength and flexibility. We closed the sales of our full service business and the PALAC variable annuity block last year. That released capital at attractive terms. And we also deployed capital to the second-largest PRT transaction with IBM.", "We also, as we mentioned and discussed on our last call, absorbed the capital impact of the assumption update in our life insurance business and the noneconomic impact of higher rates on stat capital. Again, that was expected. It's manageable. And we've appropriately addressed those capital implications.", "When you put that all together, we ended 2022 in a solid capital position. Our RBC ratios were above our AA objectives, and our target there is to be above 375. Our Japan solvency margin ratios are above their AA objectives. We have an HLA balance of 4.5 billion at the holdco.", "And as you mentioned, that's at the high end of our target range. And we have a healthy outlook for our businesses with sustained profitability and free cash flow. So, that led our board to authorize $1 billion of share repurchases for next year -- this year, actually 2023, and that's reflective of our capital position as we end 2022. That also considers the free cash flow outlook for our businesses and our opportunities to deploy capital and also the macroenvironment, whether that's the potential for another recession or other stress events.", "So, again, when we put that all together, we feel good that we're consistent with our AA objectives. We have a level of flexibility. And that's what our board considered when they issued -- when they authorized $1 billion in share repurchases for this year and increased our dividend 4%, which, again, is the 15th straight year of dividend increases. So, hopefully, I gave you a much broader answer there, but I hope that's helpful context." ] }, { "name": "Erik Bass", "speech": [ "Yes, thank you. And then my second question is, just hoping you could provide a bit more color on the company's sensitivity to short-term interest rates, which it seems like that a big uplift, particularly in the individual retirement business. Hoping to get a little bit of the sensitivity there. And then just wondering if it were to reverse and the Fed were to cut interest rates, would then you'd see kind of the earnings pattern for individual retirement move back lower?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Erik, I'll start and then turn it over to Caroline to give a broader business context. But just from a sheer, you know, sensitivity to short-term rates, yes, we are benefiting from short-term rates. And generally, overall, our variable annuity business is sensitive to rates, both long term and short term.", "So, a rise in both is actually helping us. In terms of short-term rates, we did see a pickup in earnings because we're earning a higher return from collateral that's posted on our hedging positions, and that's driven by the uptick in short-term rates. But there's more dynamics going on broadly for the business. So, maybe, Caroline, I'll turn it over to you for that." ] }, { "name": "Caroline Feeney", "speech": [ "Yeah. Of course, Ken. So, Erik, first, I should point out that the individual annuities market had a record year last year with over 300 billion of sales. And our own individual retirement strategies business delivered strong sales and earnings.", "And our sales success continues to be driven by our FlexGuard suite of index variable annuities, where we now have over 12 billion in sales, clearly reinforcing our leadership position as a top 5 player in this market. We also saw, Erik, some strong growth in our fixed indexed and fixed annuity solutions, with fourth quarter results twice that of what we saw in the third quarter. Actually, in fact, more than 25% of our sales for the quarter came from these products. So, ultimately, we're pleased with the progress we've made in the space, and we like the diversification these products bring to our overall business mix and the role they can play as a strong complement to our fixed -- to our FlexGuard suite of solutions." ] }, { "name": "Operator", "speech": [ "Thank you. Next question today is coming from Tom Gallagher from Evercore ISI. Your line is now live." ] }, { "name": "Tom Gallagher", "speech": [ "Morning. Ken, should we think about that reduction being a planned use of the 4.5 billion of holdco cash in 2023? I think you have a callable instrument in the middle part of the year of 1.5 billion. Should we assume you're planning on calling that or you still expect -- which -- should we expect that to remain outstanding?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. You know, generally, our -- and again, I think I mentioned this on the last call, our overall level of debt has been pretty consistent over the last few years, and we do have the ability to call about 1.5 billion of debt this year in June. But that -- that's up to us. We're not obligated to do so.", "It is our practice to prefund upcoming maturities and calls, and we factored that into our debt issuance plans last year. Having said that, we're going to continue to evaluate the market conditions and our liquidity position and factor that into the decision to -- and the timing to call the debt or not. And we're also going to look at our overall funding needs going forward. And again, our discipline is to prefund upcoming plans.", "So, it's really an ongoing cycle as the best way you should think of it." ] }, { "name": "Tom Gallagher", "speech": [ "OK, thanks. And then can you -- just for my follow-up, can you talk about how big of a GUL charge you took at -- for the -- at PICA for year-end and any other, we'll call it, adjustments that we should consider that occurred on a statutory basis at year-end between -- I assume there might have been AAT reserve releases or -- and any other ins and outs that you can provide on the statutory impacts. Thanks." ] }, { "name": "Ken Tanji", "speech": [ "Sure, Tom. We -- as we described when we updated our assumptions for GAAP, we would be making those same assumption updates for stat, and that for statutory purposes occurs in the fourth quarter. So, that was -- you know, our GAAP impact was about 1.4 billion. It is larger on a stat basis that tends to be more conservative.", "And that's what would occured in the fourth quarter. That was generally what led to the -- our RBC ratio in the fourth quarter going from above 400% to below it, but still, again, above our AA objective of 375. And we didn't make a capital contribution into PICA to achieve that, again, as we expected. So, just a reminder of the moving parts there." ] }, { "name": "Operator", "speech": [ "Thank you. Next question today is coming from Suneet Kamath from Jefferies. Your line is now live." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks. I guess for Ken, just curious, have you used Lotus Re yet, and if and when you use it, should we expect sort of the freed resources to be somewhere in that neighborhood of 800 million capital contribution that you originally made?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Thanks for bringing that up. We do have a company in Bermuda called Lotus Re, which is a reinsurer. And it does give us the capability to reinsure business to that entity.", "And we did so in 2022. As you mentioned, we initially capitalized it, and then we reinsured a block of variable light business to that business -- or to that entity in 2022. And that was a source of capital release. And all that was factored into our PICA outcomes for the year, which, again, we continued to be above 375." ] }, { "name": "Suneet Kamath", "speech": [ "And can you size that capital release?" ] }, { "name": "Ken Tanji", "speech": [ "I don't think we want to put a precise number on it. It's an internal reinsurance transaction, but it does improve our flexibility." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. And then I guess my follow-up for Charlie, I guess overnight, we saw some headlines that came out about, I don't know if they were quoting you or referring to some comment that you made about Prudential's M&A strategy and perhaps a change post, I'm assuming, the goodwill write-downs for Assurance IQ. So, just wanted to give you a chance to comment on that and kind of how you're thinking about M&A, especially as you think about that strategy of around improving the earnings contribution from growth businesses that you talked about, I guess, two years ago?" ] }, { "name": "Charlie Lowrey", "speech": [ "Sure, Suneet. Thanks for the question and our ability to clarify. Yeah, we saw the headlines, too, and we're slightly surprised. The -- our strategy remains consistent with exactly what we have been doing.", "So, what we've said is that we won't be investing in early stage companies with less proven track records. What we're focusing on is developing the portfolio of programmatic acquisitions, concentrating on the more established businesses where we can expand the capabilities and scale of our existing businesses. And this approach supports what you said, which is our strategy of growing PGIM in emerging markets and really focusing on asset management and high-growth international markets that will help increase our fee earnings and growth profile. And if you look at our recent -- most recent four transactions, which include ICEA LION, Montana Capital Partners, Custom Harvest asset management, and most recently, Alexforbes, these are all examples of this approach of acquiring more established companies and are consistent with what we have done and what we will do going forward." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Alex Scott from Goldman Sachs. Your line is now live." ] }, { "name": "Alex Scott", "speech": [ "Hi. First one I had is on just sort of sources of cash flow as we think about 2023. You know, you've talked about 1 billion of share repurchases, potentially some debt reduction. Could you talk about how that would be funded, you know, between PGIM cash flows, PICA, and the U.S.", "businesses versus Japan? And specifically, I'm interested, in particular, in PICA, if you plan to take dividends out this year." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Alex, it's Ken. You know, our businesses are generating free cash flow to maintain our shareholder distributions but -- and also to support the growth of the business. And we do have diverse sources of cash flow to the parent company.", "That's provided by our business mix across our U.S. insurance and retirement, PGIM, and Japan businesses. And they're all expected to contribute. You know, over time, I think the way to think about our free cash flow ratio is it's been about 65% given our -- of our after-tax AOI given our mix of business and growth.", "And we think that's about right. And we would expect, again, to receive capital from all of our businesses, including the PICA legal entity." ] }, { "name": "Alex Scott", "speech": [ "Got it. Second question I had is on Japan. You know, sales have picked up recently and looked pretty good. I guess the premium growth is still, you know, a bit weaker on year-over-year comps and so forth.", "I was just interested in, you know, what you expect from that. What kind of top-line growth can we expect from that business?" ] }, { "name": "Andy Sullivan", "speech": [ "So, Alex, it's Andy. I'll take your question. Yeah, you sort of mentioned some of the effects as we look back from the COVID pandemic that obviously resulted in some headwinds from a sales perspective. But thankfully, as we said here, those pandemic challenges have subsided quite a bit.", "You know, we're exceptionally proud of our Japanese businesses. We've steadily increased our market share over time, and we've consistently ranked in the top 3 for new business based on amounts every year of the last decade. That's generated significant earnings and cash flows for Prudential. Our strategy to grow the business is threefold.", "First, we're very focused on continuing to strengthen and expand both our captive and our third-party distribution. Second, we're going to continue to innovate and expand on the solutions that we deliver to our customers. And finally, and importantly, we remain laser-focused on delivering an outstanding customer experience, with a particular emphasis on our digital capabilities. You know, we're very, very proud and good at that.", "In fact, we're consistently ranked by J.D. Power in the top 3 and often No. 1 in policy issuance, policy service, and claims. You know, the market remains highly attractive to us, and we intend to grow our position, you know, in the low single digits over time." ] }, { "name": "Alex Scott", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question is coming from Ryan Krueger from KBW. Your line is now live." ] }, { "name": "Ryan Krueger", "speech": [ "Hey, good morning. I had a follow-up on Japan. Have you seen any change in policyholder behavior in terms -- that may have been driven by the weaker and volatile yen that we've seen over the last year regarding the FX products? Thanks." ] }, { "name": "Andy Sullivan", "speech": [ "Yeah. Ryan, it's Andy again. I'll take the question. So, given the rise in the U.S.", "dollar and the weakening of the yen, we have seen an elevated level of surrenders in the business. The effect there is really some customers are looking to monetize their gains out of their non-yen products in yen terms. You know, that being said, we saw this effect begin to decelerate in the month of December. And that deceleration has continued here in the month of January as the yen appreciated.", "So, we would expect, as the yen starts to stabilize, this effect will stabilize in the business." ] }, { "name": "Ryan Krueger", "speech": [ "Got it. Thanks. And then on the SUL charge, is there a chance that some of that could reverse from the AAT subtests from higher interest rates when you do the look back in '23?" ] }, { "name": "Ken Tanji", "speech": [ "Ryan, it's Ken. I think you're referring to our asset adequacy testing. We're not expecting any significant change in our AAT reserves in light of the higher-rate environment." ] }, { "name": "Ryan Krueger", "speech": [ "OK. Got it. Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our next question is coming from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. A follow-up on your statutory reserve charge for your assumption update. Last quarter, Ken, you mentioned it would be absorbed within PICA's excess capital position. Has that changed in the quarter where the ultimate size ended up being higher than your expectations? And also, on like GAAP reserve charges.", "I understand that funding for a statutory reserve charge does not have to come in all at once in 4Q. So, can you share if you booked a portion of it before 4Q?" ] }, { "name": "Ken Tanji", "speech": [ "Hey, Tracy. No, in terms of the assumption update, that is recorded in -- that was recorded in the fourth quarter, again, consistent with established practice for statutory reporting, and nothing new there to report, came in as expected, and we did not need to fund PICA with capital from the holdco as -- also as expected. So, nothing really new there." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. And your latest buyback authorization level suggests you're not meeting your objective over three years of 11 billion of capital returns. So, I'm just -- if you could walk us through what has changed since you set that objective. Was it just the reserve charge or is it something else like PBR? I guess my broader question is from this experience, are you rethinking the idea of coming up with a multiyear plan versus a singular-year plan?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah, Tracy. It's Ken. Just looking back here and as a reminder, we set that three-year objective in 2021 and the target was initially $10 billion over the three-year period. Later in 2021, we increased that objective as cash flow for 2021 was very strong.", "And as I -- you know, as I kind of highlighted earlier in the call, in 2022, last year, we managed through a number of significant items, which was our assumption update in our life insurance business, the jump in rates, and the noneconomic impact on stat accounting. And then we had the major PRT transactions. And again, when we put that all together, we think we end up at the end of 2022 in a very competitive position from a capital standpoint and a healthy outlook for our businesses, with sustained cash flow going forward. So, yeah, that's what got factored into the decision, along with the outlook of the economy with the recession uncertainty.", "So, the $1 billion will put us a little shy of the 11 billion, but it'll only take about another quarter to achieve that." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Jimmy Bhullar from J.P. Morgan. Your line is now live." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hey, thanks. First, just could you talk about your sales pipeline in PGIM in both the retail and the institutional side and how that's looking?" ] }, { "name": "Andy Sullivan", "speech": [ "Sure, Jimmy. It's Andy. We have a high degree of confidence in our approach in PGIM. You know, as you've heard me say before, flows are an outcome of really three things: having a broad and diversified product portfolio, great long-term investment results, and great distribution.", "The bottom line is we've stayed very focused on those elements because we know they work. It has resulted in our strong track record of our -- with positive flows in 18 of the last 20 years. So, we're continuing to expand our product range in vehicles. Just as an example, our ultra-short bond ETF ranked No.", "2 in terms of net flow rate in its category. Second, we're continuing to invest in distribution on both the retail and institutional sites. In retail, we're maintaining our high activity, high visibility approach with advisors. And in institutional, we added a significant number of new clients this year.", "And then obviously, finally, our long-term investor track record speaks for itself over three, five, and 10 years. You know, the predominant impact that we've seen has been a fixed-income impact. And, you know, in particular, we believe that sustained higher rates are really good for the fixed-income business. So, we're going to keep doing what we know works, and we're confident that we're going to be a net grower over time." ] }, { "name": "Jimmy Bhullar", "speech": [ "Do you have enough visibility to sort of assume that you'll have positive flows on an overall basis at PGIM for 2023 or too early to say?" ] }, { "name": "Andy Sullivan", "speech": [ "So, as I've said in the past, flows vary a good bit quarter to quarter. Especially on the institutional side, they're chunky, so we wouldn't provide a forecast on that. Over the long run, we know that we're going to grow." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from John Barnidge from Piper Sandler. Your line is now live." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much. My question is around agents. As I look at the agent counts, they've declined overall in international. Is there anything being done to drive greater agent recruitment; or with productivity improved, are you taking Assurance lessons on the tax side to the agent force more generally?" ] }, { "name": "Andy Sullivan", "speech": [ "So, John, it's Andy. I'll take your question. So, really, the impact you saw is near-term. You know, COVID kept pressure on our recruiting efforts and retention efforts.", "The fact is, throughout the last couple of years, it was a harder environment to recruit and establish culture with new agents. That impacted our life consultant counts more so than our life planner counts. But it did affect both. You know, as we've started to transition to more of an endemic, we are seeing an improvement and expect to see an improvement over time.", "You know, we'll remain focused on two areas. First, strengthening our existing people's performance. And we're exceptionally proud of our talent. We have the highest number of million-dollar roundtable members who really deliver every single day for our customers.", "And second, we are continuing to lean in to attract, land, and develop new agents, which as we come out of the COVID pandemic, we believe will be easier for us. So, this is a model that has worked for us very consistently over a long period of time, and we expect to keep seeing steady performance." ] }, { "name": "John Barnidge", "speech": [ "Thank you for that. And then my follow-up question, can you talk about the decline in group new annualized premium in both group life and group disability? Is this from renewals, selective exits, or job cuts at the large and jumbo end of the market? Thank you." ] }, { "name": "Caroline Feeney", "speech": [ "Sure. John, it's Caroline. So, I'll take your question. So, first of all, just let me say, we're very pleased with the momentum that we've seen in our group insurance business.", "And as you're aware, the fourth quarter does tend to be a little lighter in terms of sales quarter, with the first quarter being our largest as the majority of our cases do you have January 1st inception dates. So, the lower sales that you're noticing on a year-over-year basis is largely due to just a large case buyout last year that drove up sales volumes. And these do occur periodically and certainly can produce some variability in sales volumes, particularly in those lighter sales quarters. So, John, if you were to normalize for last year's one-time buyout that we saw, sales are actually up about 7%.", "And obviously, this is on the disability side. On the life side, it was just a matter of timing of premiums, driven by changes in when some customers do enrollment in the year. So, I would just say, overall, we feel very good as well about our existing pipeline as we continue with our strong sales momentum." ] }, { "name": "John Barnidge", "speech": [ "Thank you for the answers." ] }, { "name": "Operator", "speech": [ "Thank you. Next question today is coming from Elyse Greenspan from Wells Fargo. Your line is now live." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi. Thanks. Good morning. My first question, can you talk about the impact that you've seen on your RBC ratio from the IMR getting forward at zero? And do you think that that issue is solvable via either NAIC changes or by getting a permitted practice from New Jersey?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Elyse. The impact on our PICA RBC ratio was about 35 basis points, maybe a little bit more. And that occurred, you know, with the rise in rates from 2Q through 4Q.", "And you'll be able to see that in our Blue Book and Green Book combined. So -- and we'll be reporting that at the end of the month. We have been with very active discussions with regulators, and I know many others have across the industry have been as well. There seems to be a good understanding of the issue, and a lot of careful consideration is being given on how to best address it.", "So, more to come. But rest assured, we're working with our regulators and many others as well to see what -- how best to address this issue." ] }, { "name": "Elyse Greenspan", "speech": [ "Thanks. And then, Rob, I think you had mentioned that the board was looking at capital deployment in the context of a recession and severe credit cycle potential. Can you talk about what kind of credit outlook factored into the board's decision on the '23 buyback plan? And what is your budget for downgrades and impairments if we enter into a recession?" ] }, { "name": "Rob Falzon", "speech": [ "Thanks, Elyse. We -- as Ken articulated earlier, the decision with regard to the buybacks factored in, you know, a number of considerations, including in that the possibility of a recession and obviously a recession that might be accompanied by a credit cycle, which could affect the portfolio. A couple of thoughts on that. First, while we do scenarios, which would anticipate the potential for both negative migration and credit losses, we also take some comfort, as our board did, from the strength that we have in portfolio management.", "We think we're incredibly well-positioned in the event of any deterioration in the economy that might lead to a credit cycle. We're not yet seeing any of that. I'll note, Elyse, if you look at our net credit migration in the fourth quarter and for the full year 2022, it was actually positive. So, we haven't seen any imminent signs of distress sort of percolating within the portfolio that would lead us to be overly concerned about that.", "But as we established the buyback amount that was authorized, we did anticipate that such a thing could occur and that we would want to be able to both anticipate that level of buyback and have the strength to be able to absorb anything that might happen from a negative migration or default standpoint." ] }, { "name": "Ken Tanji", "speech": [ "Maybe I'll just add, just to remind people, you know, we do have contingent sources of funding, in particular, our PCAPs, which is $3 billion, is a guaranteed source of funding. So, that's an important source of funding in the event of a variety of reasons, including stress." ] }, { "name": "Elyse Greenspan", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Andrew Kligerman from Credit Suisse. Your line is now live." ] }, { "name": "Andrew Kligerman", "speech": [ "Hey, good morning. I know there's been a number of capital questions and the IMR was impacted this quarter due to derivative losses given rising interest rates. Now, we've got rates coming off a bit in 1Q '23. So, I'm wondering if you could give us a little sensitivity on rates and how we can think about that impact on capital, particularly with regard to these derivatives." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Again, you know, rising rates is generally a good thing economically. But for this one item called IMR, a decline in rates would help. But it's a pretty complicated and complex item and will also vary depending upon the activity level.", "So, you know, I can't give you a, you know, a precise sensitivity as a result. But we factored it into our overall capital position in order to make sure we can deal with the volatility." ] }, { "name": "Andrew Kligerman", "speech": [ "OK. OK. And maybe help us on the expenses. So, you've got this terrific $820 million run rate savings.", "But as I look at results, I'm unable to kind of find those benefits flowing to the bottom line. So, maybe a little color geographically. Is all of it hitting the bottom line? Like just a little color as to how we could think about that 820 going forward." ] }, { "name": "Ken Tanji", "speech": [ "Yeah. It is been a companywide objective. So, the impact is across all of our businesses and the contribution that our corporate centers make toward that. And it does hit the bottom line.", "Having said that, we are investing to grow certain business lines, particularly PGIM and international. And so, there -- I just want to add that dynamic in there as well." ] }, { "name": "Andrew Kligerman", "speech": [ "Got it. And just a real quick technical question. Are you planning to deploy capital into Assurance IQ going forward or will it -- you know, now that it has generated a little profit, can it be self-funding?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah, we maintained Assurance well-capitalized and funded its losses as they've been incurred. Profitability continues to improve, and we'll continue to keep it well-capitalized going forward." ] }, { "name": "Andrew Kligerman", "speech": [ "Thanks a lot." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Michael Ward from Citi. Your line is that live." ] }, { "name": "Mike Ward", "speech": [ "Thanks, guys. Good morning. Just a high-level question. I was wondering if the capital pressures reserve charge, maybe earnings pressure in certain lines over the last 12 months or so, I'm wondering if that has changed specifically how you think about your business mix at all.", "And I know you've taken a few solid steps so far, but it seems like some incremental divestment or de-risking could help reduce some of these pressures going forward. So, I'm just wondering how you think about that prospect." ] }, { "name": "Charlie Lowrey", "speech": [ "Sure, Mike, it's Charlie. I'll take that. So, as you know, we've made significant progress in our transformation so far. But we would also note, we still have more work to do to become a higher-growth and less market-sensitive company.", "And as we look ahead, we're going to focus on our financial performance. We're going to focus on advancing our transformation, including the customer and employee experience. And we're going to focus on continuing to thoughtfully deploy capital. All of that with a goal of creating long-term sustainable value for all our stakeholders.", "And we think we're well-positioned across our businesses to be a global leader in expanding access to investment -- investing, insurance, and retirement security. And we'll do that in three ways. We'll continue to invest in our growth businesses and markets as we go forward. We'll deliver industry-leading customer experiencing, leveraging our broad capabilities and scope of diversified businesses, in which we'll continue to invest as well.", "And we'll create the next generation of financial solutions to better serve the diverse needs of a broad range of customers. So, what I'd say in summary is that we're definitely committed to becoming a higher-growth, less market-sensitive company, and our progress will obviously be dependent upon opportunities that arise and the macroeconomic conditions we face. But we're laser-focused on what we need to do, and we'll accomplish that." ] }, { "name": "Mike Ward", "speech": [ "OK, great. Thank you. And most of my questions were asked, but I was curious, just sort of nail in the coffin, making sure you're not liable for the earnout with Assurance IQ." ] }, { "name": "Ken Tanji", "speech": [ "Yeah, I'll cover that. Actually, one of the things that we disclosed for GAAP is the fair value of that earnout, and we've been disclosing that as zero. So, I think that would give you a good indication." ] }, { "name": "Mike Ward", "speech": [ "OK, great. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is a follow-up from Suneet Kamath from Jefferies. Your line is now live." ] }, { "name": "Suneet Kamath", "speech": [ "Great. Thanks for the follow-up. Maybe just two quick ones, just for Ken. I was curious about your comment about no change to AAT reserves, even with the move-up in rates.", "Can you just talk about why that would be the case?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah, because AAT, I mean, it looks at a number of scenarios, and it's -- it also looks at not just the level of ending surplus, but also interim periods. And, you know, with derivatives, we have some interim periods that kind of offset the impact of higher rates on the ultimate period. So, it's a little technical question. But overall, little changes there." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. And then just curious on LDTI. I know you said that the AO impacts offset across businesses, but can you just give us a sense of maybe which businesses saw benefits and which businesses saw some pressure?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah, sure. So, yeah. Again, no -- overall, we don't expect an overall change to the run rate level of the earnings. And actually, some of the businesses will have no or little impact, which would be, as you would expect, PGIM, Assurance, and group insurance.", "The earnings from our international and institutional retirement businesses are expected to increase on a run rate basis. And that's really due to the earlier recognition of the unrealized insurance margins, which are quite sizable. On the other hand, earnings from individual retirement and life insurance in the U.S. are expected to be lower, and that's primarily due to the slower recognition of revenue for those businesses.", "Again, kind of some pluses and minuses that offset, but that's sort of the segment-level information. We, like others, will be providing a lot more information prior to our first quarter earnings when we restate under the new standard. So, you can expect to get a lot more." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Lowrey for any further or closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "OK. Thank you. And thank you, everyone, for joining us today. I hope we demonstrated the progress we are making to transform Prudential to deliver sustainable long-term growth and meet the evolving needs of our customers.", "Looking ahead, we remain confident in our strategy and the strength of our company. For nearly 150 years, Prudential is focused on creating value for our customers and other stakeholders who we will continue to serve as we strive to be a global leader in expanding access to investing, insurance, and retirement security. Thank you again for your time today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2023-08-02	[ { "description": "Vice President, Investor Relations", "name": "Bob McLaughlin", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "Executive Vice President and Head of International Businesses", "name": "Andy Sullivan", "position": "Executive" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Wes Carmichael", "position": "Analyst" }, { "description": "Head of U.S. Businesses", "name": "Caroline Feeney", "position": "Other" }, { "description": "Jefferies -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Michael Ward", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by and welcome to Prudential's quarterly earnings conference call. At this time, all participants have been placed in a listen-only mode. Later, we'll conduct a question-and-answer session. Instructions will be given at that time.", "[Operator instructions] As a reminder, today's call is being recorded. I will now turn the call over to Mr. Bob McLaughlin. Please go ahead." ] }, { "name": "Bob McLaughlin", "speech": [ "Good morning and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of international businesses and PGIM, our global investment manager; Caroline Feeney, head of U.S. businesses; Ken Tanji, chief financial officer; and Rob Axel, comptroller and principal accounting officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measure and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slides titled Forward-Looking Statements and Non-GAAP Measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.", "And now, I'll turn it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Bob, and thanks to everyone for joining us today. Our second quarter results reflect continued momentum across our businesses, including the fourth consecutive quarter of underlying earnings growth and record operating earnings for group insurance. We continue to execute on our strategy by reducing market sensitivity and increasing our capital flexibility, enhancing our capabilities, and optimizing operating efficiency to support long-term growth. Our strategic progress and financial strength position us well to navigate the current macroeconomic environment and maintain our disciplined approach to capital deployment. Turning to Slide 3.", "I'll start this morning by noting two significant milestones demonstrating how we are reducing market sensitivity and increasing our capital flexibility. During the second quarter, we completed the reinsurance transaction for a $10 billion block of traditional variable annuities and received proceeds of $650 million. With this transaction, I'm pleased that we have achieved our objective of lowering the proportion of traditional variable annuities while continuing our progress in pivoting to less market-sensitive and higher-growth products. Additionally, last week, we announced another transaction to Reinsurer a $12.5 billion block of guaranteed universal life policies, which will be accretive to earnings. We expect to receive approximately $450 million of proceeds when the transaction closes, which is expected to be in the fourth quarter of this year. We also continue to deliver on our vision to increase access to investing, insurance, and retirement security by enhancing our capabilities and customer experiences and by expanding our distribution channels and products to more people around the world.", "In Latin America, we continue to expand our distribution through the Mercado Libre platform and added 150,000 new customers last quarter. Also, Prudential of Brazil achieved a record sales quarter driven by strong performance by life planners and continued expansion of the third-party distribution channel. Prudential of Brazil is now the third-largest life insurance company in the country, growing at twice the market average and reaching more than 3.5 million customers. In addition, we see continued opportunity and feel we are well positioned in the international longevity risk transfer market as we completed more than $3.5 billion of transactions in the second quarter. In the U.S., our individual retirement strategies business achieved annuity sales of $1.9 billion in the second quarter, a 20% increase year over year and the highest since the fourth quarter of 2020.", "Our FlexGuard suite has reached $15 billion of sales over the past three years, and our fixed annuity sales in the quarter represented over one-third of new business as we innovate our portfolio of annuity solutions to meet customer needs. As we look ahead, we are well positioned as a global leader at the intersection of asset management and insurance. We are confident that our strategy and mutually reinforcing business mix, which leverages the combined strength of our brand, global asset and liability origination capabilities, and multi-channel distribution will enable us to drive future growth and continue to expand access to investing, insurance, and retirement security. At the same time, we continue to enhance the ways we leverage technology to improve customer experiences and optimize operating efficiency. One recent example is Model My Retirement, a new digital tool designed to help institutional pension customers gain a better understanding of their retirement benefits and adjust their financial planning accordingly. Customers can now quickly and seamlessly get an estimate of their available annuity benefits through our self-service website.", "We also announced a strategic partnership with Nayya, a leading benefits experience platform. The new partnership will allow group insurance clients to harness AI and data science capabilities to make more informed workplace benefit decisions. And we are also using chat bot technology and robotic process automation to reduce transaction processing time across our U.S. businesses. As part of our continuous improvement framework, we are focusing on creating a leaner, faster, and more agile company so that we can better meet the needs of our customers while driving growth and efficiency. We've made good progress in this area, having exceeded the target we established two years ago, but we think there's more work we can do.", "We are evaluating additional opportunities, including further evolving our operating model, simplifying our organizational structure, and streamlining decision-making. Turning now to Slide 4. Prudential's rock-solid balance sheet and robust risk and capital management frameworks have allowed us to confidently navigate the current macro environment. Our AA financial strength is supported by our strong capital position, including approximately $50 billion of unrealized insurance margins; $4.5 billion in highly liquid assets at the end of the second quarter, which does not include the $650 million of proceeds from the traditional variable annuities reinsurance transaction that was completed this quarter; and a high-quality, well-diversified investment portfolio and disciplined approach to asset liability management. Moving to Slide 5. Our disciplined approach to capital deployment, coupled with the added capital flexibility achieved through our de-risking transactions, enables us to effectively balance investing in the long-term growth of our businesses with returning capital to shareholders.", "In the second quarter, we returned approximately $700 million in capital to shareholders. And with that, Rob will now provide an overview of our second-quarter financial results and an update on our business performance." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results and business performance for our PGIM, U.S., and international businesses. I'll begin on Slide 6 with our financial results for the second quarter of 2023. Our pre-tax adjusted operating income was $1.4 billion, or $2.94 per share, on an after-tax basis. These results reflect underlying business growth, including the benefits from a higher interest rate environment and favorable underwriting experience, partially offset by elevated expenses and lower variable investment and fee income.", "Our GAAP net income was 576 million lower than our after-tax adjusted operating income, primarily driven by mark-to-market losses on currency and interest rate derivatives and losses on fixed maturity sales driven by higher rates. Turning to the operating results from our businesses compared to the year-ago quarter. PGIM, our global investment manager, had lower asset management fees driven by rising rates and net outflows and higher expenses to support growth initiatives, while other related revenues increased primarily from higher seed and co-investment earnings. Results of our U.S. businesses primarily reflected a more favorable comparable impact from our annual assumption update, higher spread income, and more favorable underwriting, partially offset by the absence of a one-time gain from the sale of PALAC in the prior-year quarter and lower fee income. The increase in earnings in our international businesses primarily reflected higher emerging markets earnings and a favorable impact from our annual assumption update and other refinements. Turning to Slide 7.", "PGIM, our global active Investment manager, has diversified capabilities in both public and private asset classes across fixed income, equities, and alternatives. PGIM's long-term investment performance remains attractive with 80% or more of assets under management outperforming their benchmarks over the last five- and 10-year periods. In addition, our short-term performance has improved since the last quarter with 80% of assets exceeding their benchmarks over a one-year period. PGIM experienced third-party net outflows of 5.2 billion in the quarter, primarily from public equity strategies. Institutional outflows were primarily driven by client redemptions for liquidity needs, and retail outflows were driven by sub-advised equity mandates. As the investment engine of Prudential, the success and growth of PGIM and of our U.S.", "and international insurance and retirement businesses are mutually reinforcing. PGIM's asset origination capabilities, investment management expertise, and access to institutional and other sources of private capital are a competitive advantage, helping our businesses bring enhanced solutions and create more value for our customers. Our insurance and retirement businesses, in turn, provide a source of growth for PGIM through affiliated net flows, as well as unique access to insurance liabilities. In addition, we continue to grow both organically and through acquisitions our private alternatives and credit business, which has assets of approximately $234 billion across private corporate and infrastructure credit, real estate equity and debt, and secondary private equity. Capital deployment across PGIM's private assets platform increased from the prior quarter to $8 billion, benefiting from strong private placement and direct lending originations.", "Turning to Slide 8. Our U.S. businesses produce diversified earnings from fees, net investment spread, and underwriting income and benefit from our complementary mix of longevity and mortality businesses. We continue to drive toward a higher-value, higher-growth, and less market-sensitive mix of earnings as evidenced by the de-risking transactions that Charlie mentioned, invest in our businesses to deliver best-in-class customer experiences and expand our addressable market with new financial solutions, leveraging the capabilities across Prudential.", "Retirement strategies generated strong sales of $7.6 billion in the second quarter across its institutional and individual lines of business. Our institutional retirement business has leading market capabilities which helped to produce second-quarter sales of $5.7 billion, including $3.6 billion of international reinsurance transactions as well as strong stable value sales. Retirement account values were a record high at the end of the second quarter. In individual retirement, our product pivots have resulted in continued strong sales of more simplified solutions like FlexGuard and FlexGuard Income, representing approximately 65% of sales and increased fixed annuity sales that accounted for approximately one-third of sales this quarter. Our individual life sales increased 27% from the year-ago quarter, reflecting our earlier product pivot strategy with variable life products representing approximately 74% of sales in the quarter. And group insurance sales were up 33% compared to the year-ago quarter, driven by growth in disability and supplemental health. We've been very pleased with the momentum we are seeing in our group insurance business as we execute our strategy of product and segment diversification while leveraging technology to increase operating efficiency and enhance the customer experience. Our record results this quarter include favorable group life and disability underwriting experience, which resulted in a benefits ratio of 81%.", "Turning to Slide 9. Our international businesses include our Japanese life insurance companies where we have a differentiated multi-channel distribution model, as well as other businesses aimed at expanding our presence in targeted high-growth emerging markets. In Japan, we are focused on providing high-quality service and expanding our distribution and product offerings. Our needs-based approach and protection product focus continue to provide important value to our customers as we expand our product offerings to meet their evolving needs. In emerging markets, we are focused on creating a selective portfolio of businesses in regions where customer needs are growing, where there are compelling opportunities to build market-leading businesses, and where the Prudential enterprise can add value. Our international business sales were up 9% compared to the year-ago quarter.", "Life Planner sales were up 12% driven by record sales in Brazil as well as higher single premium U.S. dollar sales in Japan. Gibraltar sales were up 6%, primarily driven by growth in the bank channel. As we look ahead, we are well positioned across our businesses to be a global leader in expanding access to investing, insurance, and retirement security. We continue to focus on investing in growth businesses and markets, delivering industry-leading customer experiences and creating the next generation of financial solutions to serve the diverse needs of a broad range of customers.", "And with that, I'll now hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 10, which provides insight into earnings for the third quarter of 2023 relative to our second-quarter results. As noted, pre-tax adjusted operating income in the second quarter was $1.4 billion and resulted in earnings per share of $2.94 on an after-tax basis. To get a sense of how our third-quarter results might develop, we suggest adjustments for the following items. First, our annual assumption update and other refinements resulted in a net benefit of $16 million in the second quarter.", "Next, variable investment income was below expectations in the second quarter by 50 million. While we have not included an adjustment for the third quarter, the potential exists for continued revaluation of real estate investments and lower prepayment activity due to the current market and economic conditions. Variable investment income will vary from period to period, however, over time, it has exceeded our expectations. Third, underwriting experience was below expectations by 5 million in the second quarter, and we expect 20 million of favorable seasonality in the third quarter.", "And last, we included an adjustment of 90 million for other items primarily due to elevated expenses in the second quarter. These adjustments combined get us to a baseline of $3.26 per share for the third quarter. I'll note, if you exclude items specific to the third quarter, earnings per share would be $3.35. The key takeaway is that our underlying earnings power continued to improve due to business growth, including the benefit of higher interest rates, partially offset by higher investments in our capabilities and growth initiatives. I would also note that due to continued opportunities to build capabilities, pursue growth initiatives, and gain efficiency, we expect an increased level of investments in these areas that will be reflected in corporate and other.", "While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the third quarter. Turning to Slide 11. Our capital position continues to support our AA financial strength rating. Our cash and liquid assets were 4.5 billion, at the high end of our liquidity target range. Our regulatory capital ratios were well above our targets, and we have substantial off-balance-sheet resources, including 9 billion of contingent capital and liquidity facilities. We remain thoughtful in our capital deployment, balancing preservation of financial strength and flexibility, investment in our businesses, and shareholder distributions.", "Turning to Slide 12 and in summary. We are transforming our business for sustainable growth. We continue to navigate the current macro environment with the financial strength of our rock-solid balance sheet, and we maintain a balanced and disciplined approach to capital deployment. Now, I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We'll now be conducting a question-and-answer session. [Operator instructions] Our first question today is coming from Tom Gallagher from Evercore ISI. Your line is now live." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. First question is, can you talk a little bit about the -- the dividend flows -- the dividends that were paid up in the quarter from -- from the subs? It seemed like a pretty strong capital generation quarter, so a little bit behind, what -- what drove that? And relatedly, the capital that you're going to be -- that you received for the VA transaction or the freed-up capital and the SGLI deals later this year, would you expect to be able to dividend those up and use the proceeds? And then, finally, the IMR role change, can you comment on whether that affected your RBC this quarter? Do you expect that to affect it later in the year? Thanks." ] }, { "name": "Ken Tanji", "speech": [ "Yeah, hey, Tom. It's Ken. Yeah, we executed planned distributions from our businesses in the second quarter. You know, that cash flow reflected dividends from PICA and Japan and other affiliated cash flows from subsidiaries as well.", "Again, it was -- it was all part of our plans for the year. Our capital position as a result is very healthy. Our regulatory capital ratios are above our AA objectives that would include the benefit of the recent VA reinsurance transaction but does not yet reflect the GUL transaction which will be subject to close later. And again, our holdco assets were 4.5 billion, you know, relatively flat from the prior quarter and at the high end of our target range. So, again, we'll benefit from the GUL transaction when it closes, and the NAIC IMR proposal when that is adopted. So, that's not yet in our RBC ratios.", "And these will all be key considerations for dividends from PICA to PFI in the second half of the year. Again, with the close of GUL and NAIC's decision on negative IMR. So, overall, you know, we feel very good about our capital position and the outlook for our flexibility looking ahead." ] }, { "name": "Tom Gallagher", "speech": [ "OK, thanks. Thanks, Ken. And then, just a follow-up, on the potential IMR changes, I think the limitation is now looking like 10% of surplus. Can you give a little bit of color for -- I think you had had something like 1.8 billion negative impact from that in 2022.", "Would you expect to be able to reverse most of that, some of that? And would we still be looking at potential limitations or future losses if rates keep going up here, I guess, is the other follow up on that? Thanks." ] }, { "name": "Ken Tanji", "speech": [ "Yeah, so you're right, Tom, the proposal is subject to a limitation of 10% of statutory surplus with -- adjusted for some exclusions. And for us, that's about 1.3 billion, or, you know, you can -- you can think of that as about 26 RBC points. So, that's -- that's what it would represent for us where we sit and where interest rate sits right now." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question is coming from Jimmy Bhullar from J.P. Morgan. Your line is now live." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hey, good morning. So, first, just a question on your Japan business and how do you -- how are you thinking about potential changes in your new sales mix given changes in the capital regime and also just fluctuations recently we've seen in terms of interest rates and currencies in Japan." ] }, { "name": "Andy Sullivan", "speech": [ "Hey, Jimmy, it's Andy. I'll take your question. You know, our Japan operation, as you know, is competitively advantaged with outstanding distribution, great product, and a strong brand. And we've been quite pleased with the sales results this quarter as we experienced year-over-year growth in our LP or LC and our bank channels.", "You know, that growth was aided by higher U.S. dollar product sales, but we've also been investing into the business. Clearly, our work on innovating our product designs and enhancing our customer experience is paying off. You know, as we look at the interest rate changes, as we always say, overall higher interest rates are good for Prudential and are good for our Japanese businesses.", "We do believe that those higher interest rates will obviously give us greater flexibility in our product design and in delivering value back to our customers. So, while we may see a shift of the mix between U.S. dollar and yen-denominated, we think we'll still see strong demand. And as we look forward, we're optimistic about our ability to continue to grow the Japan business and deliver shareholder value." ] }, { "name": "Jimmy Bhullar", "speech": [ "Does the change in capital affect your -- sort of the economics of your products between U.S. dollar and yen-denominated?" ] }, { "name": "Rob Falzon", "speech": [ "Hey, Jimmy, it's Rob. So, a couple of thoughts. You're referring to the eventual adoption of ESR. First point, ESR is still a work in process and -- and is not scheduled for adoption until, like, 2025.", "And so, we continue to work with the JFSA and with the industry to fine-tune the -- the ESR regime which is, you know, to date, largely mirrored the regime that's been established on the international side. As currently constructed, it would cause us to look creatively at how we manage our book of business and our sales. So, I don't think it would necessarily change our distribution and our sales. But, you know, where we -- where we -- where we hold the assets against those sales could be in Japan or it could be reinsured into other jurisdictions in order to be able to make sure that we're -- we're matching the economics of the products that we're selling into the economics of the statutory regimes in which they reside.", "So, we're comfortable that either through the combination of advocacy and getting sort of the right economic outcomes and/or the other levers that we have available to us that we'll be able to sort of continue the balance of sales that we have and sort of manage the way in which we capitalize and reserve those sales." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. And then, just shifting onto PGIM, the negative flows this quarter, how much of that is something that's maybe Prudential-related that might continue into the second half versus maybe just overall industrywide issues that a lot of your peers have had in asset management recently as well?" ] }, { "name": "Andy Sullivan", "speech": [ "Sure, Jimmy, it's Andy. I'll take your question, and I'll just hit it broadly to talk about flows for the quarter. You know, as we've talked about, flows are an outcome of having great distribution, broadly diversified products, and strong investment results. And we've been a net flow winner over a multi-year period in PGIM, and we're quite confident in the strength of our capabilities. And as always, we're going to continue to manage this for the long term.", "You know, that said, this quarter, we did see a material reduction in our outflows versus the previous quarters. On the retail end, outflows were 2.2 billion and were predominantly an equity story. We've seen retail clients rebalancing their portfolios based on the heels of strong equity market appreciation. On the institutional side, the outflows were 3 billion for the quarter. Again, that's a material improvement over the previous quarters.", "These outflows included both equity and fixed income. The equity story for institutional is the same as that for retail, it's client rebalancing. For fixed income, we saw some of our clients make asset allocation changes and others shift to passive. You know, as far as an outlook, near-term, we expect that this current investor behavior is going to continue.", "And to your question, our trend is consistent with what we're seeing across the rest of the industry. Over the longer term, we have a lot of confidence in our PGIM platform, and we know that we're going to return to strong positive flows and gain market share." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from John Barnidge from Piper Sandler. Your line is now live." ] }, { "name": "John Barnidge", "speech": [ "Morning. Thanks for the opportunity. Question on PGIM. Another investment manager on some of these risk transferred assets, how long does that agreement -- those agreements last? Can you talk about how the wind-down of those assets would work? Thank you." ] }, { "name": "Andy Sullivan", "speech": [ "So, John, it's Andy, I'll take it. Maybe I'll bring it up a level, just talk about in general as we do de-risking transactions and, in particular, the recent de-risking transactions we did in individual retirement strategies and individual life. You know, it is true we'll lose some assets under management from the general account. But we -- we -- as you've noted, we worked hard and -- and got an IMA. That is deal specific, how long they -- those IMAs go depending deal to deal.", "But, you know, it does give us the ability to continue to manage a majority of the assets. And at the end of the day, if you look across the risk transactions that we've done recently, it's not really going to have a material impact on PGIM earnings." ] }, { "name": "Rob Falzon", "speech": [ "Hey, John, it's Rob. Maybe just a little further elaboration. In the -- in the reinsurance of the PDI transaction, recall that, you know, those are individual sort of client separate accounts. And so, those -- the -- the separate account business there is something that PGIM will continue to manage.", "With regard to the GUL business, the agreement that we have there is actually a seven-year initial IMA. And obviously, with good performance, we would expect to continue to be able to -- to manage that even over a longer period of time." ] }, { "name": "John Barnidge", "speech": [ "Thank -- thank you for that. And then, my follow-up question, sticking with asset management business, the industrywide headwinds lead to inorganic opportunities. And are there products or geographies you'd want to get greater scaling?" ] }, { "name": "Andy Sullivan", "speech": [ "John, it's Andy again. I'll take that. So, -- and I'll start where I always start when we talk about this. We've demonstrated a strong ability over a couple of decades to grow PGIM organically.", "So, we certainly -- as we look at the programmatic M&A, we don't need it to grow. That being said, we do remain interested in augmenting the organic growth plans with programmatic M&A. If you look at what we've done recently, Montana Capital Partners, PGIM Custom Harvest, and now Deerpath, you know, those are really good examples of the areas that we said we are going to lean into higher fee, higher growth. As we look forward, we're going to continue to work to globalize the business and lean into areas like private alternatives and real assets.", "Clearly, you know, any disruptive environment can lead to opportunities. So, we make sure that we stay in the know and in the flow of of what's going on in the industry. But as always, we will remain very patient and be disciplined in our approach." ] }, { "name": "John Barnidge", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question today is coming from Ryan Krueger from KBW. Your line is now live." ] }, { "name": "Ryan Krueger", "speech": [ "Hi, Thanks. Good morning. I was hoping you could discuss the new open architecture platform that was referenced in the June press release and give some more specifics on really what you're looking to do there." ] }, { "name": "Rob Falzon", "speech": [ "Ryan, it's Rob. I'll take that. As we've talked about in the past, we see really interesting opportunities that exist in the intersection of asset management and insurance, as you see, evolving in the industry. And we're quite excited about what that implies for our ability to create avenues of growth both in our insurance and our asset management businesses.", "So, we're being thoughtful about how we execute against that opportunity, and that includes organizing ourselves in a way so as to institutionalize our ongoing balance sheet optimization capabilities. So, think about that on the liability side as we're looking at reinsurance solutions, the balance the use of captives, affiliates, and third-party reinsurance to continue to actively evaluate additional blocks -- existing blocks of business for reinsurance, and then also looking at flow or new sales solutions. On the asset side, it's about expanding our lens on the available assets or investments that can generate greater alpha for us while also expanding our capabilities to source those investments either directly or in partnership with others, including things like acquiring capabilities as we did with Deerpath. This is an important component of our broader strategy, which is around enhancing valuation by becoming higher growth, less market-sensitive, and more nimble." ] }, { "name": "Ryan Krueger", "speech": [ "Thanks, just one follow-up there. I mean, should we think of this as also including, you know, more potential to bring in more third-party capital in a sidecar-like structure to back some of your new business in the future?" ] }, { "name": "Rob Falzon", "speech": [ "I think we're looking at the full range of opportunities that would exist there, and so going from captive to third-party and hybrid solutions that would exist in between that." ] }, { "name": "Ryan Krueger", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our next question is coming from Wes Carmichael from Wells Fargo. Your line is now live." ] }, { "name": "Wes Carmichael", "speech": [ "Hey, good morning. I just had a follow-up on Tom's question on the holdco liquidity. So, I think in the first quarter, that was roughly around 4.5 billion. It ended this quarter at 4.5 billion.", "But if I kind of add up all the uses of capital in the quarter, you know, from buybacks, dividends, I think there was a billion and a half a callable debt. I think there were around 2 billion and 2.5 billion of uses in the period. So, I'm just curious, like, were dividends accelerated? I know you said that they were planned, but was there any other affiliated borrowings? I'm just trying to square that because it's a pretty -- a pretty sizable use of capital, and I'm just trying to trying to figure out where that came from." ] }, { "name": "Ken Tanji", "speech": [ "Yeah, hey, Wes. It's Ken. No, it was all planned. So, the distributions we received were all planned, and we didn't issue any debt in the quarter either.", "In fact, as you recognize, we -- we called some debt, which again, was all -- all planned. So -- and we didn't pull forward anything. So, it was all part of what our plans were for the year. So, I hope that helps." ] }, { "name": "Wes Carmichael", "speech": [ "OK, and just maybe any thoughts around your kind of PRT pipeline and just maybe how you think about that versus balancing that with, like, the longevity business and deploying capital to those -- those two in the -- in the institutional retirement business." ] }, { "name": "Caroline Feeney", "speech": [ "Yeah, it's -- hi, Wes. It's Caroline, and I'll take your question. So, first of all, I'd say, overall, we're very pleased with the strong results we saw across our entire retirement strategies business with just over 7.5 billion in total sales and record institutional account values of 259 billion. This included 5.7 billion in our institutional retirement strategies business, highlighted by a strong quarter in international reinsurance transactions. In terms of the pipeline overall, West, we continue to see strong opportunity in both the U.S.", "and global risk transfer markets with strong funding positions both above 100% and also high intent to transact. And I would be remiss not to mention what was just announced yesterday that we were selected to secure the pension benefits for about 2,000 of PSE&G's retirees and their beneficiaries. And so, far we've seen a record first half of the year in PRT. And while we expect to see a strong second half, we don't expect to surpass last year's record pipeline. We also see an extremely strong pipeline in the U.K.", "with funded positions over 110%. And, West, finally, I'd say that given our expertise and our ability to manage large, complex transactions, along with our financial strength, we are well positioned to remain a leader in -- in both markets." ] }, { "name": "Wes Carmichael", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question today is coming from Suneet Kamath from Jefferies. Your line is now live." ] }, { "name": "Suneet Kamath", "speech": [ "Hi. Thanks. I wanted to go back to the risk transfer deals just for a second. You know, I think, Charlie, in your comments, you talked about achieving your goal on the VA side, and obviously, you've done an SGUL transaction of late.", "Should we think about this is still ongoing activity for you, or are you sort of declaring victory here and kind of moving on to some of the more growth-oriented areas of your strategy?" ] }, { "name": "Charlie Lowrey", "speech": [ "So, I would say yes to both of those. So, let me -- let me go through and yes and. So, first, I'll go through each one sort of GUL and then -- and then the VA business. But, you know, first, we are very pleased with the valuation we received for reentering the 12 -- 12.5 billion block of guaranteed universal life policies that we announced last week.", "And -- and as we said, we expect to receive approximately $450 million of proceeds when the transaction closes. The transaction will be accretive to earnings, and we'll also reduce our market sensitivity and increase our capital flexibility. But would we consider an additional de-risking opportunity for life sub-block? You know, absolutely, as long as it met the strategic financial objectives and made sense to all our stakeholders. However, we're going to be disciplined in our approach as the individual life business continues to be core to our purpose.", "You know, there's still -- there's still significant potential for growth in the industry with a $12 trillion life insurance gap. And I think our strong individual life sales in the second quarter reflects our product pivot to less market-sensitive products. And from an enterprise perspective, our life business helps balance our longevity with our mortality. So, it remains important to us. You know, on the VA side, it's a little bit of a different story, but -- but there's some similarities. So, we've made considerable progress in reducing the market sensitivity and increasing our capital flexibility through the two transactions we've done.", "And we're pleased with the valuations, again, that we received for reentering the $10 billion block of traditional variable annuities in the second quarter, as well as a valuation for the $30 billion block we sold, you know, last year. But as a result of these transactions, as we said, and the natural runoff of this business, we have achieved the original objective that we established two years ago of lowering the proportion of traditional variable annuities. So, we're not in a position of having to do another transaction. Having said that, I want to be very clear that we'll continue to explore additional opportunities. But again, to state the obvious, but I'll state it, will only do something if it's in the best interest of all our stakeholders. But -- but these transactions aren't only about de-risking.", "As you said, they're also about growth. So, while we've been quite successful in our de-risking efforts as part of our strategy, we've also been equally focused on growing with less market-sensitive products in our businesses, which you've seen over the past few quarters. So, you know, let me turn it over to Caroline for a minute because -- Caroline, would you want to talk about some of the progress we've made with that part of our strategy?" ] }, { "name": "Caroline Feeney", "speech": [ "Yeah, sure, Charlie, I'd be happy to talk about how we're growing both these businesses. So, first of all, in the life business, as you said, we have a $12 trillion insurance gap. So, we have a strong growth path forward, particularly when you think about the 50 million Americans who are currently underinsured. And as you mentioned, Charlie, we've been very successful in pivoting our businesses to products that have a more favorable risk profile. Our new solutions have less embedded guarantees, they're less capital-intensive, and we're writing new business at attractive returns.", "And as part of that, we saw strong sales in the quarter, up more than 25% over the prior year. And then, on the individual retirement strategy side, we also continue to deliver strong sales and earnings. And in fact, we had our strongest sales quarter since the fourth quarter of 2020 and roughly a 20% increase over the prior year. And that's anchored by our FlexGuard suite of indexed variable annuities where we now have over $15 billion in cumulative sales, reinforcing our leadership position as a top-five player. And we also saw strong growth in our fixed annuity solutions, which were roughly one-third of our sales in the quarter and a significant increase over the prior year. So, I'd say that our de-risking transactions, along with our product pivots, have put us in a position to be more nimble with less market sensitivity, and we see a meaningful opportunity for strong growth in both businesses going forward." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. That makes sense. And then, I just want to follow up, I think, Ken, in your prepared remarks toward the end of your commentary, you talked about an increased level of investment, I think, in the corporate segment. I was just wondering if you could maybe size that, and then some thoughts around for -- for how long should we expect this incremental investment to be -- to be impacting that -- that line? Thanks." ] }, { "name": "Ken Tanji", "speech": [ "Sure. The -- what I mentioned there was we have found new opportunities to invest in our capabilities and including growth opportunities and to gain efficiency. It's building on the programs that we've executed in the past. And we have increased our investment level there.", "We've put a placeholder in there in terms of our run rate of about -- an increase of about 25 million a quarter. And so, that's -- given our plans now, we think that's appropriate planned increase in the pace of that. I just want to mention that, you know, the way we look at these opportunities is they're often companywide, and that's why you see the expenses occurring in corporate, but the benefits then are reflected in our -- in our business segments. And then, overall, from an expense level standpoint, we've maintained basically a flat level of expenses. While we've increased the level of -- of capacity to invest in growth and capabilities and efficiencies, the efficiencies that we've gained there have given us -- given us that capacity. And so, overall, we've seen a flat level of expenses, improved level of capabilities, gained efficiencies, and improved margins." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. So, you're not signaling that we need to reflect this 25 million in our corporate forecast going forward. It's more you're going to have this, but it's going to be offset by efficiencies and other things." ] }, { "name": "Ken Tanji", "speech": [ "Well, yes, but if you think -- if you think about corporate, you should think about that as being a ongoing level of spend in corporate." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. Just offset at the segments." ] }, { "name": "Ken Tanji", "speech": [ "Yes." ] }, { "name": "Suneet Kamath", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Erik Bass from Autonomous Research. Your line is now live." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. Can you provide an update on your emerging markets businesses, and what they're currently contributing to earnings, and how they're growing from a bottom-line perspective?" ] }, { "name": "Andy Sullivan", "speech": [ "So, Erik, It's all -- Andy, it's Andy. I'll take the question. Let me just start by kind of reminding everyone of the strategy. Our focus on emerging markets, as part of shifting our overall business mix, to be higher growth.", "And we're quite pleased with the performance of our EM portfolio, which is obviously, and as you could see, steadily growing and positively contributing to our earnings profile. I would highlight a couple of areas. We're very pleased with our results in Brazil and quite optimistic about our prospects. Brazil posted strong double-digit year-over-year sales growth with success across basically every channel, Life Planner, third party, and group. And we had another record quarter.", "Second, I would highlight our Habitat -- Habitat joint venture has contributed steady growth since the acquisition in 2016. As of the end of the second quarter, total Habitat assets under management is 67 billion. That makes us No. 1 in Chile and No.", "2 overall in Latin America. Third, we're continuing to invest in emerging Asia and Africa. And then, finally, and Charlie mentioned this sort of at the top of the call, was this really exciting partnership we have with Mercado Pago, which is a financial subsidiary of Mercado Libre. Mercado Libre is the largest e-commerce system in Latin America and has given us access to the mass market in Latin America, and we're seeing really nice growth there. So, we don't -- we don't necessarily break out the specific growth rates, but this is a portfolio that's becoming quite meaningful with our particular emphasis being on how Brazil and Latin America are growing. And as we look forward, we really do believe we're in the right spots at the right time, and that growth will continue." ] }, { "name": "Erik Bass", "speech": [ "Thank you. And then, on PGIM, I was just hoping you could talk about the drivers of the other related revenues and your outlook for the second half of the year. I think the baseline outlook assumes that these normalize, so is that an expectation or just a modeling assumption?" ] }, { "name": "Andy Sullivan", "speech": [ "So, thanks, Eric, it's Andy again. I'll talk about the quarter, and then I'll talk about the outlook. In the second quarter, ORR came in at 31 million, which was about 20 million below our average expectation. The bottom line there is the slowdown in the real estate market is playing through, as we predicted, and we've seen lower agency earnings, lower real estate transactions fees, and lower incentive fees. As far as looking forward, we would expect, near term, to see pressure remain on the ORR line really until the market experiences a rebound in the real estate transaction volumes." ] }, { "name": "Erik Bass", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. Let's talk about RBC improvements. I appreciate that you quantify the IMR relief. How many RBC points are you expecting from your VA deal and ULSG deal?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah, hey, Tracy, it's Ken. The VA deal, it's -- the 650 is about 13 RBC points, and the 450 from the GUL deal is about nine RBC points. So, that's the quantum expressed in RBC." ] }, { "name": "Tracy Benguigui", "speech": [ "OK, awesome. When thinking about these transactions and the counterparty credit risk, do you look at the size of capital by reinsurer, let's just put the ratings aside, like the Somerset Re capital base feels a little bit light. You did say there was over-collateralization, but I don't think there's a comfort trust. What mechanisms do you put in place to reduce recapture risk? And if you could also share any assumptions that Somerset liked with that deal." ] }, { "name": "Ken Tanji", "speech": [ "Sure, Tracy, it's Ken. A number of things there. So, let me -- let me cover them. If I missed them, make sure I come back to them.", "But overall, you know, we utilize reinsurance in our counterparties, you know, very carefully. We spread our reinsurance across a select group of high-quality third-party reinsurers. And as you would expect, we have standards for that reinsurance that we certainly apply to these transactions. You know, while the -- they're entering into the business, they do have experience, the management team of these reinsurers have a lot of industry experience and are committed to the business in the long term. But beyond that, we have contractual provisions, some of which you alluded to, but also want to highlight that we'll be doing the administration of the business. So, we have complete control over that.", "And the reserves for the business, in one instance, will be in a comfort trust and the other to the structure. It's a segregated -- segregated account, but they provide similar assurances and protections and, again, will be overcollateralized with the procedures for timely settlement. We also want to highlight that we have investment guidelines for the investment portfolios, for the investments that are -- that are held in these trusts or accounts. So -- so, overall, when we put that all together, you know, we think the counterparty risk is well positioned for us. I think I covered your -- your questions there but hopefully that helps." ] }, { "name": "Tracy Benguigui", "speech": [ "It definitely does. If I could just slip in if there was any assumptions, like mortality or lapse rates, that Somerset is light. I'm looking at the deal." ] }, { "name": "Ken Tanji", "speech": [ "Yeah, obviously, those are their assumptions. Again, they have a lot -- the people there. On the other side with Somerset, they have a lot of experience, but they make their own assumptions. But also, they obviously are going to be subject to their own regulatory standards in the jurisdictions of which they -- they operate. So, this got a lot of regulatory attention on both their side and our side, and I think that's also in good standing." ] }, { "name": "Tracy Benguigui", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Mike Ward from Citi. Your line is now live." ] }, { "name": "Michael Ward", "speech": [ "Thanks, guys. Really appreciate all the commentary around the de-risking and simplification. I'm just -- I'm just curious, should we think about this as -- as you guys are sort of saying you're open for considering more block deals or, you know, internal reinsurance, restructuring, and whatnot? Or should we think about it as potentially more significant, like a more material split or divestiture within the organization to unlock value?" ] }, { "name": "Charlie Lowrey", "speech": [ "Hi, Mike, this is Charlie. I think it's really the -- the former. In other words, if you think about what we're trying to do, if we take a step back and think about strategy of becoming a higher-growth, less market-sensitive, and more nimble company, this clearly falls, as Caroline and I talked about, in the first and second buckets. So -- so, we are de-risking and have the risks and would consider further de-risking transactions if they made sense to stakeholders but, at the same time, using that as a way to pivot to becoming a higher-growth company." ] }, { "name": "Michael Ward", "speech": [ "Thank you. That's very helpful. Maybe on group insurance, hasn't gotten much airtime, results were pretty favorable, they have been for peers. Just curious if there's any sort of updated kind of, you know, annual go-forward earnings power for a group now?" ] }, { "name": "Caroline Feeney", "speech": [ "Yeah, so Mike, it's Caroline, and I'll take your questions. So, certainly, I'll start by saying it was indeed a great quarter for group insurance. And as Charlie mentioned upfront, we saw record earnings and an overall benefit ratio of 81%. That reflects the execution of our strategy of product and segment diversification and our continued focus on profitability. Total disability new business premiums grew 24% year to date compared to the same period last year.", "And our supplemental health business, a core component of our product diversification strategy, also saw strong double-digit growth. And our segment diversification strategy is focused on growing in the under 5,000 lives market. We've got great momentum with that segment now comprising about a quarter of our block. We're also pleased to be achieving that diversification and growth without sacrificing profitability and pricing discipline. The current quarter also reflects favorable mortality experience in the working-age population driven primarily from lower incidents and the impact from positive rate actions on renewals.", "And also, disability continue to see strong results as well. That was driven by lower incidents, strong employment numbers, and our continued focus on effective claim management. The disability benefits ratio we saw was our second-best reported ever, trailing only last quarter. So, moving forward, Mike, we are confident in our group business. We believe we're in a great position to continue executing on our strategy while continuing to grow in a disciplined and profitable manner.", "Because of this, you'll note that we've already increased our expectations for core earnings going forward." ] }, { "name": "Charlie Lowrey", "speech": [ "Hey, Mike, one other thing. It's Charlie. You know, we talk a lot about the investments we're making in technology, processes, infrastructure, and other things. And this is -- what's pleasing about this is that this is a tangible -- you can see a tangible outcome of some of the investments we're making, specifically in group this time.", "But -- but there are tangible outcomes we're beginning to see." ] }, { "name": "Michael Ward", "speech": [ "Thank you, guys. Appreciate it." ] }, { "name": "Operator", "speech": [ "Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Lowrey for any further closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "All right. Thank you again for joining us today. We are making progress, transforming Prudential to deliver sustainable long-term growth and to meet the evolving needs of our customers. We are confident that our strategy and mutually reinforcing business mix will enable Prudential to become a leader in expanding access to investing, insurance, and retirement security.", "Thank you again, and have a great day." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2021-08-04	[ { "description": "Vice President, Investor Relations", "name": "Darin Arita", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Controller and Principal Accounting Officer", "name": "Rob Axel", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "KBW -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Head, U.S. Businesses", "name": "Andy Sullivan", "position": "Other" }, { "description": "Autonomous Research -- Analyst", "name": "Erik Bass", "position": "Analyst" }, { "description": "Dowling & Partners -- Analyst", "name": "Humphrey Lee", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Andrew Kligerman", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Head, International Businesses", "name": "Scott Sleyster", "position": "Other" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Elyse Greenspan", "position": "Analyst" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "JPMorgan Chase & Co. -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Mike Ward", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by and welcome to Prudential's quarterly earnings conference call. [Operator instructions] As a reminder, today's call is being recorded. I'll turn the call now over to Darin Arita. Please go ahead." ] }, { "name": "Darin Arita", "speech": [ "Thank you, John. Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman; Andy Sullivan, head of U.S. businesses; Scott Sleyster, head of international businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer.", "We will start with prepared comments by Charlie, Bob, and Ken, and then we will take your questions. Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures.", "For a reconciliation of such measures to the comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-Looking Statements and Non-GAAP Measures in the appendix to today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com. With that, I'll hand it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Darin, and thanks to everyone for joining us today. As always, we hope you and your families remain safe and healthy. We reported strong financial results for the second quarter, reflecting robust investment performance and further progress in achieving our cost-savings target. We also made significant progress executing on our strategy to become a higher-growth, less market-sensitive and more nimble company.", "As an example, we announced an agreement to sell our full-service retirement business last month. Second, our cost-savings program is progressing well and is ahead of our original plan. And third, with the support of our rock-solid balance sheet, we are thoughtfully redeploying capital both by increasing capital return to shareholders and by selectively pursuing acquisition opportunities. I'll now provide an update on each of these strategic initiatives, beginning with our recent divestiture activity.", "Turning to Slide 3. Following the sale of our Korea business last year, we successfully closed on the sale of our Taiwan business during the second quarter. And in July, we announced an agreement to sell our full-service retirement business to Empower Retirement in a transaction which is expected to close in the first quarter of 2022. Including the announced full-service sale and the completed sales of our Korea and Taiwan businesses, we expect net proceeds of approximately $4.2 billion from these divestitures.", "Meanwhile, we continue to pursue opportunities to reduce the size of our legacy block of traditional variable annuities with guaranteed living benefits. Moving to Slide 4. As I mentioned earlier, we are progressing well and remain on track to generate $750 million of cost savings by the end of 2023. To date, we have achieved $515 million of run-rate cost savings, which exceeded our original target of $500 million, and did so 18 months ahead of plan.", "These savings include $130 million in the second quarter and a total of $240 million for the first half of 2021. We have also identified new cost savings to replace those we had not yet realized in our full-service retirement business, and as a result, continue to expect to generate $750 million of cost savings. Turning to Slide 5. These initiatives are complemented by our thoughtful approach to capital redeployment, including through increased shareholder distributions.", "Last month, when announcing our agreement to sell the full-service retirement business, we increased our share repurchase authorization by an additional $500 million, our second increase of this amount since the beginning of 2021. This brings our total shareholder distributions to a targeted $11 billion through the end of 2023, up from the $10 billion target we initially identified earlier this year. Year to date, we've returned $2.2 billion to shareholders, including $1.3 billion in the second quarter, comprised of $875 million in share buybacks and $460 million in dividend payments. In addition, consistent with our disciplined approach to capital management and guided by our philosophy of being prudent stewards of shareholder capital, we intend to reduce leverage and enhance our financial flexibility by redeeming $900 million of outstanding debt in the third quarter.", "Meanwhile, we are being disciplined in executing on our programmatic M&A opportunities as we have done in the past with a focus on higher-growth areas, including asset management and emerging markets. As evidence of this, earlier this year, our Africa joint venture partner closed on a minority stake in ICEA LION Holdings, a highly respected financial service market leader in Kenya with operations in Tanzania and Uganda. More recently, in July, PGIM announced a deal to acquire Montana Capital Partners, a European-based private equity secondaries asset manager, which will enhance PGIM's capabilities and further expand its $250 billion alternatives platform. These transactions are consistent with our strategy to add capabilities in PGIM and deepen our presence in emerging markets, enhancing our growth opportunity.", "Our capital deployment is supported by our rock-solid balance sheet, including highly liquid assets of $4.9 billion at the end of the second quarter and AA financial strength capital levels at our primary business subsidiaries. Before turning it over to Rob, I'd like to provide an update on our environmental, social, and governance commitments, which are integral to our business strategy and purpose of solving the financial challenges of our changing world. This quarter, I'll focus on our environmental commitments. Last month, we took an important next step to integrate our ESG and financial frameworks with the renewal of a standing $4 billion credit facility, which now directly links our financing costs to our progress in meeting previously established sustainability targets.", "These targets include reducing our greenhouse gas emissions as well as improving diverse representation among our senior ranks. We also continue to make strong progress against other goals outlined in our 2019 global environmental commitment, including investing in sustainable companies and projects, issuing our inaugural green bond last year, and by providing greater transparency around our general account investment allocations. We are also reducing our reliance on paper documentation both internally and in the volume of letters and other mailings shared with our customers. In partnership with American Forests, we aspire to significantly reduce our paper use by the end of 2022.", "We are committed to ensuring that sustainability runs through everything we do at Prudential. This also includes fulfilling the nine commitments to advance racial equity that we established one year ago this week, which are in addition to our ongoing diversity, equity, and inclusion efforts. I look forward to updating you next quarter on the progress of this work as well as on our other social commitments. With that, I'll turn it over to Rob for more specific details on our business performance." ] }, { "name": "Rob Axel", "speech": [ "Thanks, Charlie. I'll provide an overview of our financial results and business performance for PGIM, U.S., and international businesses. I'll begin on Slide 6 of our financial results for the second quarter. Our pre-tax adjusted operating income was $1.9 billion or $3.79 per share on an after-tax basis and reflected the benefit of strong markets, business growth, and lower-than-typical expenses, which exceeded the net mortality impacts from COVID-19.", "PGIM, our global asset manager, had record asset management fees driven by record account values of $1.5 trillion that were offset by lower other related revenues driven by a decrease in seed and co-investment income and higher expenses supporting business growth. Our U.S. Business results were more than double the year-ago quarter and reflected higher net investment spread results driven by higher variable investment income, higher fee income, primarily driven by equity market appreciation, and a more favorable impact from our annual assumption update, partially offset by less favorable underwriting experience driven by COVID-19-related mortality. And earnings in our international business have increased 16%, reflecting continued business growth, higher net investment spread results, lower expenses, and a more favorable impact of the annual assumption update.", "This increase was partially offset by lower earnings from acquired co-investment in our Chilean pension joint venture and less favorable underwriting results, primarily driven by higher COVID-19 claims in Brazil. Turning to Slide 7. PGIM continues to demonstrate the strength of its diversified active management platform as a top 10 global investment manager. PGIM's diversified global investment capabilities in both public and private asset classes across fixed income, alternatives, real estate, and equities position us favorably to capture flows.", "In addition, PGIM's investment performance remains attractive, with more than 93% of assets under management outperforming their benchmarks over the last three-, five- and 10-year periods. Our diversified capabilities and strong investment performance helped contribute to more than $5 billion of third-party net flows during the quarter driven by continued strong public fixed income flows with $5.6 billion of institutional flows, partially offset by modest retail outflows. These retail outflows reflected continued positive inflows into PGIM's mutual funds, offset by outflows from sub-advisory mandates in U.S. equities.", "As the investment engine of Prudential, PGIM also benefits from a mutually beneficial relationship with our U.S. and international insurance businesses. PGIM's asset origination capabilities and investment management expertise provide a competitive advantage, helping our businesses to bring enhanced solutions and more value to our customers. And our businesses, in turn, provide a source of growth for PGIM through affiliated flows that complement a successful third-party track record of growth.", "PGIM's asset management fees increased 16% compared to the year-ago quarter to a record level as a result of market appreciation and continued positive third-party net flows. This contributed to PGIM's adjusted operating margin of 33%, which is above our expectation of 30% across the cycle. Now turning to Slide 8. Our U.S.", "Businesses produced diversified earnings from fees, net investment spread, and underwriting income and benefit from our complementary mix of longevity and mortality businesses. We continue to strengthen our businesses, transform our cost structure and expand our addressable markets while shifting away from low-growth, capital-intensive and interest rate-sensitive products and businesses. Our product pivots have worked well, demonstrated by continued strong sales of our buffered annuity, FlexGuard, which were $1.5 billion in the second quarter, representing 87% of total individual annuity sales. Over the past three quarters, FlexGuard sales have totaled $4.3 billion.", "These sales reflect customer demand for investment solutions that offer the potential for appreciation from equity markets combined with downside protection. We have exercised discipline through frequent pricing actions, and our sales continue to benefit from having a strong and trusted brand and highly effective distribution team. Our Individual Life sales continued to be strong with higher variable life sales compared to the year-ago quarter, offset by lower sales of other policies, in particular universal life sales, consistent with our product pivot strategy. In group insurance, financial wellness capabilities are core to our business success and continue to differentiate our value proposition, enhance benefit participation and accelerate growth in our targeted markets.", "With respect to assurance, total revenues, our primary financial metric as we concentrate on scaling the business, were up 92% over the prior-year quarter. I would also note that similar to last year, we plan to increase the number of agents in the third quarter to help meet the seasonally higher expected demand of the Medicare annual enrollment period that occurs in the fourth quarter. Turning to Slide 9. Our international businesses include our Japanese life insurance operation, where we have a differentiated multichannel distribution model, as well as other operations, focused on high-growth markets.", "Sales across both Life Planner and Gibraltar operations held up well amid the state of emergency in Japan. Life Planner sales were 49% higher than the year-ago quarter, while Gibraltar sales were 33% higher than the prior year. We remain encouraged by the resiliency of our unique distribution capabilities, which have helped to continue the growth of our in-force business. And with that, I'll hand it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 10, which provides insight into earnings for the third quarter of 2021 relative to our second-quarter results. Pretax adjusted operating income in the second quarter was $1.9 billion and resulted in earnings per share of $3.79 on an after-tax basis. To get a sense of how our third-quarter results might develop, we suggest adjustments for the following items.", "First, our annual assumption update and other refinements resulted in a net charge of $34 million in the second quarter. Next, variable investment income outperformed expectations in the second quarter by $365 million. Third, underwriting experience is adjusted by a net $30 million. This adjustment includes a placeholder for COVID-19 claims experienced in the third quarter of $25 million for our U.S.", "Businesses based on 30,000 COVID-19-related fatalities in the U.S. and $20 million for our international businesses. While we have provided this placeholder for COVID-19-related underwriting experience for the third quarter, the actual impact will depend on a variety of factors, such as infection and fatality rates, geographic concentration, and the continued acceptance and effectiveness of the vaccine. Fourth, we expect earnings will be lower in the third quarter by $290 million, primarily due to the timing of expenses between the second and third quarters, and a make-whole fee of approximately $90 million associated with the previously announced redemption of $900 million of debt in the third quarter.", "This also includes the reduction in adjusted operating income from the sale of our full-service business, which will be reclassified to a divested business, as well as retained costs that will be reported in corporate and other. Last, we anticipate net investment income will be reduced by about $10 million, reflecting the difference between new money rates and disposition yields of our investment portfolio. These items combined get us to a baseline of $2.59 per share for the third quarter. I'll note that if we exclude items specific to the third quarter, earnings per share would be $3.", "The key takeaway is that our underlying earnings power has increased from last quarter as the benefits from business growth, our cost-savings program, and higher-equity markets more than offset the reduction in earnings from the sale of the full-service business. While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the third quarter. I would also note that with the debt make-whole fee and retained cost of Full Service, we now expect the full-year 2021 corporate and other loss to be about $1.65 billion. Turning to Slide 11.", "We continue to maintain a robust capital position and adequate sources of funding. Our capital position continues to support a AA financial strength rating, and we have substantial sources of funding. Our cash and liquid assets were $4.9 billion, which is greater than three times annual fixed charges. And other sources of funds include free cash flow from our businesses and other contingent capital facilities.", "The redemption of debt, as previously mentioned, will complete our plan to reduce financial leverage in 2021 and generate annual interest savings of approximately $30 million while also enhancing our financial flexibility for the future as we execute on our strategic transformation. Turning to Slide 12 and in summary. We are executing on divestitures. We are ahead of schedule on cost-savings initiatives.", "And with the support of our rock-solid balance sheet, we are thoughtfully redeploying capital. Now I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] And first, from the line of Ryan Krueger with KBW. Please go ahead." ] }, { "name": "Ryan Krueger", "speech": [ "Hi. Good morning. Could you provide an update on your progress toward a variable annuity transaction? And also, I think in the past, you had commented that the market tended to be interested in $1 billion to $2 billion in size VA transactions. Also curious if that's still the case." ] }, { "name": "Andy Sullivan", "speech": [ "Hi, Ryan. Good morning. It's Andy. I'll take your question.", "So let me start by reiterating what Charlie said in his prepared remarks at the top: we are committed to significantly reducing the earnings contribution from traditional variable annuities with guaranteed living benefits. And as you remember, we talked about this as a two-step process. Step one is runoff, and we expect about 40% to 45% of the earnings reduction will come from runoff. And we're executing on what we consider to be a highly successful pivot.", "If you look at this quarter, we had 0% of our sales in those legacy products, those traditional variable annuities. And we experienced $3.8 billion in runoff in those products in the quarter. And we've pivoted to products that are much better-balanced consumer value with shareholder value, and obviously, FlexGuard being the chassis product there, where we saw a 17% market share in the first quarter. And we were the No.", "2 provider of index variable annuity. So step one is all about runoff. Now having said that, step two is a transaction, and conducting a transaction does remain a priority for us. We have work in progress, and we're progressing that work forward.", "As you noted, I would say the $1 billion to $2 billion range, if you look at the tractions that we have done in the marketplace is a good precedent. And I would say that we continue to see tailwinds of capital coming toward the space. As we've articulated before, we have a very high-quality block of business. As always, as we continue to progress, we're going to be disciplined to make sure we only do things that are shareholder-friendly and have the right economics, much like you saw us do with the full-service transaction.", "So we're going to keep moving down the tracks, and we will share when we have something more to share." ] }, { "name": "Ryan Krueger", "speech": [ "Thank you. And a follow-up is other than variable annuities, what you've already said there and the full-service retirement sale, are there any other businesses that you'd consider divesting at this point?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yes, Ryan. It's Charlie. As Andy said and as I said in my opening remarks, we're making significant progress, I think, executing on becoming a higher-growth, less market-sensitive, and more nimble business. And this includes the announced full-service sale but also the completed sales of some of the things we've done before, including the sale of our Korea, Taiwan, Italy, and Poland businesses.", "So we'll continue to pursue opportunities to reduce the size of our legacy block, as Andy said, of traditional variable annuities with guaranteed living benefits. But as we've noted in the past, we're looking at life insurance blocks of business as well. So we've accomplished a significant amount, but we still have a lot more work to do. And we're going to be very thoughtful about how we execute on the dual goals of fulfilling our purpose on the one hand and creating value for shareholders on the other." ] }, { "name": "Ryan Krueger", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from Erik Bass with Autonomous Research. Please go ahead." ] }, { "name": "Erik Bass", "speech": [ "Hi. Thank you. Last night, we saw another jumbo PRT transaction, and one of your competitors is talking about this being potentially a record year for industry volumes. And Prudent has historically been the dominant competitor in the jumbo market.", "But now we've seen some others take the lead. So was just hoping you could talk about your appetite for PRT business going forward and the competitive dynamics in the market currently." ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Thanks, Erik. This is Andy. I'll take your question.", "And thank you for your recognition. We absolutely have been a pioneer and a leader in the space of pension risk transfer. We have a great brand. We have very strong capabilities, and we believe that we have a unique and distinguished track record of execution.", "We also are seeing strong market opportunity. The market size in the second quarter was about $4.5 billion. That was similar to what we saw in the first quarter. We expect the back half of the year to be very healthy.", "If you look at the average funding rate is 99%, and sponsors still have a high desire to transact. That being said, this has become a more competitive market, both from the perspective of the number of competitors competing in it but also the number of competitors that are seeking larger and larger deals. So very consistent to what we've told you in the past, we're going to be disciplined in our approach, and we're going to pick our spot. And that is what you're seeing from us, and you should expect to see quarter-to-quarter variation.", "But if you combine the strong pipeline that we see going forward with the strength of our business, number one, we feel comfortable we could take this approach; and number two, we expect that we'll be a net winner over time and experience good flows." ] }, { "name": "Erik Bass", "speech": [ "Thank you. And then next question is you highlighted two examples of programmatic M&A that you've done year to date. Can you give us a sense of how capital was allocated to these transactions? And will deals of this size be enough to meet your capital reallocation targets, or do you expect to potentially do something bigger?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yes. I'll jump in on that one. We're not going to talk about the specific size of some of these transactions. But it is fair to say that we are taking a very disciplined approach and balanced approach to M&A and that the -- and that with programmatic M&A, you can expect us to do more of this type of deal going forward." ] }, { "name": "Erik Bass", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Next, we'll go to Humphrey Lee with Dowling & Partners. Please go ahead." ] }, { "name": "Humphrey Lee", "speech": [ "Good morning, and thank you for taking my questions. Just a follow-up on M&A. I understand some of the transactions you've done year to date. But just thinking about the impact of the full-service sale and the stranded costs being left behind, is the priority going to be something focused more on the mature businesses that provide more solid earnings so that you can absorb and offset the stranded costs from the full-service sale?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yes. Humphrey, it's Charlie. Let me take that one. First of all, again, we're going to take a very disciplined and balanced approach to this.", "But when we think about acquisitions, we think about them both from a strategic and a financial perspective. Right? So from a strategic perspective, we look to add capabilities, such as product or distribution or increased scale in a market or country. And from a financial standpoint, we look at a variety of metrics when assessing potential acquisitions. And that can be earnings contribution, it can be growth.", "It's going to be a number of factors that we consider. But most importantly, our focus is on becoming a higher-growth, less market-sensitive, and more nimble business. And we're going to continue to be very thoughtful and disciplined about how we execute with the goal of creating value for shareholders." ] }, { "name": "Ken Tanji", "speech": [ "And maybe, Charlie, I'll just add, in terms of, Humphrey, what you described as stranded cost or the retained costs from the transaction. As we've sort of demonstrated across the company, we've made excellent progress in transforming our operations, gaining efficiencies but also including capabilities. We have an institutionalized process and structure, and it's accelerating our progress on our cost objectives. We're focused on meeting the cost-saving objectives of $750 million by 2023.", "And as we reallocate and redeploy capital, we'll look to reallocate overhead across our businesses as well." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. Shifting gears. So you talked about using some of the proceeds from the full-service sale to lower your leverage. Can you just talk about the rationale behind the decision since the sale doesn't really trigger any issue with your leverage, especially given the expected gain from the sale?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Humphrey, this is really part of our regular review of capital and liquidity profile. And given our current position, we thought it was a good time to redeem the debt. That redemption will have a near-term earnings benefit, but it's also going to provide debt capacity and flexibility for the future.", "So it really just reflects -- we thought it was a good way and a good time to reduce our debt in an efficient way." ] }, { "name": "Humphrey Lee", "speech": [ "OK. So I shouldn't read it as like a potential VA transaction that may have an impact on your book value? Or you maybe more leaning toward -- lever up down the road, but just your kind of periodic -- your regular review and just finding it's a good time right now?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Exactly. I think I don't -- I wouldn't connect it directly to any specific transaction. It's -- we're overall regularly reviewing where we are, and we thought it was a smart thing to do." ] }, { "name": "Humphrey Lee", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question is from Andrew Kligerman with Credit Suisse. Please go ahead." ] }, { "name": "Andrew Kligerman", "speech": [ "Hey. Good morning. I'm thinking about Assurance IQ and that superb 92% year-over-year growth in revenue. But then you had a loss pre-tax of about $38 million, which was up materially year over year.", "Could you talk a little bit about, a, the growth rate? Can you keep it at this pace? And b, when might we think about a time frame for when you get to breakeven?" ] }, { "name": "Andy Sullivan", "speech": [ "So thanks, Andrew. It's Andy. I'll take your question. As we've discussed in the past, we are very intentionally building out the business and the platform.", "And we're doing that because as we brought this business into Prudential, we saw just real opportunity and incredible customer demand. We saw, again, 7 million shoppers in the quarter, and we're looking at hundreds of thousands of policies that were going to have sold. And these are customers that we would have never reached at Prudential. So very much part of expanding our addressable market.", "As you look at those investments, there is, I'll call it, a J-curve to those investments, whereas we're adding agents, as an example, they will become more and more productive over time. And a number of these investments are fixed expense. So that's why we say the predominant metric is scale. We have to scale up to -- I'll use the word overcome, that fixed expense.", "And we're seeing great progress. That -- we're also -- we're very pleased with the $112 million and the 92% growth rate. We believe that we have a lot of continued room in front of us to grow. To specifically answer your question as to a specific time frame around achieving the long-term economics, we're not going to provide more exact guidance." ] }, { "name": "Andrew Kligerman", "speech": [ "OK. Fair. Yes. That was helpful.", "And the buffered annuity market, now that was, I think, 87% of your total segment sales there. Do you see a point where you could get to the volumes even of what you were doing on the legacy products? And how do you see the competition there? I mean it seems like a lot of players have been jumping into the buffered annuity market. Is that going to kind of impede your growth?" ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Thanks for the question on the buffered annuity market and on FlexGuard. Let me start by saying the driver of our success has a lot to do with we're a very well-established brand. That's very well respected.", "We have just an outstanding distribution system and distribution partners. And we came to market with a very differentiated product from the indexing strategy perspective. All of that has enabled us to have one of the best launches in probably the history of the industry. So we're very, very proud of it.", "The market itself is growing. So we're seeing more and more volume industrywide shift from more traditional-type product designs over to the index variable annuity area. And I would think of this as more of a chassis. It's really a pretty broad area of accumulation-oriented products that have upside and downside buffering.", "So we see a good bit of room still to run. Having said that, we have, at this time, rolled it out to all of our third-party relationships, and we're in all of our key geographies. So quite pleased with how we've done. As far as its ability to get to some of the very high levels that we saw five to 10 years ago, I'm not going to put a prediction on that." ] }, { "name": "Andrew Kligerman", "speech": [ "Thanks a lot." ] }, { "name": "Operator", "speech": [ "Our next question is from Tracy Benguigui with Barclays. Please go ahead." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. I have another Assurance IQ question. It looks like there is a changing of the guard. I understand the original founders are not there anymore and have left before a potential earnout, which would have been on meeting performance targets anyway.", "What is the new strategic direction under new management that we should anticipate?" ] }, { "name": "Andy Sullivan", "speech": [ "So thanks, Tracy. It's Andy. Let me hit the tail end of your question first. There is 0 change in strategic direction or change in strategy with the Assurance platform and with its fit with Prudential and what we're trying to accomplish.", "As you would expect, we have been adding to the team and deepening the talent as the business matures. You rightly identified, at the top of the house, Mike Rowell, Founder, has moved over to a strategic advisor role to me. That enables me to take a broader use of his experience and expertise. In addition to that, we promoted Allison Arzeno, who was the chief data scientist, to be the CEO.", "I'm very excited by that. She is a fantastic leader and has jumped in and has continued the momentum. The other thing I'd mention is we've been very pleased that through the combination of Prudential's brand and the unique and attractiveness of the Assurance platform, we've been able to attract top, top industry talent specifically for our product P&L roles. So as an example, we recruited a gentleman by the name of Chris [Inaudible], who has deep health expertise both in core health but also was a key leader at eHealth, and he's leading our Under 65 Health and Medicare Advantage.", "So we're pleased with the talent situation, and we're confident that we have the right team and the right talent to take it forth." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Great. Maybe moving on to your assumption update. I see that you did not change your long-term rate assumption, and I get that interest rates are at a higher spot now than this time last year.", "But I guess my thinking was that insurers would still want a grade into lower reversion in the main assumptions to prepare for LDTI. Is that part of your thinking at all, or is it more near term when you conducted your review?" ] }, { "name": "Ken Tanji", "speech": [ "Hi, Tracy. It's Ken. As you know and we've talked about, we have a very established process for setting our long-term rate assumptions. And in doing so, we look at a variety of forecast for long-term rates both internally and externally.", "And when we did that this year, we saw very little movement in those forecasts. And therefore, we didn't see it appropriate to change our long-term rate assumptions. So we look at it very consistently the way we've done it in the past. In terms of long-duration target improvements, that's still a year and a half away.", "But we're making great progress in implementing that, and we'll be ready to adopt that on time. But it won't be a transition. It's an adoption date, and that's the method that we think is appropriate." ] }, { "name": "Tracy Benguigui", "speech": [ "OK. Great. Thank you." ] }, { "name": "Operator", "speech": [ "Next, we'll go to Tom Gallagher with Evercore ISI. Please go ahead." ] }, { "name": "Tom Gallagher", "speech": [ "Hey, Charlie. When you mentioned you were looking at life insurance risk transfer deals as well as VA, can you provide a little bit of color on the process here? Is that a dual-track process, where you're sort of simultaneously looking at both VA and life deals so you could get either/or transaction and the timing is unclear between the two? Or any way of sort of handicapping whether you're more likely to do life insurance over VA first? And then just relatedly, now that you do have those two lines you're looking specifically at doing risk transfer on, are we now looking closer to maybe the high end of the $5 billion to $10 billion of freeing up of capital that you guys have laid out?" ] }, { "name": "Charlie Lowrey", "speech": [ "So let me start and then Rob can elaborate. So right now, we said that we're at sort of $4.2 billion if you include Korea, Taiwan, and the full-service business. We won't make predictions. We've said $5 billion to $10 billion because we're going to take a very prudent approach to doing this.", "We don't have to do anything. But if it makes sense for shareholders, we will do things. And we'll see where we fall out in there. But that's an intentionally wide band.", "In terms of annuities versus life insurance, I think we have said that we're focused on annuities right now, but we will also think about life insurance as we go forward. Rob, do you want to add to that?" ] }, { "name": "Rob Axel", "speech": [ "Yes. Just, Tom, that we have distinct teams focused on each of those initiatives. But as Charlie indicated, the more important initiative from the standpoint of the impact, we believe, on valuation to shareholders -- overall valuation of the company is to get the VA transaction done first. And so it's been a priority but not necessarily to the detriment of having resources that are dedicated to looking at the opportunities within the life sector as well." ] }, { "name": "Tom Gallagher", "speech": [ "OK. That's helpful, guys. Thanks. Just a quick follow-up.", "Based on the guidance you've given out for 3Q, it looks like you're estimating virtually all of the COVID impacts are going to come on group and not Individual Life. Is that what you saw in this quarter also? And you could provide a little color about what you're seeing from COVID impacts for group versus individual." ] }, { "name": "Andy Sullivan", "speech": [ "Yes. Tom, it's Andy. I'll take your question. So we saw in second-quarter COVID mortality impacts in both Individual Life Insurance and Group Insurance.", "And going forward for 3Q, similarly, overall, we estimate that we will continue to see impact from COVID mortality in both Group Insurance and Life. But I would note that, that COVID impact and trend is beginning to moderate as we go into 3Q. I think what you're picking up there in ILI is like the COVID impact is being partially offset by the fact that third quarter is the highest quarter for our seasonal underwriting results. So that's why that looks a little different in the exhibit." ] }, { "name": "Scott Sleyster", "speech": [ "And, Tom, this is Scott. On the international front, we're continuing to see really modest impacts across the board in Japan. We are seeing more of our impact in our Brazil operations. And similar to the U.S., we are seeing a mix across both group and individual lines." ] }, { "name": "Tom Gallagher", "speech": [ "OK. Thanks, guys." ] }, { "name": "Operator", "speech": [ "And next, we'll go to Elyse Greenspan with Wells Fargo. Please go ahead." ] }, { "name": "Elyse Greenspan", "speech": [ "Hi. Thanks. Good morning. My first question, when you guys announced the full-service sale, you did up your buyback by $500 million for this year.", "So as we think about additional transactions with VA and perhaps Life Insurance, should we think about some portion of the capital potentially going to incremental repurchases as well as for the M&A bucket?" ] }, { "name": "Charlie Lowrey", "speech": [ "Yes, Elyse. It's Charlie. I'll take your question. we've said all along, we want to be good stewards of capital.", "And we have and will continue to demonstrate a disciplined and a balanced approach to the redeployment of capital within our businesses and to our shareholders. So that's the overriding concept. And to date, we've already returned a significant amount of capital to shareholders. We've returned over $2 billion and have increased both the dividend and the share repurchase authorization.", "So we plan over the next three years or through the end of 2023 to return $11 billion of capital. But stepping back, let me share with you how we think about capital allocation, and in particular optimization of that capital because we look across all our businesses, both domestically and internationally, to ensure that we're optimizing capital deployment. And we'll continue to look for ways to optimize that capital to maximize outcomes for shareholders. And as we've stated, to the extent we cannot find attractive capital deployment opportunities to meet our strategic and financial criteria, then we'll return excess capital to shareholders, as you've seen us do in the past." ] }, { "name": "Elyse Greenspan", "speech": [ "That's helpful. And then when we think about corporate costs, I guess I'm thinking more beyond 2021, going into 2022 and 2023. Can you give us a sense of how corporate costs could come in as you think about both implementation costs and how we should see those trending in the out-years and then also the stranded costs from the full-service retirement business? So I know the guys -- so it was $1.5 billion up this year, but how should we think about corporate costs over the last couple of years?" ] }, { "name": "Ken Tanji", "speech": [ "Elyse, it's Ken. As I mentioned earlier, we're making great progress with our transformation effort, including gaining efficiencies. And it is an ongoing and institutionalized and continuous improvement process at this point. So we continue to expect to make progress toward our $750 million cost-savings objective by 2023, and we think we're well on track to continue with that.", "Again, as we reallocate capital and redeploy capital, we'll reallocate some of our overhead costs, and you can expect that to continue as well. So overall, we continue to make good progress with our cost objectives. I think you should expect us to continue to make progress like we have in the past." ] }, { "name": "Elyse Greenspan", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "And our next question is from John Barnidge with Piper Sandler. Please go ahead." ] }, { "name": "John Barnidge", "speech": [ "Thank you. With the group disability loss ratio coming down for two straight quarters, how should we be thinking about the relationship with the administrative expense ratio as that's been elevated for a few quarters to handle those increased cases?" ] }, { "name": "Andy Sullivan", "speech": [ "So thanks, John. It's Andy. Yes,. As you rightly noted, we have had enhanced staffing levels in our group insurance business.", "I think we talked about this on previous quarters. Given the nature of the pandemic and the morbidity effects, we have seen an enhanced level of STD and absence claims. And we've been maintaining higher staffing levels to make sure that we provide the right level of service. We also have been making sure that we maintain our long-term disability claims staff at higher levels.", "So you're definitely seeing that as a contributor to the elevated administrative ratio. The other thing I would mention is, and we've talked about this on previous conversations, we have entered into a strategic relationship with Accenture to do some of the operations for us. And the nature of that, we are implementing that as we speak. And there's some transition costs basically that are doubling up.", "But that's a onetime effect. And over time, we expect everything we're doing in our group business will bring down the admin ratio as part of our transformation efforts." ] }, { "name": "John Barnidge", "speech": [ "OK. And then second question, have you developed a sense of maybe vaccination rates of insured life blocks versus that of general population?" ] }, { "name": "Charlie Lowrey", "speech": [ "Generally, John, we believe that the vaccination rate of the insured population is higher than the general population. And that reflects a variety of factors between age, geography, and a number of things. But yes, we generally feel that the insured population has a higher vaccination rate." ] }, { "name": "John Barnidge", "speech": [ "Thanks for the answers." ] }, { "name": "Operator", "speech": [ "Next, we'll go to Jimmy Bhullar with J.P. Morgan. Please go ahead." ] }, { "name": "Jimmy Bhullar", "speech": [ "Good morning. First, I had a question on your Japan -- your outlook for the operating environment in Japan. Your sales were obviously pretty strong in 2Q, but it was mostly because of easier comps. To what extent are you seeing an improvement in trends in the market as businesses are opening up versus sort of ongoing challenges given the increase in the case count in the country?" ] }, { "name": "Scott Sleyster", "speech": [ "Thanks, Jimmy. This is Scott. As you pointed out, current quarter sales were well ahead of the prior year, but that was significantly impacted by COVID really ramping up at that time. But this quarter was only slightly below the first quarter.", "And as you know, our typical first-quarter sales are quite strong because that's when we're closing out our annual incentive measurement cycle. Although the situation with COVID and its related impacts remains fluid, dynamic, whatever you want to call it, we are pleased with our strong underlying business performance this quarter, particularly considering the ongoing challenges of the global pandemic. The demand for our products remain strong, I'd even say somewhat elevated because of awareness of threatening life issues. And we continue to focus in Japan on our needs-based selling approach, and that's anchored by recurring premium death protection.", "And then we add on to that supplemental other products like accident, health, and retirement to meet our evolving customer needs. Our operations are also increasing and enhancing and adapting to the use of digital and virtual tools to support sales activities amid the social distancing restrictions. So that -- maybe that's a longer answer than you wanted. I would say we feel pretty good about the level that we're at.", "We feel that we've adapted to the technology. I have to acknowledge that it is so difficult to recruit at past levels in both LPs and LCs amid the COVID environment. But right now, we feel pretty good -- actually quite good about how the business is performing in Japan." ] }, { "name": "Jimmy Bhullar", "speech": [ "Thanks. And on Assurance, when you had announced the deal, I think you had mentioned that there was the potential for up to $1.2 billion of earnouts. Can you discuss how results have tracked versus the metrics that the business would have had to hit for the earnout payments?" ] }, { "name": "Ken Tanji", "speech": [ "Hey, Jimmy. It's Ken. When we set that earnout, you may recall that it was above what we set as a baseline for the performance of the business. It was to provide compensation if they were to exceed our original expectations.", "So that's the way we thought about when we did the deal, and that continues to be the way that earnout is positioned." ] }, { "name": "Jimmy Bhullar", "speech": [ "But you're not -- I'm assuming that you don't think that the likelihood of you having to pay anything out is high. Right?" ] }, { "name": "Ken Tanji", "speech": [ "Again, it was there to provide upside if they outperformed our expectations, and that's still the way it's designed." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. And when can you -- so when would you have clarity on whether or not you're going to have to pay anything?" ] }, { "name": "Ken Tanji", "speech": [ "It extends to the end of next year. So we're midway through it at this point." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. And is it based on the results so far? Any color on like yes or no or sort of how that will go?" ] }, { "name": "Ken Tanji", "speech": [ "I think we've been -- Jimmy, I think we've been pretty transparent with the results so far. They're separately disclosed, so you can evaluate them for yourself." ] }, { "name": "Jimmy Bhullar", "speech": [ "Got it. OK. Thank you." ] }, { "name": "Operator", "speech": [ "And next, we'll go to Mike Ward with UBS. Please go ahead." ] }, { "name": "Mike Ward", "speech": [ "Hi. Good morning. Thanks for taking my question. I was just wondering on the retirement segment net flows.", "There was some pressure. My understanding is that it's being driven in part by some seasonality in PRT flows coming through mostly in the second half. So I guess what I'm just wondering is, should we be thinking about that phenomenon becoming more prevalent going forward with Full Service being divested?" ] }, { "name": "Andy Sullivan", "speech": [ "So, Mike, it's Andy. I'll take your question. As I think you're aware, the PRT and LRT business, they're transaction-oriented businesses, which means by definition, on the sales inflow side, that it's going to be episodic. But on the outflow side, it's going to be more steady and consistent.", "And we obviously have pretty large blocks given our past success. So I do think it's right to think of that, that will produce quarter-to-quarter variation. But I would repeat what I said earlier in the call: we are a pioneer and a leader in this. It has been quite competitive, and we plan to be disciplined.", "But given the opportunities in front of us and given the strength of our platform, we think over the long term, we'll see good flows and we'll be in that winner." ] }, { "name": "Mike Ward", "speech": [ "Great. Thanks. That's helpful. And then I was just wondering about the organic earnings mix change within the transformation, specifically annuities.", "I know you've mentioned the natural VA value running off, but just wondering what we should be thinking for the trend in the dollar amount of earnings from annuities organically. Do you have a placeholder that you used to think about what you expect just from the trend in organic earnings from annuities ex any deals?" ] }, { "name": "Andy Sullivan", "speech": [ "So sorry --" ] }, { "name": "Charlie Lowrey", "speech": [ "Andy, go ahead." ] }, { "name": "Andy Sullivan", "speech": [ "OK. So, Mike, what I would say is we expect that -- as we said, we're going to be very committed to reduce the earnings for traditional variable annuities and that the runoff effect is -- will produce 40% to 45% of the overall result. And obviously, we would look to do transactions to get the remainder of the impact." ] }, { "name": "Rob Axel", "speech": [ "So Mike, it's Rob. The -- I think the number that we've given out is that the legacy book runs off at about $3 billion a quarter. And so you can use that as a sort of a metric for thinking about that runoff against the sales that we're doing on our newer products, which are less market-sensitive and very attractive from a return profile. You can look at the offset between those two to get a sense for how the earnings profile would run off absent anything happening with markets.", "Obviously, what you've seen is despite that net runoff, our accounts are up as a result of continued depreciation in the market." ] }, { "name": "Mike Ward", "speech": [ "Thanks very much." ] }, { "name": "Operator", "speech": [ "And with no further questions, I'll turn the call over to Charlie Lowrey for closing remarks." ] }, { "name": "Charlie Lowrey", "speech": [ "All right. Thank you very much. Thank you for joining us today. I hope our performance this year, the progress we're making on repositioning the portfolio, advancing our cost-savings program, and our thoughtful consideration to capital deployment confirms that our strategy to transform Prudential remains on track.", "We will continue to act with conviction and with speed to evolve our company and deliver greater financial opportunity to all of our stakeholders. We look forward to keeping you updated on our progress, and thanks again for your time today." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
PRU	2023-11-02	[ { "description": "Vice President, Investor Relations", "name": "Bob McLaughlin", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Charlie Lowrey", "position": "Executive" }, { "description": "Vice Chairman", "name": "Rob Falzon", "position": "Other" }, { "description": "Chief Financial Officer", "name": "Ken Tanji", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "Tom Gallagher", "position": "Analyst" }, { "description": "Keefe, Bruyette and Woods -- Analyst", "name": "Ryan Krueger", "position": "Analyst" }, { "description": "Controller and Principal Accounting Officer", "name": "Rob Axel", "position": "Executive" }, { "description": "Piper Sandler -- Analyst", "name": "John Barnidge", "position": "Analyst" }, { "description": "Head of International Businesses", "name": "Andy Sullivan", "position": "Other" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Wes Carmichael", "position": "Analyst" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Jimmy Bhullar", "position": "Analyst" }, { "description": "Head of U.S. Businesses", "name": "Caroline Feeney", "position": "Other" }, { "description": "Barclays -- Analyst", "name": "Tracy Benguigui", "position": "Analyst" }, { "description": "Raymond James -- Analyst", "name": "Wilma Burdis", "position": "Analyst" }, { "description": "Jefferies -- Analyst", "name": "Suneet Kamath", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Mike Ward", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for standing by, and welcome to Prudential's quarterly earnings conference call. At this time, all participants have been placed in a listen-only mode. Later, we'll conduct a question-and-answer session. Instructions will be given at that time.", "[Operator instructions] As a reminder, today's call is being recorded. I will now turn the call over to Mr. Bob McLaughlin. Please go ahead." ] }, { "name": "Bob McLaughlin", "speech": [ "Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, chairman and CEO; Rob Falzon, vice chairman and head of international businesses; and PGIM, our global investment manager; Caroline Feeney, head of U.S. businesses; Ken Tanji, chief financial officer; and Rob Axel, controller and principal accounting officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions.", "Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measure and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slides titled Forward-Looking Statements and Non-GAAP Measures in the appendix of today's presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.", "And now, I'll turn it over to Charlie." ] }, { "name": "Charlie Lowrey", "speech": [ "Thank you, Bob, and thanks to everyone for joining us today. Our third-quarter results reflect continued momentum across our businesses, including the benefits from strong sales and the fifth consecutive quarter of underlying earnings growth. We continue to execute on our strategy to become a higher growth, less market-sensitive and more nimble company. This quarter, we increased our capital efficiency and enhanced our capabilities in mutually reinforcing business system.", "We are also optimizing our operating model to drive both efficiency and growth. Our strategic progress and financial strength position us well to navigate the current macroeconomic environment and maintain a disciplined approach to capital deployment. Turning to Slide 3. During the quarter, we launched Prismic, a life and annuity reinsurance company alongside Warburg Pincus and other investors.", "It is one of our most exciting opportunities to drive sustainable long-term growth across our investment management, insurance, and retirement businesses. Through Prismic, we can ensure portions of our life and annuity in-force and new business to reduce market sensitivity, free up capital, and invest in growth opportunities. Prismic can also offer its services to other insurance companies in need of reinsurance support, tapping into additional sources of third-party capital to drive further growth. In addition, Prismic expands PGIM's assets under management.", "Prismic is a great example of how Prudential can unlock value for customers, shareholders, and other stakeholders with our mutually reinforcing business system, which combines the power of our brand, global asset and liability origination capabilities, and multichannel distribution. We're also growing and investing in our businesses to better serve our customers through both the products and services we offer and through the ways we do business. Our distribution channels continue to evolve and expand to provide more people around the world with our products and services in the way they want them. I'll provide a few examples from the third quarter.", "In Brazil, we achieved the second consecutive quarter of record sales, driven by continued expansion in the third-party distribution channel and the strong performance of our life planner channel. In the U.S., individual retirement strategies posted its strongest sales quarter in three years, driven by the continued success of FlexGuard as well as the expansion of our fixed annuity suite with the launch of our new WealthGuard multiyear guaranteed annuity. Within the institutional market, retirement strategy secured $2.5 billion in new pension risk transfer transactions and entered the health savings account space by securing a $1.2 billion transaction with a top HSA provider, expanding our addressable market. And in our Prudential Advisors distribution channel, we announced a strategic relationship with LPL Financial, which upon completion in the latter part of next year, will enhance both our advisor and customer experience by leveraging LPL's expertise, industry-leading technology, and robust broker, dealer, and registered investment advisor services.", "Alongside these investments in our businesses, we continue to focus on customer service through enhanced sales, service, and claims platforms. For example, this year, we have announced seven customer experience technology partnerships within group insurance. These include Enrollify, an innovative platform transforming the enrollment experience for millions of employees, and EvolutionIQ, an AI-driven platform that will streamline the disability claims process. We're also working to create a leaner, faster, and more agile company so that we can better meet the changing needs and expectations of our customers around the world while driving growth and efficiency to further strengthen our competitive position.", "We're taking new steps to simplify our organizational structure by reducing management layers, complexity, and costs while making investments in technology and data platforms. Our goal is to empower faster decision-making and bring our integrated business teams closer to our customers and clients. Turning now to Slide 4. Prudential's rock solid balance sheet and robust risk and capital management frameworks have allowed us to confidently navigate the current macroeconomic environment.", "Our AA financial strength is supported by our strong capital position, including approximately $48 billion of unrealized insurance margins, $4.3 billion in highly liquid assets at the end of the third quarter, and a high-quality, well-diversified investment portfolio and disciplined approach to asset liability management. Moving to Slide 5. Our disciplined approach to capital deployment, coupled with the added capital efficiency from the Prismic transaction, enables us to effectively balance investing in the long-term growth of our businesses with returning capital to shareholders. In the third quarter, we returned over $700 million of capital to shareholders.", "And with that, I'll turn it over to Rob." ] }, { "name": "Rob Falzon", "speech": [ "Thank you, Charlie. I'll provide an overview of our financial results and business performance for our PGIM, U.S., and international businesses. I'll begin on Slide 6 with our financial results for the third quarter of 2023. Our pre-tax adjusted operating income was $1.6 billion or $3.44 per share on an after-tax basis, up 45% from the year-ago quarter.", "These results reflect underlying business growth, including the benefits from a higher interest rate environment, more favorable variable investment income and underwriting experience, partially offset by lower fee income. Our GAAP net loss was $2.1 billion lower than our after-tax adjusted operating income, primarily driven by mark-to-market losses on interest rate derivatives due to the higher rates. Turning to the operating results from our businesses compared to the year ago quarter. PGIM, our global investment manager, had lower other related revenues driven by lower agency and seed and co-investment earnings and higher expenses.", "Results of our U.S. businesses primarily reflected higher spread income, including more favorable variable investment income and lower expenses, partially offset by lower fee income. And the increase in earnings in our international businesses primarily reflected higher spread income. Turning to Slide 7.", "PGIM, our global active investment manager, has diversified capabilities in both public and private asset classes across fixed income, equities, and alternatives. PGIM's long-term investment performance remains attractive with 80% or more of assets under management outperforming their benchmarks over the last five- and 10-year periods. In addition, our short-term performance continues to improve with 83% of assets exceeding their benchmarks over a one-year period. PGIM experienced third-party net outflows of $5.7 billion in the quarter.", "Institutional outflows were primarily driven by lower than normal fixed income inflows and a large client outflow. Retail outflows were driven by sub-advised equity mandates. As the investment engine of Prudential, the success and growth of PGIM and of our U.S. and international insurance and retirement businesses are mutually reinforcing.", "PGIM's asset origination capabilities, investment management expertise, and access to institutional and other sources of private capital, including through the recently launched reinsurer of Prismic, our competitive advantage, helping our businesses bring enhanced solutions and create more value for our customers. Our insurance and retirement businesses, in turn, provide a source of growth for PGIM through affiliated net flows as well as unique access to insurance liabilities. In addition, we continue to grow both organically and through acquisitions our private alternatives and credit business, which has assets of approximately $230 billion across private corporate and infrastructure credit, real estate equity and debt, and secondary private equity. Capital deployment across PGIM's private assets platform of $8 billion during the quarter benefited from robust private placement and direct lending originations.", "Turning to Slide 8. Our U.S. businesses produced diversified earnings from fees, net investment spread and underwriting income and benefit from our complementary mix of longevity and mortality businesses. We continue to drive toward a higher value, higher growth, and less market-sensitive mix of earnings, invest in our businesses to deliver best-in-class customer experiences and expand our addressable market with new financial solutions leveraging the capabilities across Prudential.", "Retirement strategies generated strong sales of $6.7 billion in the third quarter across its institutional and individual lines of business. Our institutional retirement business has leading market capabilities, which helped to produce third-quarter sales of $4.7 billion, including $2.5 billion of pension risk transfer transactions as well as strong stable value sales. Individual retirement posted $2 billion in sales, up 40% from the prior-year quarter. Our product pivots have resulted in continued strong sales of FlexGuard and FlexGuard income, which represented about two-thirds of sales and fixed annuities that accounted for approximately one-third of sales this quarter.", "Our individual life sales increased 24% from the year-ago quarter, reflecting our earlier product pivot strategy with variable life products representing approximately 73% of sales in the quarter, including the benefit from our recently launched FlexGuard life product. And in group insurance, we continue to execute on our strategy of product and client segment diversification while leveraging technology to increase operating efficiency and enhance the customer experience. Our strong results this quarter included favorable group life underwriting experience, which resulted in a benefit ratio of 82.4%. Turning to Slide 9.", "Our international businesses include our Japanese life insurance companies where we have a differentiated multichannel distribution model as well as other businesses aimed at expanding our presence in targeted high-growth emerging markets. In Japan, we are focused on providing high-quality service and expanding our distribution and product offerings. Our needs-based approach and protection product focus continue to provide important value to our customers as we expand our product offerings to meet their evolving needs. During the third quarter, we launched a new U.S.", "dollar indexed annuity product, and Prudential of Japan was ranked as the No. 1 Japanese life insurer in the Forbes world best life insurance companies this year. We are proud to be recognized for the value we provide to our customers. In emerging markets, we are focused on creating a select portfolio of businesses in regions where our customer needs are growing, where there are compelling opportunities to build market-leading businesses, and where the Prudential enterprise can add value.", "Our international business sales were up 19% compared to the year-ago quarter. Life planner sales were up 18%, driven by our second consecutive quarter of record sales in Brazil as well as higher sales in Japan. Gibraltar sales were up 20%, primarily driven by growth in the bank channel. As we look ahead, we are well positioned to cross our businesses to be a global leader in expanding access to investing insurance and retirement security.", "We continue to focus on investing in growth businesses and markets, delivering industry-leading customer experiences and creating the next-generation of financial solutions to serve the diverse needs of a broad range of customers. And with that, I'll now turn it over to Ken." ] }, { "name": "Ken Tanji", "speech": [ "Thanks, Rob. I'll begin on Slide 10, which provides insight into earnings for the fourth quarter of 2023 relative to our third-quarter results. As noted, pre-tax adjusted operating income in the third quarter was $1.6 billion and resulted in earnings per share of $3.44 on an after-tax basis. To get a sense of how our fourth-quarter results might develop we suggest adjustments for the following items: First, variable investment income was below expectations in the third quarter by $25 million.", "Second, we adjust underwriting experience by $10 million to normalize for third-quarter experience. And last, we include an adjustment of $350 million for expenses and other items. This includes elevated seasonal expenses and lower international earnings due to timing of seasonal premiums in the fourth quarter. In addition, as Charlie mentioned, we are implementing changes to our organizational structure as part of our continuous improvement process, and we have included an estimated restructuring charge of approximately $200 million that will be incurred in the fourth quarter.", "We expect these actions will create operating efficiencies and provide reinvestment capacity to build capabilities. This will allow us to realize additional efficiencies, strengthen our competitiveness, and fuel future growth. These adjustments combined get us to a baseline of $2.75 per share for the fourth quarter. I'll note that if you exclude items specific to the fourth quarter, earnings per share would be $3.48.", "The key takeaway is that our underlying earnings power continued to improve due to business growth, including the benefit of higher interest rates. While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the fourth quarter. Turning to Slide 11. Our capital position continues to support our AA financial strength rating.", "Our cash and liquid assets were $4.3 billion within our liquidity target range of $3 billion to $5 billion. Regulatory capital ratios are above our targets, and we have substantial off-balance sheet resources, including approximately $9 billion of contingent capital and liquidity facilities. We remain thoughtful in our capital deployment, balancing the preservation of financial strength and flexibility, investment in our businesses for long-term growth, and shareholder distributions. Turning to Slide 12 and in summary.", "We are transforming our business for sustainable growth. We continue to navigate the current macro environment with the financial strength of our rock solid balance sheet, and we are maintaining a balanced and disciplined approach to capital deployment. Now, I'll turn it to the operator for your questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We'll now be conducting a question-and-answer session. [Operator instructions] And please ask one question and one follow-up. Our first question is coming from Tom Gallagher from Evercore ISI.", "Your line is now live." ] }, { "name": "Tom Gallagher", "speech": [ "Good morning. Just a couple of questions on capital. Did the GAAP net income loss you had this quarter also impact statutory capital at all? And if so, did that require any contributions to subsidiaries or otherwise?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah. Hey, Tom, it's Ken. Our GAAP results included the mark-to-market on interest rate hedges, and a portion of that increased our negative IMR balance for stat. But our RBC ratios remain above our target and didn't require a capital contribution." ] }, { "name": "Tom Gallagher", "speech": [ "OK. Thanks, Ken. And then the follow-up is when I think about the transition that lies ahead to ESR from SMR in Japan, do you have enough clarity at this point to know how you should be positioned? Is it likely to consume capital, release capital? What do you think it should mean for Pru?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. Sure. First, let me start with our Japan businesses financial profile, which the businesses are high quality profitable, financially strong, generating earnings, strong earnings, and have good solvency margin ratios under the current regime. The FSA is taking steps to implement new capital standards, and that's underway with adoption still now a couple of years away.", "But generally, we still believe our businesses are well capitalized, financially strong, and that would be evident under any reasonable capital standard. We also have ways to manage the outcomes. We can reinsure business internally or externally to better match the economics of the business if we need to do that. And so, we're -- it's something that we're looking at and working on.", "We're also advocating for reasonable and responsible standards, and we'll have strategies to adapt to the new potential regime." ] }, { "name": "Tom Gallagher", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Your next question is coming from Ryan Krueger from KBW. Your line is now live." ] }, { "name": "Ryan Krueger", "speech": [ "Hi, good morning. My first question was on the restructuring charge. Can you talk a little bit about the potential economic benefits of that on a go-forward basis in terms of potential expense reduction?" ] }, { "name": "Charlie Lowrey", "speech": [ "Hey, Ryan, it's Charlie. Let me take that at a high level and provide you some context and then turn it over to Ken to specifically answer your question. But in terms of the restructuring program, we made good progress toward becoming a higher growth, less market-sensitive and more nimble company. And if you think about what we've done, that's including releasing a significant amount of capital through the disposition of market-sensitive and/or low-growth businesses and products executing a series of programmatic acquisitions to expand our investment capabilities and growth potential.", "Launching Prismic, another arrow in our quiver, if you will, enhancing our mutual reinforcing business system and then exceeding our initial expense goal that we established a number of years ago. But we've also said that we plan to continuously improve and build upon the progress we've made to further accelerate our vision and our growth objectives. We operate in an increasingly competitive environment. And in order to remain competitive and grow sales and earnings, we will continue to focus on further investing in our businesses and technology, reducing our cost of capital, enhancing the risk-adjusted returns we earn on our products and investments, and transforming our operations to produce efficiencies while enhancing both our customer and employee experience.", "So, we're taking steps to create a leaner, faster, and more agile company, including simplifying our management structure by reducing management layers, complexities, and costs with the goal of bringing our integrated teams closer to our customers and our clients. We're also empowering our employees with faster decision-making in part through investments in technology and data platforms. And as we make progress in each of these areas, we'll update you as we have in the past. So, with that as context, Ken, let me turn it over to you to answer the specific question Ryan had." ] }, { "name": "Ken Tanji", "speech": [ "Yes. So, I think, Ryan, we expect, as you just heard from Charlie, a number of benefits in the way we're transforming but also financially, the restructuring will result in annual cost savings that will be greater than the restructuring charge of 200 million. And those savings will provide expense capacity to invest in capabilities and gain further efficiencies sort of, as Charlie described there, to help offset inflation and also to grow our businesses. And the way we think when we put that all together is we'll be keeping expenses flat over the near term.", "And that's, again, how we think of things holistically, not just the saves but also combined with the investments in growing our businesses while keeping operating expenses flat and improving margins. And that's the continuous improvement mindset that we're striving for." ] }, { "name": "Ryan Krueger", "speech": [ "Thank you. And then a question on Prismic. You've launched it with $1 billion of capital. I assume that the structured settlements transaction consumed a good amount of that.", "Can you give us any color on how much committed capital that you have already in place for future growth?" ] }, { "name": "Rob Axel", "speech": [ "Ryan, Rob. Maybe let me give a perspective about that. If you're asking that from the perspective of sort of the Prismic standpoint in terms of the appetite there, a couple of thoughts. One is, as Charlie actually indicated in opening remarks, we see very interesting opportunities, growth opportunities that are at the intersection of asset management and insurance, and we expect Prismic to play a material role in executing against that.", "And we think the benefit of that is it's going to actually accelerate growth across all of our businesses. And in the course of doing so, actually helped to shift the business mix so that it's higher growth, less market-sensitive, and more highly valued at the end of the day. With respect to Prismic itself, I think what we've articulated before is that we and our investors share operations that go well beyond the initial $10 billion structured settlement transaction. So, we anticipate that that will include opportunities to further optimize our balance sheet.", "It's going to include what's called flow. So, the reserve and capital financing for our new sales across our businesses. And importantly, third-party blocks that will be -- we're looking to reinsure into Prismic as well." ] }, { "name": "Ryan Krueger", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from John Barnidge from Piper Sandler. Your line is now live." ] }, { "name": "John Barnidge", "speech": [ "Great. Thank you very much. Appreciate the opportunity. The restructuring program, you talked about a portion being there to invest.", "Can you talk about human capital versus automation and then the offshoring opportunity as well? Thank you." ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. It's Charlie again. As part of the continuous improvement process, we'll be simplifying our operating model and organizational structure, as you said, really streamlining decision-making to create a leaner, faster, and more agile company, so we can better meet the needs -- better meet the needs of our customers while driving growth and efficiency. So, we are far more focused on optimizing organizational structure through organizational design and investments in technology as opposed to offshoring.", "That is the predominant direction in which we're going." ] }, { "name": "John Barnidge", "speech": [ "Fantastic. Thank you. And my follow-up question, can you maybe talk about M&A interest? Do you have what you need to grow organically from a product perspective? And is there opportunities for PGIM to get larger in certain products? Thank you." ] }, { "name": "Charlie Lowrey", "speech": [ "Yeah. It's Charlie again. Let me take that. We've done many acquisitions that have significantly grown the company over time.", "And these acquisitions include companies of various sizes as well as teams of specialists. And programmatic M&A, to your point, will continue to play a role as we think about the development of the -- of what we want to do going forward and a series of well-executed programmatic M&A transactions will become material over time. As a result, we continue to look at a variety of opportunities and different sizes. But we're continuing to be thoughtful about the deployment of capital, especially in light of the current macroeconomic conditions.", "And our M&A interest continue to be focused on mature companies that support our strategy of growing PGIM and emerging markets by which we can expand our capabilities or our distribution and continue to increase the scale of our existing businesses. But regardless of size, we're going to be thoughtful about evaluating the strategic and the financial merits of each transaction." ] }, { "name": "Andy Sullivan", "speech": [ "Hey, John, it's Andy. Maybe I'll just add in because you asked about PGIM. We're going to continue to work to globalize the business and, as we've talked about before, focus on higher growth, higher fee areas. So, you should think about private alternatives and real asset capabilities." ] }, { "name": "John Barnidge", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Wes Carmichael from Wells Fargo. Your line is now live." ] }, { "name": "Wes Carmichael", "speech": [ "Hey, good morning. I had a question on RBC. I think your slide showed that PICA's RBC ratio is in excess of 3.75. I just wanted to confirm, is the benefit of negative IMR within that RBC ratio? And could you maybe just size that for us?" ] }, { "name": "Ken Tanji", "speech": [ "Yes, sure. It's Ken. Yes, that -- the benefit of admitting the negative IMR as part of the new standard is -- has been adopted and is in effect for our third-quarter results. We were able to admit 1.3 billion, which is at the cap level relative to our surplus, so that is already reflected in there." ] }, { "name": "Wes Carmichael", "speech": [ "Thanks, Ken. And maybe just a follow-up on an earlier question on Japan and ESR. Could you maybe just help us understand how your USD-denominated products are proposed to be treated under ESR versus the current SMR framework?" ] }, { "name": "Rob Falzon", "speech": [ "It's Rob. Let me take that question. The -- first of all, this is a regulatory framework that's still in development, and I want to emphasize that. It's a regulatory framework that to date has been based on the international, the ICS capital standards, that have been developed.", "And those standards are actually not -- don't necessarily reflect the underlying economics of more iteration product, particularly in the U.S. So, we continue to work on the international front on the ICS, and we continue to work with Japan as well in terms of how that ultimately gets reflected into their regime, whether it's modified at the international level or not. But what we found is one of the coming of the current set of proposals is that they don't quite get the economics right when you get into the -- the types of long-duration products that are typically sold in the U.S., both on the life side and on the retirement side. So, that's an area where industry continues to work with the regulators.", "And we're hopeful of making progress there. As Ken mentioned earlier, to the extent that's challenged any way that we do have alternatives that are available to us to think about how we would then manage that product on a go-forward basis. There's a strong demand for the products in the Japan marketplace. So, for Japanese consumers like the U.S.", "dollar-denominated products. And so, the industry will want to continue to sell those products in the marketplace, and we'll come up with solutions for being able to do that and be able to finance that on an economic basis." ] }, { "name": "Andy Sullivan", "speech": [ "This is Andy. I was just going to add in. We have a lot of ability and flexibility to navigate those changes that are coming at us. We obviously have incredibly strong distribution, both captive and third party.", "We have a very wide product portfolio from both a yen and U.S. dollar perspective and single premium and recurring premium, and we've been very successful at delivering a top-notch, great customer experience that we've been recognized for. So, the strength of that business complex will really enable us to navigate the changes that are coming down the road." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Jimmy Bhullar from JPMorgan. Your line is now live." ] }, { "name": "Jimmy Bhullar", "speech": [ "Hi. First a question on PGIM flows. If you could just talk about what drove the negative flows in both retail and institutional funds? And to what extent do you think it's a function of just industrywide issues that asset managers are seeing versus maybe the slight dip that you saw in your performance? And then relatedly, the impact on fees, should it be considered to the assets? Or are the fees lower or higher on the assets that you've lost?" ] }, { "name": "Andy Sullivan", "speech": [ "So, Jimmy, it's Andy. I'll take your question. So, this quarter, we experienced third-party outflows of 5.7 billion. On the retail end, outflows were 1.9 billion.", "That was predominantly an equity story. We've seen clients rebound for a variety of reasons, including to recognize gains as the funds have performed well. We have produced strong equity performance with 89% of our equity asset performing benchmark in the last year. On institutional side, outflows were 3.8 billion.", "Net outflows were primarily fixed income. We are seeing a lower level of gross inflows into this asset class. Investors are hesitant to come back in until it's clear rates have stabilized. We also saw one large low fee rate mandate lapse in institutional.", "As to your question, industry or specific, these are consistent with the industry. And in particular, the fixed income headwinds are consistent. As far as our outlook looking forward, a stable higher rate environment will be good for our flow. So, we know that once rates stabilize, we expect to benefit flow-wise.", "Your question around fees, obviously, it depends very much on the mix of assets, but we're being very successful in bringing inflows into higher fee rate strategies, in particular, into the private alts areas of our business." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK. And then on individual life, that's a business where the results have been weak the past several quarters, but this quarter was actually a good quarter. I think you mentioned in the presentation, there's a benefit from lower expenses and a legal reserve release. Can you quantify how much each was so that one gets an idea on sort of the underlying earnings in the business? And what your outlook is for individual life earnings?" ] }, { "name": "Caroline Feeney", "speech": [ "Yes. So, Jimmy, it's Caroline, and I'll take your question. So, as you mentioned, this quarter, individual life did see favorable expense experience, and that includes a number of one-time items, but it also, as you mentioned, does include the release of a legal reserve. So, Jimmy, it's our practice to regularly review our legal reserves and then make appropriate adjustments reflecting activity within the quarter.", "And the release this quarter reflects the results of that review. In terms of the outlook for life overall, I would say, in addition to what you saw in favorable expenses on the life side, we also saw strong investment results and also underwriting results that were largely aligned to our expectations. And overall fundamentals of the business continue to remain very solid, and we're very optimistic about the growth there." ] }, { "name": "Jimmy Bhullar", "speech": [ "And just any color on the size of the legal reserve because that -- I view that more as sort of a onetime versus expenses tend to move around?" ] }, { "name": "Caroline Feeney", "speech": [ "Jimmy, I would not comment on the specific size of a particular legal reserve. As I said, we saw favorable expenses overall and part of that was the release of a league overserved, but we do not comment on the specific size of a case." ] }, { "name": "Jimmy Bhullar", "speech": [ "OK." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Tracy Benguigui from Barclays. Your line is now live." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you. Good morning. I know it's early, but I was wondering if you could just share your thoughts on DOL and the impact on your FIA business." ] }, { "name": "Caroline Feeney", "speech": [ "Sure, Tracy, it's Caroline, and I'll take your question. So, I'll first start off by saying, Tracy, we've been a longtime support of regulations that provide consumer protections while ensuring that all Americans continue to have access to quality advice and the solutions they need for a secure retirement. So, the proposal was just released two days ago, and so we're very much still in the midst of thoroughly reviewing and analyzing it so we can assess any potential impact on our customers and specifically their ability to access critical retirement products. And you specifically strike you about.", "So, we do realize that in the proposal, there appears to be a focus on fixed indexed annuities, which today, for us, accounts for less than 20% of our total annuity sales, but are also part of a well diversified suite of annuity solutions as we continue to focus on delivering valuable solutions to help our customers meet their retirement savings needs. That being said, I will just reiterate that we're still in the process of reviewing the proposed rule. And finally, I'll just add that under the last proposed rule change, we implemented policies and procedures to comply with the final prohibited transaction exemption in a timely fashion, and we'd expect to do the same here." ] }, { "name": "Tracy Benguigui", "speech": [ "Do you think that evolution also took place in the IMO channel, so they could comply with new standards?" ] }, { "name": "Caroline Feeney", "speech": [ "I'm sorry, Tracy, I want to make sure I heard your question." ] }, { "name": "Tracy Benguigui", "speech": [ "The IMO channel? The independent agents? Yeah, would they also be well equipped since the last proposal to improve their standards?" ] }, { "name": "Caroline Feeney", "speech": [ "So, what I could comment on -- yes. So, Tracy, what I couldn't comment on is others in terms of their IMO channels and whether they'd be prepared or not. What I will say, particularly, and I'll just reiterate, with the last DOL-proposed rule, we were very much ready as an entire enterprise across all of the various businesses where there was any impact. And we are ready to comply with the rule.", "And as I mentioned, we would expect to do the same here. That would include all of the distribution channels that would, in any way, be impacted by the new proposed rule." ] }, { "name": "Tracy Benguigui", "speech": [ "Got it. I want to touch on Prismic and thinking about the investor consortium. Could you let me know like what they're thinking in terms of an investment time horizon? Will there be like a call option being arbitrary here but, let's say, like in 10 years, would prune you to provide liquidity to those investors after a set period of time? Or do you envision raising new funds?" ] }, { "name": "Rob Falzon", "speech": [ "Tracy, it's Rob. So, we're partnering with a group of very large global institutional investors. Their intent is to operate with scale. And their investment horizon very much aligned with our own is quite long term.", "Prismic itself has an independent board of directors, and that will govern the routes toward growth and otherwise. But there are no put or call provisions embedded in the agreement that we've got with Prismic." ] }, { "name": "Tracy Benguigui", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "[Operator instructions]. Our next question is coming from Wilma Burdis from Raymond James. Your line is now live." ] }, { "name": "Wilma Burdis", "speech": [ "Hey, good morning. A couple of earnings-related questions. First, I think you guys previously cited $65 million of deal closing costs with Somerset Re. I just want to know if that would lower the 275 baseline for 4Q? Or maybe just an update on timing there? And then the other is, if you could walk us through the trajectory of benefits from the restructuring.", "Will we see a benefit in 1Q? Or is it going to take a little bit longer?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. It's Ken. The deal-related costs for the reinsurance with Summerset Re will be incurred at the time of closing, and those have not been included in the baseline." ] }, { "name": "Wilma Burdis", "speech": [ "OK." ] }, { "name": "Ken Tanji", "speech": [ "And I'm sorry. And obviously, I think your second part of the question was the benefits of the restructuring or the benefits of the reinsurance will occur subsequent to close, obviously." ] }, { "name": "Wilma Burdis", "speech": [ "Yes, the restructuring, should we start to see some benefits coming in 1Q? Or is it going to take some time?" ] }, { "name": "Ken Tanji", "speech": [ "Oh, you're saying the organizational restructuring, is that what you're referring to or the reinsurer? I'm sorry. We will see benefits in 2020. Pretty soon thereafter, there will be a portion that's highly -- that's effective in the first quarter and then thereafter." ] }, { "name": "Wilma Burdis", "speech": [ "And could you talk about the impact of Prismic on PICA's RBC -- just -- I know there was a little bit of a holdco liquidity impact from the initial investments. So, could you just talk about that aspect as well?" ] }, { "name": "Ken Tanji", "speech": [ "Sure. The initial impact of the reinsurance of the structured settlement the Prismic was modest, and that was impact -- that was in our RBC ratio for September. And so, we had the impact of the initial portion of that. But over time, it will also enable capital benefits as we reallocate the retained investment portfolio.", "And so, it will -- we had some impact immediately, but they also will have continued impact as we reallocate the investment portfolio." ] }, { "name": "Wilma Burdis", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Next question today is coming from Suneet Kamath from Jefferies. Your line is now live." ] }, { "name": "Suneet Kamath", "speech": [ "Great. Thank you. I wanted to go to Prismic again. Charlie, I think in your prepared remarks, you talked about further optimization of your in-force block.", "And I think you specifically referred to life and annuity blocks. Is that sort of the extent to where we should be thinking about in terms of where you'd optimize? I guess where I'm going with this is there an opportunity for something like a long-term care in terms of your in-force and reinsuring that to Prismic?" ] }, { "name": "Charlie Lowrey", "speech": [ "Sure. Let me take a step back and just tell you generally how we're thinking about this. Prismic is really an example of our open architecture solutions and is a very important additional component of our strategy to become a higher growth, less market-sensitive, and more nimble company. We formed Prismic with Warburg Pincus and other global investors because we see significant opportunities that exist at the intersection, as Rob said, of asset management and insurance.", "And we're perfectly positioned to take advantage of those opportunities given the business which we have. And we're excited about our ability to leverage third-party capital and reinsurance to drive the incremental growth in our insurance, retirement, and asset management businesses. And Prismic, to get, to your point, really reinforces and enhances our mutually reinforcing business system in three ways. First, we can reinsure portions of our in-force business like the structural settlements transaction we just completed and have PGIM continue to manage the majority of assets locking up capital to become less market sensitive.", "And to your point, we'll look to our retirement and life businesses for those assets. Secondly, we can write new business that could be reinsured to Prismic, so forward flow. And since Prismic is mainly supported by third-party capital, we can write additional retirement and insurance business to further accelerate our growth and at the same time, increase PGIM's assets under management. And finally, Prismic can reinsure third-party blocks, which would again increased PGIM's AUM.", "So, there's a lot of potential we see for Prismic, and we're being thoughtful about how we execute against these opportunities and have recently reallocated resources to further optimize and cap our -- will further optimize our capabilities since Prismic is such an important component of our mutually reinforcing business system. So, it's going to be in the life and retirement businesses mainly that we think about reinsuring other blocks, but we could think about others as we go forward." ] }, { "name": "Rob Falzon", "speech": [ "Suneet, it's Rob. I'd sort of add as sort of a general market observation to Charlie's remarks is that we've seen investors that are behind many of the reinsurance vehicles in partnership and otherwise, having an increasingly higher appetite for a variety of different products. So, this started out very much if you look at the early reinsurance transactions in the sort of very vanilla insurance space and in the very vanilla annuity space of fixed annuities. And over time, what you've seen through our own transactions as well as others is that now is expanded into variable annuities.", "It's expanded into GUL, and we do see that that's a trend that's likely to continue. There's a robust appetite and that appetite as it gets -- as investors get more comfortable with the dynamics of the insurance marketplace and business model, their appetite will continue to grow. So, we see interesting opportunities, both domestically and importantly internationally as well." ] }, { "name": "Suneet Kamath", "speech": [ "OK. Got it. And then I guess on the VA deal, the proceeds from that transaction still in PICA, and is the expectation that they'll just sort of stay there and be used to support organic growth? Or would you expect to take those proceeds up to holdco for other uses?" ] }, { "name": "Ken Tanji", "speech": [ "Yeah, it's Ken. So, the reinsurance of our variable annuity block closed in April. And so, we had the benefit of that effective April 1st, and it is one of the considerations we made as we looked at our RBC and our dividend capacity and factored into the dividends that we made in the third quarter, which was $1 billion from PICA. So, we did get the benefit.", "It's one of the things we thought about when we looked at the overall level of our RBC and then decided to make a dividend to PICA of $1 billion in the third quarter." ] }, { "name": "Suneet Kamath", "speech": [ "Sorry, dividend out of PICA?" ] }, { "name": "Ken Tanji", "speech": [ "Yes. I'm sorry, yes." ] }, { "name": "Suneet Kamath", "speech": [ "So, just a quick follow-up there. I was just trying to track the holdco cash because it looked like it went down a little bit sequentially. Can you just kind of give us some of the bigger moving pieces there?" ] }, { "name": "Ken Tanji", "speech": [ "Sure. Yes. The bigger moving pieces, like I just mentioned, was the $1 billion that the holding company received from PICA as a dividend. And then we also made a $200 million investment in Prismic.", "And then the other would be ordinary course, interest expense, and shareholder distributions. And those are the main components that led to a very small change in our HLA." ] }, { "name": "Suneet Kamath", "speech": [ "Got it. OK. Thanks, Ken." ] }, { "name": "Operator", "speech": [ "Thank you. Next question is coming from Michael Ward from Citi. Your line is now live." ] }, { "name": "Mike Ward", "speech": [ "Hey, guys. Thank you. Good morning. Another one on Prismic.", "But for the third-party component and the mechanics, if PGIM could get the AUM of new blocks being reinsured, wouldn't the general account of the external blocks go on your balance sheet? Because I wouldn't have thought that you're targeting exposure to third-party capital intensive business." ] }, { "name": "Rob Falzon", "speech": [ "Mike, it's Rob. So, yes, PGIM will have an appetite for doing both flow and balance sheet from Prudential as well as third parties. We will look to put -- and yes, we will get the asset management on those blocks as they're brought into Prismic. So, that's part of the arrangement that we have with Prismic.", "And then separately, we'll make a decision as to how much we invest in Prismic on a go-forward basis. As of now, our ownership in Prismic is at a 20% level. It's not a contractual obligation for us to stay at that level. But having said that, we think that the returns that we get for a capital that could be deployed through Prismic, when you think about the returns on the underlying blocks enhanced by the fees that we get from from our asset management business, could be quite attractive on a risk-reward basis.", "And so, we would have some appetite for continuing to invest in those sorts of business when they significantly enhance the fee components that we get out of that business which, on an overall basis with a reduced risk profile of the earnings, stream on a go forward." ] }, { "name": "Mike Ward", "speech": [ "OK. Thank you. That's helpful. And then maybe one thing we didn't touch on CRE, commercial real estate.", "Any developments for you guys in the office area?" ] }, { "name": "Rob Falzon", "speech": [ "No, I would say that -- it's Rob again. Sorry, Mike, that nothing material to update you on from last quarter. We have a very high-quality overall real estate portfolio, including the office components to that or component of that. And we continue to see resiliency within that portfolio, as you would expect, given the experience that we have there, the dedicated team that we have from an underwriting standpoint and the quality of the overall portfolio.", "So, while on the -- from a valuation standpoint, but updating our valuations. And the valuations of the collateral supporting office loans continues to come down, but our LTV still remain quite low on a relative basis. And we feel very comfortable with the overall portfolio exposure there." ] }, { "name": "Mike Ward", "speech": [ "Thanks, Rob." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question is a follow-up from Wes Carmichael from Wells Fargo. Your line is now live." ] }, { "name": "Wes Carmichael", "speech": [ "Hey, thank you for taking my follow-up. Just had a couple of earnings ones. Should be quick. But on the baseline for Q4, the $2.75, that includes normal variable investment income.", "So, I was just hoping if you could help us with your outlook in the near term. It's a pretty modest headwind in the third quarter, but just wondering if you expect that to be a bit challenged going forward." ] }, { "name": "Rob Falzon", "speech": [ "From a VII standpoint -- Wes, it's Rob. I think about that as having two components to it. One is the returns that we get from our alternatives portfolio and the second being the level of prepayment income that we get from the fixed income portfolio. I think we've guided to the fact that we expect lower levels of prepayment income on a go-forward basis.", "That was the primary contributor to the below expectations in the current quarter. So, I think you should expect to see that. On a go-forward basis, we generally don't provide an outlook. What I would say is that as evidenced in the current quarter, we have a good portfolio that's very well diversified.", "And so, while there are different components of it that performed up and down in the current quarter, we would expect that to continue in future quarters as well. In this particular quarter, real estate performance was off, as you would expect. But actually, our private equity portfolio performed quite well. And just to be very clear, within our private equity portfolio, we have a very small exposure to sort of the DC area.", "So, it's more core private equity. And even within that, it's a fairly significant component of that that's in high yield and debt strategies. And so, that sort of caused some stabilization within that private equity portfolio. So, I think that we will vary as markets do, but we continue to believe that we'll perform on a relevant basis quite well." ] }, { "name": "Wes Carmichael", "speech": [ "Thanks. And then on PGIM, I think you lowered your expected range for other related revenues by about $10 million on a quarterly basis. Just curious if you can provide us some color on what's driving that there." ] }, { "name": "Andy Sullivan", "speech": [ "Yeah, Wes, it's Andy. I'll take your question. So, ORR came in at the quarter at 37 million. It was predominantly driven by the real estate space.", "So, this is a pretty consistent story that's been the last few quarters. Our agency earning decline from the real estate slowdown, and we saw lower real estate valuations and transactions. As far as the go-forward look, you are correct. We now expect our ORR to average about 40 million per quarter.", "That lower run rate, again, is flowing directly from the slowdown in the real estate markets. We're expecting to see lower agency earnings as well as lower private incentive fees. And while this will vary quarter to quarter as always, we expect the patterns that we've been seeing to be more muted in this environment." ] }, { "name": "Wes Carmichael", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Lowrey for any further closing comments." ] }, { "name": "Charlie Lowrey", "speech": [ "OK. Thank you again for joining us today. We're entering into the next chapter of our evolution with a unique business model and growth strategy that positions Prudential to help current and future generation secure their financial future. We are confident that our strategy and mutually reinforcing business model will enable Prudential to be a global leader in expanding access to investing insurance and retirement security.", "Thank you again, and stay well." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2020-08-18	[ { "description": "Vice President, Investor Relations, and Treasurer", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, Chief Executive Officer, and President", "name": "Craig Menear", "position": "Executive" }, { "description": "Executive Vice President of Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Executive Vice President of Outside Sales & Service", "name": "Bill Lennie", "position": "Executive" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "Barclays Investment Bank -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zack Fadem", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Elizabeth Suzuki", "position": "Analyst" }, { "description": "Nomura Instinet -- Analyst", "name": "Mike Baker", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to The Home Depot second-quarter 2020 earnings call. [Operator instructions] It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you Christine, and good morning everyone. Joining us on our call today are Craig Menear, chairman, CEO, and president; Ted Decker, executive vice president of merchandising; and Richard McPhail, executive vice president and chief financial officer. Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors.", "And as a reminder, please limit yourself to one question with one follow up. If we are unable to get to your question during the call, please call our investor relations department at 770-384-2387. Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.", "These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you Isabel. And thanks to all of you for joining our call this morning. We hope that you and your loved ones are safe and healthy, and our thoughts and prayers continue to be with all of those that have been directly impacted by COVID-19. The COVID-19 pandemic and its impact have forced us to change the way we live, work and interact with each other.", "Though these tough times have been unquestionably challenging, as we mentioned in the first quarter, we have navigated this crisis by aligning our decisions and actions to some of our most important values: do the right thing and take care of our people. Our focus has been and continues to be on two key priorities: The safety and well-being of our associates and customers and providing our customers with the products and services they need at this time. In the first quarter, we had to adjust our stores to an environment that promoted social and physical distancing, and we did this by implementing a change to store hours, limiting the number of customers in-store and eliminating traffic-driving events as well as operational changes like floor marking, signage and Plexiglas shields. In the second quarter, we continued to adapt based on our learnings and ever-changing environment.", "Our team continues to work to promote a safe shopping environment. We made several adjustments in the quarter to our operating approach. First, we expanded our operating hours from 6 pm to 8 pm This action was taken to relieve the end-of-day bottlenecks we observed in some stores while were operating under more restrictive hours. Second, we modified the national approach that we had in the first quarter to limit the number of customers in stores and now are taking a more localized approach by relying on our store managers and field teams to closely monitor safety and implement customer limits as needed.", "Third, we announced that mask or facial coverings are required for all associates and customers in our U.S. stores and other facilities. Given the ongoing demands and complexity of the current environment, we have continued to focus on taking care of our people by extending weekly bonuses for hourly associates in our stores and distribution centers. Through the second quarter, we have spent approximately $1.3 billion on enhanced associate pay and benefits in response to COVID-19.", "Additionally, the company's first half performance resulted in a record payout for Success Sharing, our profit-sharing program for our hourly associates. I'm incredibly proud of our associates for the many ways that they have lived our values by serving our customers, communities and each other during this unprecedented time. Our team has demonstrated ongoing flexibility to effectively operate in this dynamic environment, while also executing to deliver record-breaking sales. Sales for the second quarter were $38.1 billion, up 23.4% from last year.", "Comp sales were up 23.4% from last year with U.S. comps of positive 25%. Diluted earnings per share were $4.02 in the second quarter. These record results were driven by broad-based strength across our stores and geographies.", "As Ted will detail, both ticket and transactions were up double digit in the quarter, and we saw healthy growth from both our Pro and DIY customers. During the quarter, we saw customers take on projects throughout their homes, from deck building to painting projects, landscape work and home repairs due to increased wear and tear. Clearly, our customers engaged with home improvement in a meaningful way. That being said, as we discussed in the first quarter, we are cautious to extrapolate trends from the first half of the year into a forecast for the remaining of the year, particularly given the tremendous amount of uncertainty we face with regards to the duration and continued impacts of the virus.", "So while we can't predict the sales trajectory for the back half of the year, we do know that for many of our customers, the home has never been more important. Our recent customer survey work tells us that customers have a continued willingness to take on both indoor and outdoor projects in the near term. Customers are consolidating the number of retailers they visit and are blending the physical and digital elements of the shopping experience more than ever before. As a result, the distinct competitive advantages and overarching benefits of an interconnected One Home Depot strategy have never been more relevant.", "Our interconnected retail strategy and underlying technology infrastructures have supported record web traffic on a consistent basis for the past several months. Sales leveraging our digital platforms increased approximately 100% in the quarter and more than 60% of the time, our customers opted to pick up their order at a store. The accelerated growth of our interconnected and digital offerings has given us the opportunity to showcase, in a very condensed time frame, new capabilities in different ways to engage with The Home Depot that customers may not have been fully aware of. The rate at which customers are authenticating with us has also accelerated which provides us with a unique opportunity to know our customers even better.", "This is critical as we continue on our journey to offer a deeper level of personalization and further enhance the interconnected shopping experience. That being said, the step change in demand across our digital platforms is not without its challenges, particularly from a delivery and fulfillment standpoint. We have been able to leverage investments we have made in the scale and flexibility of our supply chain network to relieve some of the pressure. This is exactly what we did during the quarter when we temporarily transitioned one of our recently opened market delivery centers or MDCs, to a direct fulfillment center or DFC which primarily fulfills online orders.", "The investments that we have made in the underlying infrastructure and systems supporting the MDC, coupled with a strong cross-functional alignment across the organization, enabled us to make this conversion in just a few short weeks. The net result for our customers was the reduction in lead times for orders flowing from our direct fulfillment network. We are focused on continuing the momentum of our strategic investments to enhance the interconnected shopping experience and position ourselves for continued share capture over the long term. At the same time, we know that we must remain agile and flexible to execute against the demands of the current environment.", "Through it all, we will continue to lead with our values. And I could not be more proud of the resiliency and strength that the team has demonstrated as we navigate these extraordinary circumstances together. I want to thank our incredible associates and supplier partners for their hard work and dedication to serve our customers and communities. And with that, I'd like to turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks Craig, and good morning everyone. I, too, want to thank all our associates and supplier partners for their relentless focus on serving our customers. During the second quarter, we saw unprecedented levels of engagement from both our DIY and Pro customers. Our team satisfied the strong demand by working together in a flexible and agile manner while also prioritizing safety.", "As an example, we decided to cancel our annual Memorial Day event and adjust other spring events as we didn't want to drive even more traffic into already crowded areas of our store like garden and paint. We also removed most of our off-shelf merchandising displays in order to support social distancing. Our teams were incredibly flexible and worked in a cross-functional manner to coordinate changes. We altered marketing plans, social media, product flow, product selection and space allocation.", "Our merchants, suppliers, marketers, supply chain, merchandising execution and store teams remained agile throughout the quarter and focused on our customers. We are fortunate to have the best supplier partners in the business. Leveraging our tools and analytics, we work together to make real-time adjustments to our assortments. In many instances, we introduced alternative products and reduced assortments to the highest demand SKUs that our partners could supply most effectively.", "As an example to support in-stock levels for high-demand items such as cleaning products, we worked with suppliers to streamline production on key products, sizes and fragrances. And as you heard from Craig, the investments we've made in our supply chain over the last decade allowed us to be more flexible than ever in flowing product to the right geographies. During the second quarter, 13 of our 14 merchandising departments posted double-digit comps in the quarter, led by our lumber department. Our kitchen and bath department posted high single-digit comps.", "During the quarter, comp average ticket increased 10.1%, and comp transactions increased 12.3%. The growth in our comp average ticket was driven by both an increase in basket size as well as customers trading up to new and innovative items. In addition, inflation in core commodity categories, like lumber, positively impacted our average ticket growth by approximately 61 basis points. The strength of our comp transaction growth was driven by consistently strong in-store and online transactions.", "During the second quarter, big-ticket comp transactions or those over $1,000, were up approximately 16%. We saw very strong performance across a number of big-ticket categories like appliances, riding lawnmowers and patio furniture. However, this strength was partially offset by softer performance in certain indoor installation-heavy categories like special order kitchens and countertops. We saw strong sales growth with both our Pro and DIY customers, with DIY sales growing faster than Pro sales.", "Sales to our Pro customers accelerated meaningfully compared to the first quarter and grew double digits compared to the second quarter of last year. Looking deeper into our Pro sales, we saw notable strength with our smaller Pro customer. As markets continue to reopen, we see increasing demand from all our Pro customer cohorts. We continue to lean into our strategic investments to create a Pro ecosystem that encompasses professional-grade product, exclusive brands, enhanced delivery, credit, digital capabilities, field sales, support, HD Rental and more.", "We believe our differentiated ecosystem will continue to drive deeper engagement with our Pro customers. Turning to our DIY customers. Our DIY customers are reengaging with their home and with The Home Depot in a meaningful way, and they are engaging across the store. While we have seen strong demand with exterior projects like building decks, sheds, fences and gardens, we've also seen strong growth with interior projects like hard surface flooring, interior lighting and painting, to name a few.", "We firmly believe that our One Home Depot strategy is creating a best-in-class, interconnected shopping experience. We are building unique capabilities that let our customers engage across our digital platforms, our updated physical stores and our enhanced delivery experience. And our confidence in these new capabilities led us to change our tag line and marketing efforts to how doers get more done. During the second quarter, new and existing customers set record levels of engagement across our new capabilities.", "The rate at which our existing customers are adopting new channels to engage with The Home Depot more than doubled year to date. And we also saw a third of recently acquired customers reengage with The Home Depot for another purchase in a different department. During the second quarter, our mobile app saw a record number of downloads, and we saw significant growth in conversion rates across all digital platforms. These results confirm our belief that we have been making investments in the right areas of our business and that those investments are resonating with our customers.", "Let me give you an example to help illustrate our enhanced capabilities and options for customers. Over the last couple of years, we have enabled multiple fulfillment options including buy online, pick-up in store with convenient pickup lockers, buy online, deliver from store with our express car and van delivery and most recently, our curbside pick-up option. As customers accelerate their adoption of an interconnected shopping experience, we have seen increased usage of these different fulfillment options. During the second quarter, we saw triple-digit growth across all these platforms.", "Another example is our HD Home business. As part of our strategic investments over the last three years, we have been leaning into several home decor categories. As consumers shop fewer and fewer retailers, our research showed that our customers were increasingly looking to homedepot.com to help with project completers like room decor and textiles. We are investing to create a better, frictionless online shopping experience for decor.", "We are showcasing our collections, enabling shop by room and highlighting our capabilities and product offerings with HD Home. With record levels of traffic on homedepot.com, we have seen significant outsized sales growth with our HD Home assortment. All the investments across the business make us more flexible as we continue to navigate this fluid and dynamic situation. As we look to the back half of the year, we will be working with our supplier partners as well as our cross-functional teams to satisfy our customers' evolving home improvement needs.", "With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you Ted and good morning everyone. We appreciate everyone joining the call today, and we hope you and your loved ones are safe and healthy. In the second quarter, total sales were $38.1 billion, a 23.4% increase from last year. Foreign exchange rates negatively impacted total sales growth by approximately $200 million.", "Our total company comps were positive 23.4% for the quarter, with positive comps of 24.6% in May, 25.7% in June, and 20.4% in July. Comps in the U.S. were positive 25% for the quarter with positive comps of 27.3% in May, 27.3% in June and 21% in July. As you heard from Craig and Ted, the strong demand we saw was broad-based with a high degree of performance uniformity among our three U.S.", "divisions and Canada. All 19 of our U.S. regions posted double-digit positive comps, and our Canadian business reported record sales. Mexico's performance was impacted by a lag in COVID-19 cases relative to the U.S.", "and Canada. And as a result, Mexico's performance was negative in the beginning of the quarter before turning to positive growth at the end of the quarter. In the second quarter, our gross margin was 34%, an increase of approximately 20 basis points from last year. The change in our gross margin was driven by several factors including a benefit from a reduction of annual events during the quarter.", "This benefit was partially offset by the mix of products sold and pressure from shrink. During the second quarter, operating expense as a percent of sales of approximately 18.1% increased approximately 10 basis points compared to last year. Let me take a moment to comment on a few of our expense items. First, during the quarter, we continued to support our associates with enhanced benefits which totaled approximately $480 million in the second quarter resulting in 125 basis points of expense deleverage.", "Second, we incurred approximately $110 million of operational COVID-related expenses including personal protective equipment for our associates and customers and enhanced cleaning of our stores resulting in approximately 30 basis points of operating expense deleverage. Third, we recorded expenses related to our strategic investment plan of approximately $280 million, an increase of approximately $40 million compared to last year. We are committed to completing our strategic investments. However, given the priority around safety and the complexities of the operating environment we find ourselves in, we are deferring certain in-store investments and now expect some of the projects we initially earmarked for fiscal 2020 to be completed in fiscal 2021.", "And finally, during the second quarter, we showed strong expense control in all areas of the business and drove approximately 145 basis points of expense leverage. Included in this 145 basis points of leverage is approximately 90 basis points of pressure driven by accrued bonus expense related to our significant outperformance for our biannual store Success Sharing program and store and field-based management bonuses for the first half. Our operating margin for the second quarter was approximately 15.9%, an increase of approximately 10 basis points from last year. Interest and other expense for the second quarter grew by $54 million to $337 million due primarily to higher long-term debt levels than one year ago.", "In the second quarter, our effective tax rate was 24.4% compared to 24.6% in the second quarter of fiscal 2019. Our diluted earnings per share for the second quarter were $4.02, an increase of 26.8% compared to the second quarter of 2019. At the end of the quarter, merchandise inventories declined $1.2 billion to $13.5 billion driven by the significant and steady demand we saw during the quarter. Inventory turns were 6.1 times, up from 5.1 times last year.", "Moving on to capital allocation. While our long-term principle of returning excess capital to shareholders remains intact, we believe that in this unprecedented environment, it is appropriate for us to maintain a strong liquidity position. During the quarter, we invested approximately $445 million back into our business in the form of capital expenditures, and we repaid approximately $1.75 billion of long-term debt. We also paid $1.6 billion in dividends to our shareholders.", "Computed on the average beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 41.1%, down from 43.7% in the second quarter of fiscal 2019. This decrease primarily reflects our decision to temporarily enhance our liquidity position including the suspension of our share repurchase program back in March. Looking ahead through the first two weeks of August, comparable sales growth remains at levels similar to total company second-quarter comp sales. Our customers tell us that they plan to continue to invest in a wide variety of projects to maintain and enhance their homes.", "However, given the degree of uncertainty in our external environment, we cannot extrapolate current observations to predict future performance. As a result, we are focused on operating with discipline and flexibility in order to grow market share regardless of what demand patterns emerge. And despite the significant uncertainty in the current environment, we do believe in the resilience of home improvement demand over the long term. The home typically represents our customers' largest asset.", "The housing stock is aging, and we believe the capabilities we are investing in across our interconnect platform will position us well to continue capturing market share in any environment. Thank you for your participation in today's call, and we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks everyone. Good morning. My first question is a little medium to longer term. It's on the margin potential of the business.", "The environment now is pretty fluid, and I'm sure you'd describe it as still competitive. When you laid out the One HD plan, most of the plan was recouping some of the margin that you would be making to make investments. But you never really baked in the sales upside and by default, you never really promised or committed to more margin. Can you talk about -- does that change? And it's not about does margin go up over time, but does it create the potential for margins to trickle up over time or are you going to be steadfast on reinvesting and maintaining a certain margin level going forward?" ] }, { "name": "Craig Menear", "speech": [ "Simeon, as we shared last December, everything we're doing in terms of the investments that we're putting into the business is to be able to position us to outgrow the market for the long term. And the whole objective behind that is to be able to drive incremental op margin dollar and bottom-line growth. That's really the focus that we have. We're not -- we're really not worried about how the basis points or rate falls.", "This is all about incremental op margin dollar growth." ] }, { "name": "Simeon Gutman", "speech": [ "OK, thanks for that. And then maybe sticking with you, Craig. You mentioned in the article, I think it was this week, right, correlations don't work right now, and they don't apply which makes sense. Can you talk -- just two components of that.", "How could -- how does the surge in home improvement, could it transition from spring/summer into fall? And do you expect these conditions -- these surge conditions to persist until there's a vaccine?" ] }, { "name": "Craig Menear", "speech": [ "I mean it's really so uncertain. We don't know the answer to that which is why we can't really extrapolate current performance to future performance. What we do know is again the home has never been more important to the customer. We're all spending lots of time there.", "We're seeing things that need to be done or things that you want to be done. There's additional wear and tear and we're clearly seeing the customer engaged in a very strong way right now. The most important thing for us, as we think about the future going forward, is we operate in key areas on a pretty short cycle. So think labor planning, think inventory planning.", "Those are short-cycle activities for us. And that's what we're really focused on, how do we remain flexible and adjust. You're assuming that -- the interesting thing is we had really unbelievable demand for multiple quarters or multiple months in a row, as Richard shared the quarterly monthly comps. And the team was able to react to that.", "And that's really what we're focused on being able to do." ] }, { "name": "Simeon Gutman", "speech": [ "OK, thanks. Good luck." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. And I guess you practice what you preach, with doers getting it done. My question is on the Pro business which you mentioned was up double digits.", "Can you quantify the spread between what you think your Pro business did and what you think your DIY business did? And with that being said, is there an argument and do you subscribe to it that the Pro business is being held back by consumers not wanting outsiders in their home and they want to be dislocated from their homes in this current time? So there's a pretty visible path to future growth as the Pro business takes over for the strength in the DIY business right now?" ] }, { "name": "Craig Menear", "speech": [ "Michael, we're obviously not going to split out the numbers on cohorts for obvious reasons, but what we were super pleased that we saw double-digit growth with the Pro as well as incredible strength with the DIY customers. They're clearly engaged with projects as well. I'll let Bill jump in with a little bit more color as to what we're seeing in terms of major markets -- the markets where there's still a little pressure as it relates to permitting results." ] }, { "name": "Bill Lennie", "speech": [ "Yup. Michael, Bill Lennie." ] }, { "name": "Michael Lasser", "speech": [ "Hey Bill." ] }, { "name": "Bill Lennie", "speech": [ "We did see good Pro sales growth across all cohort toward all end markets and all geographies. There was notable strength with the low-spend Pro. They were less impacted with the downturn in Q1 but continued to rebound and accelerate in Q2. The high-spend Pro also continued to rebound, and I would see that as being an outcome of permitting and job inspections coming back online.", "There are areas where homeowners are becoming more comfortable with having Pros and service providers in their homes. There are some end markets that haven't totally recovered. I'll give you one example, and that would be multifamily property managers. Obviously, there are slower turns on the units.", "They have less access to the properties, and they still remain in more of a break-fix mode, holding back on major rehabs and capital projects. But with that said, even in multifamily Pro customers, we've seen upturn and a rebound in sales to those cohorts." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much and my follow-up question is on the gross margin. Richard, you gave us a little bit of detail on some of the moving pieces, noting that mix and shrink were still drags in the quarter. So how should we think about and how should we be calibrating our models for when shrink is going to get better? And at what point do you think the promotional environment will move from being supportive to more normal?" ] }, { "name": "Richard McPhail", "speech": [ "Michael, thanks for the question. So for the quarter, the most significant influence were really the cancellations of annual events during the quarter. If you look at the pressures again as we stated, there was some pressure from mix and from shrink. But really, those pressures were consistent with what we expected at the beginning of the year and what we saw in Q1.", "As you know, shrink is an item that we have pushed a few initiatives toward last year and this year. Those efforts are ongoing. We will see benefits from that over time. It takes a while for that to work our way through the system.", "But again, shrink and mix, those components really worked out where we expected they would have even at the beginning of the year." ] }, { "name": "Ted Decker", "speech": [ "And as far as promotions though, we'll continue to have promotions and events but they will continue to be modified. So when you think at the beginning of the year, our Spring Black Friday event and Memorial event, we essentially canceled those. We had a modified, more modest fourth of July event, where there was some promotion, not as deep. And there was some in-store activation in our event spaces.", "I would say going forward, we'd continue to have modest, modified events, but of net benefit with promotions." ] }, { "name": "Michael Lasser", "speech": [ "That's very helpful. Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. Maybe just to focus on the additional workforce benefits that you've noted here. I don't know, Richard, if you can go into a little more detail about the $480 million. Is it simply just tied to the weekly bonuses? And then just revisit sort of what the current thinking is around the continuation of these bonuses, what have you committed to? And sort of how do you sort of think about balancing the cultural impacts, right, of it with obviously the commitment you have toward safety, etc.?" ] }, { "name": "Richard McPhail", "speech": [ "Thanks for the question, Steven. So if you take a look at the approximately $480 million that we invested in enhanced benefits in the quarter, you take a look at that and say about $360 million of it would represent spend on benefits that continue into the third quarter, with the vast majority of that $360 million being in the form of weekly bonuses to associates. The remainder of that, the remaining $120 million that we expensed in Q2 represented benefits like enhanced overtime pay that have not continued into the third quarter. So again, of that second quarter, about $360 million continues in the third quarter.", "It's worth pointing out that in a 23% comp environment, there are more hours, there are more associates eligible for those weekly bonuses. We certainly were not planning at the beginning of the quarter for a 25% -- or 23% comp environment. So that number is going to naturally be a little bit higher in Q2 because of that. So that's the breakdown of our associate expense.", "And it's something that we review on a continuous basis. We think that that expense was prudent and appropriate in the second quarter, and we'll continue to review it as circumstances develop." ] }, { "name": "Steven Forbes", "speech": [ "Thank you. And then just a quick follow-up, right as we look at lumber inflation here and think about the puts and takes on the model. I don't know if you can sort of just give us your current thinking about the potential implications as we look out to the third quarter here, given that you called out mix. I mean how do we sort of contextualize the P&L impacts?" ] }, { "name": "Ted Decker", "speech": [ "Well, on lumber, we called out a commodity benefit in Q2 of 61 basis points. Now lumber in the last several weeks of the quarter and into the first two weeks of this quarter has hit all-time record highs. Each framing and panel are over $700. They're up essentially about 115% DIY.", "But I would say a big piece of that was when COVID started, none of us knew where this was going to go, and the mills took a conservative approach and largely backed off harvesting trees and cutting logs. That product started up again about mid-quarter of Q2, and we're starting to see much better flow in lumber. So I'm not going to predict lumber prices, but with more supply coming into the marketplace, hopefully, we're going to obtain these $700 levels, although we do have substantial support with housing and all the projects that Craig referred to. Certainly in pressure-treated decking, just a robust decking boom.", "But we should see some moderation, but the unit demand, even with these higher prices, has remained double digit and incredibly strong. So we see strength into Q3, certainly right now. But where it shakes out ultimately in margin, not certain." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. Just a couple of questions on the e-com. I was wondering if you could talk a little bit about the behavior with the DIY customer versus the Pro.", "I guess with respect to the growth rates for each, maybe a little color on ticket and also behavior on Buy Online and Pick-Up In Store for each segment. And then I guess I'm just curious, broadly which segment do you think you're gaining greater share with or did gain greater share with in 2Q. Then I had one other quick question." ] }, { "name": "Craig Menear", "speech": [ "Karen, on the e-com business, we're -- again, we're not going to split out that cohort in terms of the numbers, but what I'll tell you is that we saw great engagement with both the Pro and the DIY customer. And we're seeing accelerated engagement, as Ted called out, with the capabilities that we have with both the Pro and the DIY customer. And so we're very, very pleased with that and tremendous growth there. And we really believe that the current environment has allowed us to accelerate the exposure of the capabilities we've built in a tremendous way.", "So we're very, very pleased. But it's the project nature of the business, for both the Pro and the DIY customer that's driving -- helping to drive the growth in the e-com world. When you think about doing a project, customers blending the physical and digital worlds, we have an expanded assortment in the digital world. As Ted called out, when it comes to completing a room, our HD Home categories of completion, we're seeing tremendous growth there as the customer purchases that product online.", "That obviously has a tendency to be more DIY-oriented as they complete their room, but we're super pleased with what we're seeing with both the Pro and the DIY customer." ] }, { "name": "Ted Decker", "speech": [ "And I would say, clearly, with the numbers online effectively doubling that business in the second quarter, increasing penetration over 14%, as you can imagine, every metric is positive. The traffic across all our properties, the active customers, the app downloads, the conversion rates, all very, very strong. Our actual active customers, the number of active customers also doubled. So as Craig said, our job going forward now is to just not reap the benefit of this activity in Q2.", "But with all these new customers engaging across all The Home Depot capabilities, we're very closely watching reengagement rates. And I mentioned a couple statistics in my prepared remarks, but we're seeing people shopping across departments. Are they engaging in other capabilities? What is their duration before there's a repeat engagement with a capability or indeed a purchase? And the name of the game for us is engagement, and that is really what's all behind how doers get more done. The more our customers engage with our capabilities, whether it's in the store, self-checkout, app downloads, delivery, search tool rental, using our lockers, using our calculators, every time our customer engages in another capability that we've built out, that's stickiness, that's repeat business, and that's customer loyalty.", "And a quarter like this has just been terrific in advancing our initiatives, and we're working very hard to keep that momentum going." ] }, { "name": "Richard McPhail", "speech": [ "And Karen, you asked about market share. Obviously, market share is hard to calculate for us, only as good as the public data we have at our fingertips. But if you do look at census data and you look at the NAICS categories where we compete, 444 and 4441, those spaces grew significantly in the low teens. We obviously grew much faster than our space.", "So we captured considerable share we believe based on publicly available data." ] }, { "name": "Karen Short", "speech": [ "OK. That's very helpful. And I just had one quick question. In terms of the commentary, you made a comment on trading up, that you were seeing trading up.", "I was just wondering if you could just give a little more color on that." ] }, { "name": "Bill Lennie", "speech": [ "Just continued interest with our customers, both Pro and DIY, to engage with innovative product, and it certainly can be tools. But it can also be pressure-treated lumber with higher efficacy. It can be stain-resistance carpeting. I mean it's really across the business where we offer benefits and attributes to our product and the customer shows the willingness to trade up to that." ] }, { "name": "Karen Short", "speech": [ "Great. Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Thanks. Good morning. Great results. I was wondering if you could elaborate a little bit more on category performance, areas of relative strength.", "I know you called out 13 out of 14 businesses being strong. And then if you could also contextualize the opportunity for HD Home as we look ahead." ] }, { "name": "Craig Menear", "speech": [ "Yeah. I mean really, the strength we had in the business was throughout the categories as well as throughout our geographies. And when you think about -- Ted talked about the fact that every single category of goods was double digit with the exception of high single digits in kitchen and bath which is a pretty invasive indoor-type category. We were super pleased with that performance and that growth in the second quarter.", "And when we look at it on a geography basis, for example, every single region, all top 40 markets were double-digit comp growth." ] }, { "name": "Chuck Grom", "speech": [ "OK. That's helpful. And then Craig, when you look at the strength in the business, there's always the concerns about some pull-forward of demand versus the under-occurrence of sustainability. So when you look ahead to the back half, I know you talked about August being strong.", "But when we think about the back half and even into '21, how are you thinking about these mix and dynamics?" ] }, { "name": "Craig Menear", "speech": [ "I mean, we -- at this point, as I said earlier, we're looking at what's customer behavior, what's the sentiment? We're monitoring that incredibly closely. We are -- we operate on short cycle and the things that are most critical to that which is our labor planning and inventory planning. And we really don't know how to extrapolate from where we are to what the future is. What we know is we have to rely on the capabilities that we've built to be flexible and to adjust to be able to deal with whatever gets thrown at us.", "And that's really what our focus is, Chuck." ] }, { "name": "Chuck Grom", "speech": [ "OK, thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zack Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zack Fadem", "speech": [ "Hey, good morning. So relative to Q1, it looks like your ticket growth was similar in Q2. But curious if you could talk through the dynamics that drove transaction growth from negative 4% in Q1 to over 12% in Q2. How much of the traffic increase was your own doing given the Q1 restrictions? And then what would you attribute to just evolving consumer behavior and the return of the Pro customer?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. I think a significant portion of the change was in terms of the constraints that we put on the business in Q1 which were pretty severe. I mean when you close down 25% of your customer-facing hours, that's going to have an impact. And when you kill all of your spring promotions and major events that historically drive big amounts of traffic to the stores, that's going to have an impact.", "We obviously continue to learn and adjust based on the learning and feedback from our field teams. And that's really what we've done and made the adjustments that I called out in my prepared remarks in the second quarter, and that certainly helped contribute to driving transaction growth." ] }, { "name": "Zack Fadem", "speech": [ "Got it. Go ahead." ] }, { "name": "Ted Decker", "speech": [ "No. I was just going to add with the reduced traffic, we're not just are limiting the hours, but our Pro and consumer customers alike were consolidating trips. While transactions were down and ticket was up, and that was driven by units per transaction. People were definitely consolidating trips.", "So part of Q2, not only did we ease and did many shelter-in-place and customers' willingness to visit stores all ease, we still saw terrific ticket growth in units but just eased a little bit on units per transaction, although still incredibly healthy." ] }, { "name": "Zack Fadem", "speech": [ "Thanks Ted. That's helpful. And on the supply chain, curious if you would call out any headwinds or constraints from out of stocks or inventory availability, whether that was an issue at all in Q2. It doesn't look like it was, but curious if you anticipate any ongoing headwinds from lumber or other product availability as we get to the second half of the year." ] }, { "name": "Craig Menear", "speech": [ "Look, when you run 20-plus-percent comps, you certainly put pressure throughout the supply chain network from vendor community through our own supply chain. So certainly, there's pressure there. What I would tell you is again as Richard called out, with 20% comps for each of the months in a row and every single week during the quarter being double-digit growth north of 20%, the team is able to adjust and to adapt to that and did a terrific job for sure." ] }, { "name": "Zack Fadem", "speech": [ "Got it Craig. Thanks. Appreciate the time." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with RBC Capital Markets. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning guys. So with August sales reaccelerating from July's already strong trends, I'm curious if July was particularly impacted, either from supply shortages be it lumber or something else that we keep hearing about or maybe specific changes to your promotional plan?" ] }, { "name": "Richard McPhail", "speech": [ "Thanks Scot. It actually was not supply chain or demand. It was a function of really two factors. And I think the headline here is if you normalize for these two effects, June and July look almost identical from a comp perspective.", "So the first element here was our pullback on event -- on events, annual events which had a greater impact in July than for June. And the second dynamic here was that we saw an earlier start to hotter temperatures in June than we saw last year. So there were some comp benefit in categories like ACs and fans in June versus July when you do the year-over-year compare. So again, when you look at those two months and you make those adjustments, they were almost identical from a comp perspective and that's carried on to the first two weeks of the third quarter." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. That makes a lot of sense, Richard. And then you also talked about the need to delay some of your planned investments obviously the multiyear plan. Can you provide some color on maybe the magnitude of costs that may have to get pushed out to '21 from '20?" ] }, { "name": "Richard McPhail", "speech": [ "Sure. So I'd say, first of all, we don't see the need to spend any more than we originally planned. It's simply the dynamic of pushing spend into '21 as we make sure that we're focused on safety in our stores. So just to give you a little bit of context, think about our capital plan for the year which is around $2.8 billion.", "We might defer several hundred million, probably less than $0.5 billion that could be pushed into next year. Depending on the size of that deferral, 2021 capex may look more similar to 2020 levels. And from an expense perspective, the deferral is lower than the capital deferral." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Very helpful. Thanks guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with JP Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks and good morning. I want to think about the categories a little bit more as well. Can you talk maybe broadly about what indoor comps versus outdoor comps looks like, particularly as we try to get a sense of what underlying demand might look like as we get deeper into the fall?" ] }, { "name": "Craig Menear", "speech": [ "Let me start with one comment. And that is, if you back out our garden business, our seasonal business, we were north of 20% comps even with that backed out. So this isn't a quarter that was dependent upon our seasonal business. And I'll let Ted share some color on how we're seeing the engagement in indoor." ] }, { "name": "Ted Decker", "speech": [ "Yes. Chris, it was really strong demand across the business. Clearly, more DIY in the interior projects, as we've talked about the Pros and having third parties in the house and permitting and the like. But short of the installation-heavy categories, flooring and paint and plumbing and electrical, all strong.", "Kitchen and bath, we said it was just under double digit. Our bath business was double digit. So again, it was the heavy installation of kitchen-oriented product. But just super strength and add that we'd like the medium and longer-term implications of this.", "Because there have been questions for years now, would the Gen X and millennial engage to the same level of home improvement when you think The Home Depot had a big part in teaching the baby boomer to gain confidence and take on DIY. What we're seeing is that all generations are engaging, in Gen X and millennial. And when you start with that first DIY project, it may be a garden, it may be painting. Painting has traditionally been the No.", "1 DIY project. And once you accomplish that first, more modest task, you gain confidence and you take on the next task and the next task and they become bigger. And then you need more sophisticated and broader breadth of tools to continue the more ambitious projects you're taking on. So this is what we saw with the baby boomer and the growth and the establishment of this industry.", "And the -- one of the -- the bigger medium and long-term benefits of this is we know that this next very, very large generation is a very active home improver." ] }, { "name": "Christopher Horvers", "speech": [ "That's great. And then a couple of quick ones on the expense side. Can you talk about some of the investment levels that you're pushing out relative to the $40 million year-over-year investment 2Q? How do you think about that in the third and fourth quarter? And also, in case you didn't touch it, how much the PPE and COVID costs continue in the back half? Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Sure. On the expense portion of our investment program obviously we're operating in a very dynamic environment. It's not going to -- the shift is not going to be material to the company. But again, we're managing that as circumstances warrant.", "With respect to PPE, we incurred costs of approximately $110 million with respect to associate and customer safety. The majority of that were related to masks and PPE. That expense became material in the second quarter as we mandated them for our associates and our customers. And we've become more efficient in the distribution of those masks, so this expense is going to moderate in the third quarter." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Best of luck." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Elizabeth Suzuki with Bank of America Merrill Lynch. Please proceed with your question." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Thank you. Just with your -- last quarter, you've given some color around sales growth in urban markets versus rural and then the gap there. I mean did that gap close this quarter? And are you seeing your urban markets getting closer to the overall chain average?" ] }, { "name": "Craig Menear", "speech": [ "Again, we saw in all of our top 40 markets, double-digit growth. And it's one of the most narrow performances we've seen by region, by market in quite some time." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Thanks." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Our final question comes from the line of Mike Baker with Nomura. Please proceed with your question." ] }, { "name": "Mike Baker", "speech": [ "Hi. Actually, it's Mike Baker now at DA Davidson. I wanted to ask a follow-up on the regions. You had said -- so they're all very consistent, but is there any difference at all in the areas where we're seeing a resurgence in some of the COVID cases or not? And then I guess, a follow-up related to that is other retailers have talked about seeing a big benefit from stimulus.", "I guess, the continued strength that you guys are seeing would suggest that perhaps stimulus didn't really help that much. You're not dependent on stimulus. But could you provide some color on that? Thank you." ] }, { "name": "Craig Menear", "speech": [ "So look, in terms of the overall benefit from stimulus, hard to quantify, but we have to believe that there's some -- when customers have more money in their pocket, there's some benefit to that. So we don't kid ourselves to think that that didn't have some kind of impact. But clearly, the customer is engaged around their home and looking to get things fixed, looking to take on projects as they have time to be able to do that." ] }, { "name": "Richard McPhail", "speech": [ "And with respect to the COVID environment, we've really found no relationship between COVID case counts and sales performance." ] }, { "name": "Mike Baker", "speech": [ "Thanks. And any color on areas where back to school has started versus some areas where kids aren't going back to school yet?" ] }, { "name": "Richard McPhail", "speech": [ "No." ] }, { "name": "Mike Baker", "speech": [ "Very consistent. All right. Thank you. Appreciate it that." ] }, { "name": "Operator", "speech": [ "We reached the end of the question-and-answer session. Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you Christine, and thank you all for joining us today. We look forward to speaking with you on our third-quarter earnings call in November." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2022-02-22	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Craig Menear", "position": "Executive" }, { "description": "President and Chief Operating Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Gordon Haskett -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Executive Vice President of Merchandising", "name": "Jeff Kinnaird", "position": "Executive" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" }, { "description": "Executive Vice President of Supply Chain and Product Development", "name": "John Deaton", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": "Baird -- Analyst", "name": "Peter Benedict", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steve Forbes", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" }, { "description": "Zelman and Associates -- Analyst", "name": "Dennis McGill", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to The Home Depot earnings call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Welcome to Home Depot's fourth quarter and fiscal year 2021 earnings call. Following today's comments about our performance, we will take a few minutes to update you on our strategic priorities as we look toward the next phase of growth. We will hold all questions until the end of our prepared remarks.", "After that, the call will be open for questions. Questions will be limited to analysts and investors. [Operator instructions] If we are unable to get to your question during the call, please call our investor relations department. In addition, as referenced in our quarterly earnings release, after the call, we will post a few supplemental slides to the investor relations website.", "Joining us on our call today are Craig Menear, chairman and CEO; Ted Decker, president and chief operating officer; and Richard McPhail, executive vice president and chief financial officer. Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to the factors identified in the release and in our filings with the Securities and Exchange Commission.", "Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and good morning, everyone. Thanks for joining our call this morning. As you know, this is my last earnings call, and it has been a blessing and an honor to serve our customers, associates, shareholders, and communities for the last seven and a half years as CEO. I'm extremely proud of the progress this team has made together, but perhaps our greatest accomplishment has been nurturing the culture of our company, which I believe is a competitive advantage.", "I am confident that this leadership team will effectively guide The Home Depot through its next phase of growth. But before we talk about that, let's first discuss our results for the year. Fiscal 2021 was another record year for The Home Depot as we achieved the milestone of over $150 billion in sales. We have continued to navigate a challenging and fluid environment with agility.", "This resulted in double-digit comp growth for fiscal 2021 on top of nearly 20% comp growth that we delivered in fiscal 2020. We've grown the business by over $40 billion over the last two years. For context, prior to the pandemic, it took us nine years from 2009 to 2018 to grow the business by over $40 billion. So to achieve that level of growth in two years' time is truly a testament to our investments, our teams, and their exceptional execution.", "None of what has been accomplished over the past two years would have been possible without our orange-blooded associates. Our associates have maintained their relentless focus on the customer while simultaneously navigating the ongoing pandemic, industrywide supply chain disruptions, inflation, and a tight labor market. The tenure and strength of our relationships with our supplier and transportation partners has also been key to our success. Our respective teams have worked tirelessly to build depth in key product categories and flow product to stores and distribution centers as quickly and efficiently as possible.", "I could not be more proud of the resilience and strength that our associates have continued to demonstrate, and I want to thank them and all of our partners for their hard work and dedication to serving our customers, communities, and each other. Their extraordinary efforts in fiscal 2021 resulted in record Success Sharing, our bonus program for our hourly associates. With that, I'd like to turn it over to Ted, who will provide some additional details on our fourth-quarter performance." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. We finished the year with another exceptional quarter as home improvement demand remained strong. Sales for the fourth quarter grew approximately $3.5 billion to $35.7 billion, up 10.7% from last year. Comp sales were up 8.1% from last year with U.S.", "comps of positive 7.6%. During the fourth quarter, all our regions and merchandise departments posted positive comps. Departments of comps above the company average were plumbing, electrical, building materials, millwork, decor, and storage and paint. Our kitchen bath department was in line with the company average.", "And hardware tools, lumber, flooring, appliances, and our garden departments were positive but below the company average. During the fourth quarter, our comp average ticket increased 12.3%. Comp transactions decreased 3.8%. The growth in our comp average ticket was driven primarily by inflation across several product categories.", "Core commodity categories positively impacted our average ticket growth by approximately 185 basis points in the fourth quarter driven by inflation in lumber, building materials, and copper. Lumber prices remain volatile. For example, in the fourth quarter alone, the pricing for framing lumber ranged from approximately $585 to over $1,200 per 1,000 board feet, an increase of more than 100%. On a two-year basis, both comp average ticket and comp transactions were healthy and positive in the fourth quarter.", "Big-ticket comp transactions or those over $1,000 were up approximately 18% compared to the fourth quarter of last year. We saw continued strength in both our Pro and DIY customers. During the fourth quarter, Pro sales growth outpaced DIY growth. Sales growth for both our Pro and DIY customers accelerated in the fourth quarter relative to the third quarter and showed strong double-digit growth on a two-year basis for both customer groups.", "Sales leveraging our digital platforms grew approximately 6% for the fourth quarter and approximately 9% for the year. Over the past two years, sales from our digital platforms have grown over 100%. Our focus on delivering a frictionless, interconnected shopping experience is resonating with our customers as approximately 50% of our online orders were fulfilled through our stores in fiscal 2021. We feel great about our position as the No.", "1 retailer for home improvement, and we look forward to serving our customers in the busy spring selling season. Before I hand the call over to Richard, I also want to say a huge thank you to all our associates as well as our supplier and transportation partners for their incredible effort in 2021. Over the last year, we faced a number of challenges, including rising cost pressures, disruptions throughout the supply chain, and the ongoing pandemic. We're extremely grateful for the way our cross-functional teams work with our partners to mitigate these challenges while staying focused on serving our customers and communities.", "With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ted, and good morning, everyone. In the fourth quarter, total sales were $35.7 billion, an increase of approximately $3.5 billion or 10% -- 10.7% from last year. Our total company comps were positive 8.1% for the quarter with positive comps of 7.3% in November, 10.2% in December, and 7% in January. Comps in the U.S.", "were positive 7.6% for the quarter with positive comps of 7.2% in November, 10.9% in December, and 5.4% in January. Our results in the fourth quarter were once again driven by broad-based strength across the business and our geographies. All 19 U.S. regions posted positive comps, and Canada and Mexico, both posted double-digit positive comps in the fourth quarter.", "For the year, our sales totaled a record $151.2 billion, with sales growth of $19 billion or 14.4% versus fiscal 2020. For the year, total company comp sales increased 11.4%, and U.S. comp sales increased 10.7%. In the fourth quarter, our gross margin was 33.2%, a decrease of approximately 35 basis points from last year.", "And for the year, our gross margin was 33.6%, a decrease of approximately 30 basis points from last year, primarily driven by product mix and investments in our supply chain network. During the fourth quarter, operating expenses were approximately 19.7% of sales, representing a decrease of approximately 120 basis points from last year. Our operating leverage during the fourth quarter reflects comparisons against significant COVID-related expenses that we incurred in the fourth quarter of 2020 to support our associates, the anniversarying of $110 million of non-recurring expenses related to the completion of the HD Supply acquisition in the fourth quarter of 2020, and solid expense management for the quarter. During the fourth quarter of fiscal 2021, we also incurred approximately $125 million of COVID-related expenses.", "For the year, operating expenses were approximately 18.4% of sales, representing a decrease of approximately 170 basis points from fiscal 2020. Our operating expense leverage in fiscal 2021 reflects a decrease in our COVID-related costs compared to last year, partially offset by wage actions taken at the end of 2020 as well as throughout 2021. Our operating expenses for the year included a consistent level of investment in our business, which we intend to continue. For the year, we are very pleased with the operating expense leverage we were able to deliver.", "Our operating margin for the fourth quarter was approximately 13.5% and for the year was approximately 15.2%. Interest and other expense for the fourth quarter was essentially flat with last year. In the fourth quarter, our effective tax rate was 25.5% and for fiscal 2021 was 24.4%. Our diluted earnings per share for the fourth quarter were $3.21, an increase of 21.1% compared to the fourth quarter of 2020.", "Diluted earnings per share for fiscal 2021 were $15.53, an increase of 30.1% compared to fiscal 2020. During the year, we opened seven new stores and added 14 new stores through a small acquisition, bringing our store count to 2,317 at the end of fiscal 2021. Retail selling square footage was approximately 241 million square feet at the end of fiscal 2021. Total sales per retail square foot were approximately $605 in fiscal 2021, the highest in our company's history.", "At the end of the quarter, merchandise inventories were $22.1 billion, an increase of $5.4 billion versus last year. And inventory turns were 5.2 times, down from 5.8 times from the same period last year. Moving on to capital allocation. During the fourth quarter, we invested approximately $830 million back into our business in the form of capital expenditures.", "This brings total capital expenditures for fiscal 2021 to $2.6 billion. During the year, we paid approximately $7 billion of dividends to our shareholders. We look to grow our dividend every year as we grow earnings. And today, we announced our board of directors increased our quarterly dividend by 15% to $1.90 per share, which equates to an annual dividend of $7.60.", "And finally, during fiscal 2021, we returned approximately $15 billion to our shareholders in the form of share repurchases, including $4.5 billion in the fourth quarter. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was 44.7%, up from 40.8% in the fourth quarter of fiscal 2020. Now I'll comment on our outlook for 2022. The broader housing environment continues to be supportive of home improvement.", "Demand for homes continues to be strong, and existing home inventory available for sale remains near record lows, resulting in support for continued home price appreciation. On average, homeowners' balance sheets continue to strengthen as the aggregate value of U.S. home equity grew approximately 35% or $6.5 trillion since the first quarter of 2019. The housing stock continues to age, and customers tell us the demand for home improvement projects of all sizes is healthy.", "While we are encouraged by the consistent and resilient demand we've seen for home improvement, broader uncertainty remains with respect to the impact of inflation, supply chain dynamics, and how consumer spending will evolve through the year. Given these factors establishing full year 2022 guidance based on macroeconomic fundamentals remains challenging. As a result, our fiscal 2022 guidance is based on the run rate of dollar demand we have observed over the last two quarters. We adjust this dollar run rate for our historical seasonality to calculate our sales outlook for 2022.", "Based on this approach and assuming there are no material shifts in demand, we calculate that sales growth and comp sales growth will be slightly positive for fiscal 2022. We expect our 2022 operating margin to be flat to 2021. And we would expect low single-digit percentage growth in diluted earnings per share compared to fiscal 2021. Over the course of fiscal 2022, we plan to invest approximately $3 billion back into our business in the form of capital expenditures, in line with our annual expectation of approximately 2% of sales going forward.", "We believe that we have positioned ourselves to meet the needs of our customers in any environment as evidenced by our results. The investments we've made in our business have enabled agility in our operating model. As we look forward, we will continue to invest to strengthen our position with our customers, leverage our scale and low-cost position to drive growth faster than the market, and deliver shareholder value. With that, I'll hand it back to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Richard. And again, let me congratulate the team on an exceptional year. In a few moments, Ted and Richard will share their thoughts on the next phase of growth for our company. The leadership team has spent a lot of time over the past year talking about what's next for The Home Depot, and I have never been more excited about the opportunities that are ahead of us.", "While change is constant in our business, our strategic priorities remain consistent: deliver the best customer experience in home improvement and extend our low-cost provider position. Our objectives to grow market share and deliver exceptional shareholder value are also unchanged. And as Ted will detail, the investments we have made and will continue to make in differentiated capabilities throughout the business will unlock the opportunity to deliver a value proposition that we believe is unique in our industry. We are well-positioned to leverage our distinct competitive advantages to capitalize on a compelling growth opportunity in our space.", "We have a world-class leadership team who have the vision and experience to guide our company to new heights. We have a team of approximately 500,000 associates who are committed to the culture that our founders instilled in our business over 40 years ago. These associates have demonstrated exceptional execution and an unwavering commitment to our customers regardless of the operating environment. I believe that the greatest days for The Home Depot are ahead of us.", "And it is my honor to turn the call over to Ted, who will share a bit more about our strategic priorities for 2022 and beyond." ] }, { "name": "Ted Decker", "speech": [ "Thank you, Craig. Let me take a moment to express my sincere appreciation for all that you have done for this company throughout your 25-year career. You're a tremendous steward of our culture, ensuring our values guide every decision we make as a leadership team. You led us through a transformational period and positioned us well for the future.", "So on behalf of all our associates, thank you. I believe that Home Depot is an organization unlike any other. Our success is driven by our orange-blooded associates, unique culture, customer focus, and operational excellence. This is the power of The Home Depot and why we are the No.", "1 retailer for home improvement. I'd like to spend some time talking about the future, what's next for this great company. We've seen several inflection points in our company's history, all spurred by a desire to maintain the growth mentality and entrepreneurial spirit created by Bernie and Arthur when they revolutionized the home improvement industry over 40 years ago. Over the years, we have used these inflection points to adapt to changing market conditions and customer expectations.", "Approximately 15 years ago, we pivoted from new stores as a driver of growth to growth driven by productivity. Years later, we began building capabilities to better enable a multichannel shopping experience through an end-to-end approach. In recent years, we focused on a customer-back approach to deliver the best interconnected shopping experience in home improvement. Customer expectations continue to evolve, and there is little tolerance for any friction in the shopping journey.", "So we will continue to adapt to stay ahead of the customer. We have seen a tremendous amount of growth in the past decade. We could have never predicted the more than $40 billion in growth since the end of 2019. With this growth, we are reimagining new milestones for the business.", "I'm going to turn it over to Richard, who will briefly talk through our goals and help frame the opportunity within the context of our total addressable market." ] }, { "name": "Richard McPhail", "speech": [ "Thanks, Ted. Our objectives to grow market share and deliver exceptional shareholder value are unchanged. Aligned with these objectives, our goals are: first, to grow the business to $200 billion in sales, which represents incremental growth of approximately $50 billion from where we are today; and second, and just as importantly, deliver best-in-class operating profit dollar growth and return on invested capital. We believe that we will achieve these goals through what we are confident is the winning formula for our customers, our associates, and our shareholders.", "We intend to provide the best experience in home improvement, extend our position as the low-cost provider and be the most efficient investor of capital in home improvement. Over the last two years, as we've grown by over $40 billion in sales, our addressable market has also grown. We now estimate that our total addressable market in North America is greater than $900 billion. We have invested in capabilities that improve our competitive positioning and allow us to pursue opportunities we could not meaningfully address in the past, which provides significant growth opportunities with both consumers and Pros.", "We estimate that each of these respective customer groups represent about 50% of the total addressable market. We also estimate that each of these important customer groups represent approximately 50% of our total sales. For Pro, we believe this addressable end market is over $450 billion. Within this end market, we believe our addressable maintenance, repair, and operations, or MRO space, has expanded to over $100 billion.", "So while we are the No. 1 home improvement retailer across all of our geographies, we represent a relatively small part of a large and fragmented total addressable market that has expanded significantly over the past two years. To support our growth objectives, we have a straightforward approach to capital allocation that will also remain unchanged. Investing in the business is our primary capital allocation priority, and we have learned that it is critical to invest in a more consistent and agile way.", "Our investment cadence has become more real time, allowing us to pivot more quickly, giving us the ability to move faster when we see positive results. After investing in the business, it is our intent to return excess cash to shareholders through a balanced approach of paying a healthy dividend and making share repurchases. While there is more to do as we fine-tune new go-to-market strategies and refine our processes to better serve our customers, we believe what we are creating will extend our leadership position. We intend to leverage our unmatched scale as we continue to optimize assets and capabilities to compete in a more disruptive way.", "The macroeconomic environment is supportive, the opportunity in front of us is compelling, and our capital allocation principles will continue to create value for our stakeholders." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Richard. We have a powerful foundation and distinct competitive advantages. First, as I mentioned earlier, our unique culture and values as well as our knowledgeable associates will remain a competitive differentiator. Second, our stores are the hub of our business and will always be important in the future of home improvement retail.", "We have a premier real estate footprint that provides convenience for the customer. Third, we believe we have the most relevant brands and products and are continuously driving innovation in the marketplace. Fourth, we have a best-in-class supply chain and have demonstrated our ability to operate with agility and navigate any environment. And finally, we have consistently improved the interconnected shopping experience as our customers increasingly blend physical and digital worlds for their projects.", "We continue to invest and strengthen these advantages to ensure the best experience for our customers. While there is more work to do, we've made important strides in removing friction from the customer experience. Let me give you real examples of how the investments we've made across the business are earning us more share of wallet with our customers. Let's take the example of one of our Pro customers in the Dallas market.", "Years ago, this large-scale repair/remodeler primarily shop with us in our stores for their unplanned immediate need purchases, largely out of convenience. Over time, their in-store spend increased and they were signed a dedicated Pro Account Representative, or PAR, to deepen our relationship with them. As we invested across the interconnected experience, this customer engaged with us more often and occasionally used us for job site delivery. At this point, we saw their spend with The Home Depot grow to more than $100,000 annually but still for mostly unplanned immediate need purchases in store.", "Fast forward to today, this customer now utilize the number of new and/or improved capabilities. Last year, this customer downloaded our mobile app. Their mobile orders increased. They joined our Pro loyalty program and authenticated with us via our B2B website.", "We began offering personalized pricing on certain products. And they took their first deliveries from several of our new fulfillment centers, including one of our new flatbed distribution centers. As a result, we've seen spend with this customer more than triple to over $300,000 annually. While this is one example, we see that customers increase spend with us as they build confidence in our capabilities.", "While we continue serving this customer for their unplanned immediate-need purchases, we now believe our capabilities are beginning to satisfy important planned purchase occasions. We believe the ability to serve our Pros' planned and unplanned purchase occasions will be an important driver of growth as we work toward a $200 billion sales milestone. And while Pro is an important driver of growth going forward, removing friction from the DIY customer is equally important. Let's take the example of a customer we'll call Geena, a DIY customer tackling a bathroom remodel four years ago and compare that with the same shopping experience today.", "Four years ago, she would have relied heavily on our stores and website for helping completing her project. Geena's engagement on our digital applications is a little more difficult. The mobile experience wasn't as intuitive, search results weren't as relevant, and associated recommendations were limited. As a result, she likely made multiple trips to the store for items didn't know she needed.", "And when she did go to the store, buy online pick up in store, or BOPUS, was essentially the only option outside of the traditional cash-and-carry model for collecting whatever tools and materials her project required. Today, Geena's experience would be meaningfully different as her shopping journey is met with a lot less friction. As Geena begins her project online, improvements in search provide her with more relevant results. We also have a better understanding of the intent of her shopping journey and can make recommendations supporting her whole project.", "And we know these product-relevant recommendations matter. Over the last four years, we've seen a significant increase in sales driven by product recommendations. When Geena comes to our stores, our recently updated mobile app and improved signage help her more easily navigate our aisles. We've made investments in the front end to improve her checkout experience.", "And as always, our knowledgeable associates are there to help Geena throughout her project. If Geena chooses to place an order online for pickup in the store, she has multiple fulfillment options. She can pick up her items at the service desk, grab those items from a locker or have them brought to her car with curbside pickup. Geena can also receive same- or next-day delivery on thousands of items.", "We have seen customers like Geena increase their spend with The Home Depot as a result of our improved in-store experience, more robust and personalized online shopping journey and greater delivery and fulfillment options. We are also shifting our mindset to deliver a truly seamless interconnected experience. The flywheel we are building goes beyond retail's traditional channel mindset to an ecosystem of capabilities and operational efficiencies working together to remove friction at every step of the customer shopping journey. For example, while we believe the supply chain network we are building is transformational, it's just not about the buildings themselves.", "The value lies in their connection to the overall fulfillment and store ecosystem in the improved customer experience. The new fulfillment centers enable us to expand our assortment and inventory depth as well as offer faster and more reliable delivery options. In addition, these new facilities removed some fulfillment pressures historically placed on stores, creating a better in-store shopping experience and freeing up associates to help drive additional sales. Our intention is to build an unrivaled delivery network for home improvement goods.", "While early days, we continue to develop our capabilities, and we are encouraged as we see a measurable lift in sales with a more interconnected shopping experience. As we move forward toward this next phase of growth, we will remain focused on driving productivity, a long-standing hallmark of The Home Depot. Enabled by technology, we are focused on eliminating unnecessary tasks and making our processes more efficient while also making our shopping experience the best in home improvement. When I think about our stores, I think about the tremendous amount of productivity over the years, all of which helped us achieve over $600 in sales per retail square foot in 2021.", "As we set our sights on our goal of $200 billion in sales, we have many opportunities to improve freight flow throughout the store and drive further space optimization in SKU productivity. The productivity initiatives don't reside solely in our stores, we see many opportunities across the business. When our founders started The Home Depot over 40 years ago, they transformed an industry. We are continuing that legacy but doing so in an interconnected way.", "We believe that the interconnected ecosystem we are building will increase our ability to capture share. We intend to disrupt traditional business models with new go-to-market strategies. The opportunity in front of us is exciting today as it was when we first opened our doors, and I am honored to help lead this company into the next phase of growth. Thank you for your interest in The Home Depot.", "And Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Thank you. Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Good morning, everyone. Craig and Ted, congratulations on the transition. My first question is -- the first question is on the outlook for sales. So if you're guiding to slightly positive comps and we were to assume if this is the right assumption that the level of inflation that you mentioned around 2%, just around it, that means units are roughly flat for the year.", "Can you tell us what you're seeing that would suggest that volumes are flat? I heard Richard's comment around the on-the-run in the last two quarters of business, but is there any housing component or interest rate increases? And do you think this ends up being a more conservative approach to your guidance then as opposed to anchoring into some type of housing or interest rate metric?" ] }, { "name": "Ted Decker", "speech": [ "Simeon, on the comment around inflation, let me clarify how we approach that. The -- what we've seen in the marketplace that's embedded in our business over the last two quarters is kind of our assumption going forward. We're neutral. And as we establish a point, put together our outlook, we don't plan on inflation or deflation from that point forward.", "We just deal with whatever comes our way. So there is no inflation built in, if you will. It's what's there in the business today. And then we'll deal with what comes at us in '22." ] }, { "name": "Craig Menear", "speech": [ "I think just to go back to your macro questions and then we can talk about unit. On the macro side, as we said, look, there are a lot of dynamics in the environment right now. And so it's difficult to rest guidance on any given set of macroeconomic assumptions. That's actually why, when we look at the last two quarters of 2021, we saw a level of stability and consistency that gave us some confidence in being able to extrapolate those numbers on to '22.", "So it's really more of a math exercise based on current demand patterns than it is macroeconomics. Now we know the housing environment is supportive of home improvement demand. And Ted maybe can give some color on unit in that context." ] }, { "name": "Ted Decker", "speech": [ "Yes. So transactions in units have been negative coming off that incredible year in 2020, but they have improved on a two-year basis over what we saw in Q2 and Q3. And what we're really seeing on the demand side and as we think of transactions in units is it's not dissimilar to a storm environment, Simeon. It's a matter of -- particularly in Pro-oriented categories.", "When we receive the goods and get them on our shelves, they go. While we're seeing a lot of substitution, we still think there's plenty of upside as the supply chain continues to restock our shelves." ] }, { "name": "Simeon Gutman", "speech": [ "Got it. OK. And then my follow-up is the best-in-class operating profit dollar growth. Not trying to get cute to the letter of a number, but who is it? Is it sector-relative retail? And is there anything about the end markets that you mentioned, the Pro or MRO, that's actually margin-dilutive?" ] }, { "name": "Richard McPhail", "speech": [ "No. It's -- I'd say we think of it in terms of our sector, our $900 billion-plus addressable market. And I'd say we have opportunities that have many different profiles, but I'll share one thing, which is the ability to deliver exceptional return on capital. And so that's what we're looking to push." ] }, { "name": "Craig Menear", "speech": [ "And Simeon, when you look at our business historically, we have Pros that shop across the store. Our Pro business, for example, in and of itself is a relatively common margin profile to our DIY business. Certainly, within specific trades, you have variation like masons versus painters. But in total, it's very similar." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you. Good luck." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. Craig and Ted, congrats." ] }, { "name": "Ted Decker", "speech": [ "Thanks." ] }, { "name": "Michael Lasser", "speech": [ "A little embarrassing, but you forgot to include the year that you expect to get to $200 billion. So if you could just get into that real quick, that would be great." ] }, { "name": "Richard McPhail", "speech": [ "So -- good morning, Michael. We've established a goal of $200 billion in sales. We intend to get there as soon as we can in a sustainable and profitable way." ] }, { "name": "Michael Lasser", "speech": [ "Would you expect the growth rate to be higher, moving toward, in the 3.5% to 4% that you had signaled last time you provided a formal long-term outlook?" ] }, { "name": "Richard McPhail", "speech": [ "There are a lot of dynamics in our market right now, but what we are confident in is our ability to take share in any environment. And we intend to grow market share every -- in every period." ] }, { "name": "Ted Decker", "speech": [ "So Michael, as we think about this $200 billion, it's clearly the next phase of growth. It's a goal for the team and investors, obviously, that having passed $150 billion that we set our sights on $200 billion. And without getting into the specific growth components, the way we think about it is we operate in a huge market, as Richard described, a market that we think is larger at $900-odd billion. That market is very healthy and growing.", "And obviously, we have a level of base growth that would track with that market. We've also demonstrated over time that we've been able to take share, and we believe we'll continue to take share in that market. And then perhaps most importantly, as we've chatted about in our prepared remarks, we're working on developing the best interconnected experience in retail. So if you take the artifact of Geena, as we build this seamless, interconnected shopping experience, we think we'll gain even more share with our consumer and Pro customers.", "What we're building is relevant for both consumers and Pros. But specific to Pros, when you think about the example of the Pro in Dallas, we're building capabilities with our Pro ecosystem to accelerate Pro share growth, particularly in planned purchases. We've always talked about every Pro is in our building. We're sort of the 7-Eleven for Pros, convenience, value, tremendous product and brands.", "But what we're building now is something completely different and revolutionary to get the Pro planned purchase. Add to that the expanded MRO space, now we think $100 billion with the acquisition of HD Supply, and then wrap that all with our hallmark of productivity, we know that we leave money on the table every time we have a shelf out. We've talked to you about all the productivity activities in the store: overhead maintenance, freight flow, on-shelf availability, the supply chain that John and team are building to increase our on-shelf availability, their share gain just by being better in stock. And we're certainly seeing that in this storm-esque environment we're operating in right now.", "So that's sort of a broad-brush framework of how we think about that next $50 billion of growth." ] }, { "name": "Michael Lasser", "speech": [ "Understood. And my follow-up question is on the outlook for this year. How do you frame the upside/downside for this year with respect to your operating margin? If your sales are down, call it, low single digits, can you still have a flat operating margin in that scenario? And if your sales are up low single digits, would you let that flow through to the bottom line since your operating margin would be up? Or would you look to reinvest that back in the business? Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Michael. First, we're clear on our focus, which is to drive operating profit dollar growth. We do maintain a degree of financial flexibility in our model, and so we are able to make adjustments as we see fit. I think it's important to say that in an environment as dynamic as this, we would have to understand the circumstances to make a decision around what we -- what management action we might take.", "But we do have that degree of financial flexibility in the model. We have a history of delivering operating expense leverage as volume grows, and we intend to do that." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much. Good luck." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chris Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, everybody, and congratulations to everybody on their retirement and, Ted, on your new job. Really exciting. Can you talk a little bit about this inflation commentary? Some of your vendors have announced further price increases coming in the new year.", "They're sort of assuming units roughly flat. Are you taking those price increases? And have you seen actual any elasticity issues as you've passed those through to the consumer?" ] }, { "name": "Ted Decker", "speech": [ "Yeah. Chris, it's Ted, and thanks for your comment. Clearly, with double-digit AUR, we are taking cost. I would say that AUR increase is about two-thirds price, which includes the 185 basis points of commodity we called out, and about one-third mix in new.", "If I can just hit on that for a moment. We continue to see tremendous innovation with the products and the customers' willingness to trade up to that more innovative product. So that continues to drive about a third. And if you may recall, last quarter, it was more 50-50.", "So the inflation component increased to two-thirds this past quarter. I would say our merchants deal with this every day. Jeff and team are obviously in constant discussions with our suppliers working on the end-to-end cost and the value chain. And when we take cost, we're working to be the customers' advocate for value.", "We think being a scale player, that matters. And again, that end-to-end value equation, we should be able to offer the best value in any environment, including this inflationary environment. But as Craig said, we're not forecasting any further inflation, same way we don't forecast commodity inflation. We just start the year where we end the year, and we assume neutrality.", "We're doing the same for inflation in goods. Well, we're priced in cost and priced where we are as we end the year, and we don't have any incremental inflation in our plan." ] }, { "name": "Chris Horvers", "speech": [ "And you haven't seen the consumer trade down, and substitution has been very high?" ] }, { "name": "Ted Decker", "speech": [ "So -- yes. So on your elasticity question, for sure, every product -- and it's different by product categories, but every category has its elasticity curve, which the merchants watch very carefully. As we called out in Q2 with lumber, for example, when lumber hit those extraordinary highs in the early part of last year, we saw a dramatic unit productivity falloff, and then we also saw a very quick falloff in lumber prices. As lumber prices have recovered through this quarter, we are starting to see some unit pressure on lumber.", "But again, I'd say a lot of it is supply related as well. I mean we could -- it's tougher to get that elasticity curve completely right when we have the supply imbalances. But for sure, there's elasticity curve, Chris, for every product category. We're not kidding ourselves about that, but we're managing it appropriately.", "And our merchants are all about driving unit volume. That's the way we're wired. And we will always price per unit volume over rate." ] }, { "name": "Chris Horvers", "speech": [ "Got it. And then my follow-up question is, just think about the fourth-quarter gross margin and the outlook into next year, was there anything unique in the fourth quarter on gross margin? And given that you're pulling a lot of costs up in the supply chain as you build out the fulfillment, I would think that that would mean continued pressure on gross margin and the opportunity comes in on the operating expense line." ] }, { "name": "Richard McPhail", "speech": [ "Right, Chris. So for Q4 this year, it was really a story of sort of rebate timing year over year. There was pressure from the build-out of One Supply Chain as we've had every quarter for a few years. That -- the pressure on gross margin, as we continue building One Supply Chain out in 2022, will continue.", "And so that's sort of the way we're thinking about freight." ] }, { "name": "Ted Decker", "speech": [ "And I'd also say, Chris, that our merchants don't necessarily differentiate the transportation cost, where most of the pressure in supply chain is coming in from an initial cost of a good. They're both costs that need to be covered in the portfolio, which I think we did effectively throughout 2021." ] }, { "name": "Richard McPhail", "speech": [ "As a whole, 2021 was a mix of products sold and a slight pressure from investment in One Supply Chain's story." ] }, { "name": "Chris Horvers", "speech": [ "Understood. Best of luck." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Chris." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Good morning and congrats on a great year. I was curious on Pro backlog levels. If you could just give us an update on that front. And then also was curious if you're seeing any noticeable changes in spending patterns by income cohorts in light of some of these inflationary pressures and the end of stimulus in January?" ] }, { "name": "Craig Menear", "speech": [ "Everything we hear from our Pro customers is they've got more work than they can handle. I know for myself, it took a while to get somebody out to just do simple projects around my house. We hear that all over the country. And so the Pro business backlog is healthy." ] }, { "name": "Richard McPhail", "speech": [ "And it's really sort of across the business. When you take that elasticity comment to a more macro level, as Ted said, this is a storm-like environment. And when you look at external third-party surveys of remodelers, the index numbers have never been higher. So all of that points to healthy conditions." ] }, { "name": "Craig Menear", "speech": [ "Wouldn't say, to your question, that we've seen changes. We haven't seen any dramatic shifts in customer patterns. And again, it's a little hard right now because as Ted said, this is almost like a storm environment. I mean you get the product, it goes.", "And so pretty hard to see any patterns that have changed much." ] }, { "name": "Chuck Grom", "speech": [ "OK. That's helpful. And then bigger picture, I was wondering if you guys just dig a little bit deeper in terms of the space optimization and SKU productivity efforts. Just maybe just a little bit more color on where in the store you think you can gain improvement off that $600 in sales per square foot." ] }, { "name": "Ted Decker", "speech": [ "Well, we mentioned last quarter in our prepared remarks are -- what we call get stores right, GSR initiative, where we tested over more than a year. And this is largely about macro space allocation and getting the facings and the inventory depth to drive the volume that we do. As you say, that's $600 a square foot. And we continue to be thrilled with that initiative.", "We did several hundred stores last year, and that will be our largest store investment that will continue in 2022. And we'll do hundreds of more stores this year. Jeff, maybe you can give some color of what you're seeing." ] }, { "name": "Jeff Kinnaird", "speech": [ "Yeah. Thank you, Ted. GSR is working exceptionally well for us. It's addressing the sales per square foot opportunity we have in our highest-volume stores.", "Not to mention, we're gaining a tremendous amount of learning that we're taking back to all stores in terms of addressing every eight-foot bay, for lack of a better term, and we're improving space productivity. So an enormous opportunity on GSR. And then alongside that, we do manage a very long-standing product line review process, where we continue to look at hundreds of programs every year, again, to drive more productivity inside of our stores." ] }, { "name": "Chuck Grom", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, everyone. I was hoping you might be able to provide a little bit more color regarding the increase in TAM that you just discussed. I think it's a pretty big increase from the last time. And I guess what I'm wondering is, how much of that is just expansion of existing markets where Home Depot was already highly competitive.", "Versus how much is, let's call it, a sizable component from newer market penetration with kind of stuff like MRO as kind of newer market, if you will?" ] }, { "name": "Richard McPhail", "speech": [ "Sure, Scot. So in maybe a different order than you asked. So first of all, base growth in the market in which we've always competed has been exceptional over the last two years. And so if you look at the U.S., if you look at Canada, if you look at Mexico, those markets have expanded.", "And you can see that if you triangulate it -- and measuring this market is kind of an art in triangulation. We're looking at census data. We're looking at third-party consulting data. We're asking our vendors.", "We have a high degree of confidence we have a really good perspective on it. And we triangulate all that and you just look at the numbers that, again, exist in those third-party data sets, you see exceptional growth. It's notable to add that for the first time, we are including our Canadian and Mexican businesses within our definition. So $900 billion plus is a definition of our North American addressable market.", "We don't really include -- you mentioned new market opportunities. There aren't really new market opportunities per se, with the exception of MRO, which with the acquisition of HD Supply, we became even better positioned to grow share in. And as we've gotten smarter about that business, as we've gotten smarter about understanding the opportunities of it, that led us to sort of resize the opportunity. So those are the building blocks.", "But the growth over the past two years has been impressive. The macro backdrop for continued growth is also really encouraging." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "Hi, guys. I'll ask a few sort of shorter-term-type questions. But one, in the past, you've given some color on current quarter trends to date. I think that's maybe particularly important now as we cycle up against the stimulus from a year ago.", "And then -- sorry, one question in two parts. Within your guidance for 2022, what are you including for share buybacks? I don't think you said that unless I missed it. Thanks." ] }, { "name": "Richard McPhail", "speech": [ "Thank you. Well, we are off to a strong start as the year begins. It is two weeks into a 13-week quarter, and we've got the more difficult compares of the year coming up in March and April. So it's early to draw any conclusions there.", "And obviously, timing of spring is important for the first half of the year, but we're off to a strong start. With respect to share repurchases -- sorry, Ted, would you -- and with respect to share repurchases, we intend to continue to return excess cash to our shareholders through dividends and share repurchases, and we'll do that again this year. We have $9.5 billion remaining in our current share authorization program." ] }, { "name": "Michael Baker", "speech": [ "So I guess a follow-up on that, is it fair -- I mean you must have a number in the EPS plan. In the past, you've provided that. Is it fair to say that that includes the full buyback relative to your authorization?" ] }, { "name": "Richard McPhail", "speech": [ "We like to maintain some degree of flexibility in the cash that we hold on the balance sheet and our liquidity position. But you can rest assured that it's our intent to return excess cash to shareholders." ] }, { "name": "Michael Baker", "speech": [ "Yep. OK. Understood. One more, if I could ask a follow-up.", "I don't know if that counts as my follow-up, but -- and maybe this is too long of a question for -- getting close to an hour here. But when you talk about competing in a more disruptive way, I think sometimes we think of that as -- is that more than just price? That's not -- are you signaling anything in terms of a change in your pricing strategy? Or is it bigger than that?" ] }, { "name": "Ted Decker", "speech": [ "No. It's a capability comment. We're not changing our promotional or pricing approach at all. The disruption is in the ecosystem we are building.", "We are -- have been, 42 years, the No. 1 home improvement retailer. We are built -- have been building and will continue to build frictionless, interconnected experiences that we think are disruptive in the essence of the frictionless nature of them as our customers weave in between the physical and digital worlds. That can be installation, that can be delivery, that can be pickup, that can be cash and carry.", "As we build that frictionless ecosystem, we think that in and of itself is disruptive because our aim is to build the next level of frictionless experience. And then perhaps more disruptive is our pursuit of the Pro planned purchase. As we've said, all Pros are in our buildings. We always use the term that Pros use us as a 7-Eleven.", "Certainly, we have more share of wallet with smaller Pros. But the opportunity with larger Pros, to build their confidence that The Home Depot is going to be there for them with a sales representative, appropriate pricing, reliable delivery, breadth, and depth of inventory, that is the real disruption. And if I can just expand on that for a minute. When we think about what we're seeing in the Pro planned purchase, I mentioned this, I believe last quarter, that we're seeing a redefinition of what we thought was a job lot quantity.", "We've always talked about being a project store, having job lots in the store. And I think I used an example of a foreign job, that we might have had three-odd jobs worth of flooring in the store. So an average job might be 1,000 square feet. So we'd have 3,000 square feet in the store at any one time to satisfy three jobs.", "What we're seeing going out of the flatbed distribution centers, orders of 7,000 square feet, completely redefining what a job lot quantity is. Recently, in millwork, if you think of interior doors, we have different widths, right- and left-hand swing. We might have 20 doors in stock of any particular SKU. Just this week, we are delivering door orders of counts of 150 doors out of our FDCs.", "This is completely redefining our fulfillment capability with the Pro for their planned purchase. So that's what we mean by disruptive." ] }, { "name": "Michael Baker", "speech": [ "Thanks. That's really interesting. Appreciate the color." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Zaccone with Citi. Please proceed with your question." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Good morning, everyone. Thanks for taking my question. Craig, best wishes for the next step in your career.", "Ted, congrats on the new role." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Steven Zaccone", "speech": [ "I had a question on the operating margin outlook for the business. I understand the focus is on operating dollar growth, but gross margin has been somewhat of a hindrance to EBIT margin in the past four years. The business is roughly 120 basis points below the prior peak gross margin in the business. Do you think the business could get back to that level of gross margin over time? Or has something changed structurally?" ] }, { "name": "Richard McPhail", "speech": [ "Nothing. Nothing has changed structurally. We have been and will continue to be the low-cost provider in our market. That provides us with plenty of opportunities to go after opportunities in a lot of ways.", "But let's just -- let's talk about operating margins. So first of all, we set a goal today of driving to $200 billion in sales. But we said just as importantly, we're going to deliver best-in-class operating profit dollar growth and ROIC. We're going to watch operating margin, but dollar growth and returns are our focus.", "So we can break the operating margin question down. Operating margin is a function of two things: it's a function of operating expense leverage and a function of gross margin dollar growth. So first, on operating expense leverage. Historically, we've delivered operating margin expansion, driven primarily by operating expense leverage.", "We expect this relationship to continue, and we're committed to levering expense with volume. Gross margin dollar growth will be a function of the opportunities we take to drive outsized share gains. And throughout our history, we've driven share gains in categories that deliver gross margin rate higher than our company average and lower than company average, but we've always created operating profit dollar growth and shareholder value creation that we're proud of. So appliances is a great example.", "And Ted, maybe you can -- you'd want to talk about that." ] }, { "name": "Ted Decker", "speech": [ "Yeah. I mean appliances was a business -- and we've been in it for some time, but it was a business initially we didn't want to be in because of what we thought was the low-margin profile. But what we realized is the gross margin dollars delivered with the type of volume of the business we've built, particularly since it's a virtual inventory in a sense, it's all special order. For sure, it's a much lower rate than our average, but the gross margin dollar return on investment is one of our highest.", "And the operating profit dollars that it delivered and the growth as we've built sort of a double-digit billion-dollar appliance business is something we're thrilled we ultimately leaned into." ] }, { "name": "Richard McPhail", "speech": [ "And so if we have opportunities to take share and drive strong capital returns, we're going to continue to do that." ] }, { "name": "Steven Zaccone", "speech": [ "Great. That's very helpful context. A follow-up just on the external supply chain environment. Maybe just talk about the status of it right now.", "What's your expectation for the supply chain environment as we move through 2022? Do you see the situation improving at any point as we get through the year?" ] }, { "name": "John Deaton", "speech": [ "Yeah. This is John Deaton. We have seen some improvement, but we believe the constraints on the industry supply chain are likely to persist in the near term. Specifically, we've seen a little bit of easing of pressure at our ports, but we've planned for this and have been proactive in landing product earlier than usual to make sure that we're ready for the business." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Greg Melich with Evercore ISI. Please proceed with your question." ] }, { "name": "Greg Melich", "speech": [ "Hi. Thanks. Again, Craig, thanks for all the help over the years. And Ted, congrats." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Greg Melich", "speech": [ "The -- on inflation, I want to make sure I got this right. If ticket was up 12% in the fourth quarter, two-thirds of that was inflation, around 800 bps. Is that -- am I thinking about that the right way?" ] }, { "name": "Ted Decker", "speech": [ "Yes." ] }, { "name": "Greg Melich", "speech": [ "Got it. And so then as we think about the guidance for this year and when we talk about the level of inflation, it's basically -- we're starting at that kind of run rate. And presumably, it would come down over the course of the year and might be mid-single digits for the full year in your guidance." ] }, { "name": "Craig Menear", "speech": [ "We don't know where it goes. So presume the rate that was built in as we established that outlook based on our run rate. And we have no planned adjustment, up or down, in the guidance that we provided. So we plan -- in other words, think of inflation as neutral from the point in time that we established the guidance." ] }, { "name": "Greg Melich", "speech": [ "OK. So from today, but that -- is that looking at it on the price of inventories? If the rate is up 800 bps year-on-year and the level stays the same, then presumably by the end of the year, if we just stay at these levels, we'll basically have zero inflation by the fourth quarter. But in the first quarters, you could have positive." ] }, { "name": "Richard McPhail", "speech": [ "That's right. There is an anniversarying of AUR." ] }, { "name": "Greg Melich", "speech": [ "Thank you." ] }, { "name": "Richard McPhail", "speech": [ "That was taken in '21 that is reflected in 2020. That's correct, and your -- the way you're thinking about it is fair." ] }, { "name": "Greg Melich", "speech": [ "Got it. And so then maybe the transition would be if you think about -- maybe Richard, you could help us understand that -- as we think about the cadence through the year, not necessarily on top line, but even on costs and operating expenses, what unusual things are there? Or is 2021 a reasonable base now given all the COVID costs and wage actions that you took as we're thinking about modeling out this year?" ] }, { "name": "Richard McPhail", "speech": [ "I would say 2021 still included COVID cost. I would tell you that we, after having grown $40 billion over two years, are really excited that we see growth beyond that base after two years of unprecedented growth. 2021 did include, particularly in the fourth quarter, a significant amount of COVID expense. Just the month of January alone was a real spike, and that has come down.", "We still do include some COVID expense in our 2022 outlook. And so we're not completely through what I would say could be, at least, hopefully, nonrecurring expenses going into the future. So there is a little bit of that in 2022." ] }, { "name": "Greg Melich", "speech": [ "Got it. And are there any wage actions? I mean we've seen rising labor costs and tightness there. How do you feel about getting people for the peak spring? And do you see any additional wage actions on the horizon?" ] }, { "name": "Craig Menear", "speech": [ "Greg, I mean, we're out -- as we've indicated, we're looking to hire 100,000 people for the spring. We're going to utilize all of our capabilities and our messaging around attracting folks to The Home Depot. We've been able to do that. On the wage front, we're doing the same thing that we've always done.", "We look at this every single month. We look at market by market, and we're going to make sure that we're competitive in the marketplace so that we can attract folks into The Home Depot. Nothing's different there. There's certainly more action and more pressure than we've seen in the past, but our approach has not changed." ] }, { "name": "Ted Decker", "speech": [ "Greg, I think the good news on hiring 100,000 people are applications are up meaningfully. So we feel good about hiring that spring cohort." ] }, { "name": "Greg Melich", "speech": [ "That's good news. Thanks, and good luck." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Peter Benedict with Baird. Please proceed with your question." ] }, { "name": "Peter Benedict", "speech": [ "Hey, guys. Good morning. Congrats, too, Craig, Ted." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Peter Benedict", "speech": [ "My question is on inventory. My first question is on inventory. As you sit here, it's up a little more than 50% over 2019 levels, sales up a little less than 40%. Just how are you thinking about that gap and what the right level of inventory is as we move through '22? I know your -- there was a comment earlier about landing product earlier.", "So just maybe talk us through the kind of the inventory situation, where you sit right now, and how you see that flowing through the year." ] }, { "name": "Craig Menear", "speech": [ "Peter, a couple of comments. I mean, first of all, we feel good about the makeup of our inventory. As John said, we are working to bring goods in early to make sure that we're ready for spring. That's our busiest time of the year.", "I think an important thing to step back and look at is we delivered 5.2 turns. That turn level was higher than pre-pandemic levels, which ran 4.9. So we feel really good about the inventory productivity that we have in place. Last year's 5.8 was off of a scenario where we just didn't have a level of goods for a good portion of the year that we wanted to have.", "And then finally, as it relates to the inventory, as it's been referenced on the call here, we're in a -- still, in many categories, we're in a storm-like environment. The more goods we get, the more we sell. And the merchants and the supply chain team have been working like crazy to continue to build inventory to find out what the high level of demand actually is. So we're kind of watching the productivity.", "At the same time, we're not concerned about the inventory build at $5 billion at all." ] }, { "name": "Peter Benedict", "speech": [ "OK. That's helpful. Thank you. And then I guess my next question is on to a category standpoint.", "Flooring was mentioned a little bit below, I guess, the company average. Just curious if there's anything going on within that category from just an overall tone or what you're seeing. Or is that not really a material change?" ] }, { "name": "Jeff Kinnaird", "speech": [ "Peter, it's Jeff Kinnaird. We had a great quarter in flooring. We're happy with our business. The hard surface categories are exceptionally strong.", "If you look at vinyl flooring, electrified tile business, thrilled with the LifeProof private brand strategy we've got deployed. And on top of that, we just -- we're leveraging new capabilities that Ted spoke to with our supply chain and larger format tile. Very happy with the flooring business." ] }, { "name": "Peter Benedict", "speech": [ "OK. Terrific. Thanks. Good luck, guys." ] }, { "name": "Craig Menear", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steve Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steve Forbes", "speech": [ "Good morning, and also congrats all around. I wanted to focus on the 2021 expense build. So maybe to start with -- for Richard. Can you remind us how the Success Sharing program trended during 2021 relative to plan? And then as we think about incentive compensation for the whole year, is there anything to call out in terms of that weight right on the business as we look out to 2022?" ] }, { "name": "Richard McPhail", "speech": [ "We're proud that we paid impressive levels of Success Sharing to our amazing associates. We do see that bonus normalizing in 2022. So that's part of the dynamic allowing us to keep operating margin flat in a slightly positive sales environment." ] }, { "name": "Steve Forbes", "speech": [ "Thank you. And then just a follow-up, maybe thinking longer term, so for Ted or Richard. As we think about the level of investment spending you're sort of indicating -- because it sounds like investment spending is going to be more constant. But any updated thoughts on how you sort of think about what the right level of spend is? Or maybe you could just update us on your methodology on how you sort of approach your planning process for investment spending.", "Is it a certain percentage of sales that we should think about as the normal sort of base case level? Any sort of high-level thoughts on how we should be thinking about the model implications of investment-related spending?" ] }, { "name": "Richard McPhail", "speech": [ "We do think that a steady and agile approach to capital investment in the business is the right one. We had what I would say is objectively an extraordinary return on investment in the period 2018 to 2020 when we ramped up our capital investment. But starting with last year, we established a sort of a guideline where we expect appropriate capital expenditures to be around 2% of sales. We intend to invest on a much more consistent basis but also a much more agile basis.", "And I think one benefit that we took from the period over the last two years is a much more frequent, almost evergreen constant reevaluation of where our investments were going and whether we were seeing returns. We pivoted significant investment within the capital plan and within the P&L during 2021, but that didn't mean it was incremental. We just saw where we had more favorable return on investment, and that's where we went. GSR is a great example of that over the last two years, an idea that our brilliant associates really kind of drove from grassroots and has become a major component of what we're doing from a productivity perspective.", "So that's the long answer. The short answer is we think 2% of sales should be adequate." ] }, { "name": "Craig Menear", "speech": [ "Yeah. It's important to note that we do a reasonably robust testing scenario in most capital investments that we make. And we look to test and see a result before we actually roll. And that's a process that we've been using for the better part of the last 15 years." ] }, { "name": "Steve Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. A couple of questions just on, well, on the TAM and market share. So when you look at your share in 2019, I'm kind of at around 16% on the $650 billion TAM.", "And then when I look at '21, on a $900 billion TAM, you're kind of still at 16%. So I guess the first question is, why would your share not have increased? And maybe I'm not using apples-to-apples on the TAM, but maybe just clarify that." ] }, { "name": "Richard McPhail", "speech": [ "Well, I think it is such an imprecise science. We're trying to give you a sense that this is a huge market and it is fragmented. I think that trying to measure market share with precision is difficult. That's why when we check ourselves in market share gain, we do a lot of triangulation, vendor partners, third-party data.", "And -- but as far as thinking about the $650 billion and the $900 billion, both of them had pluses attached to them. Again, it's not completely apples-to-apples. We've included the entirety of North America. We've expanded our view of MRO.", "Previously, our view of that market was $55 billion. As we understand that market is just a bigger market, we have a smaller share than we thought. And what I love about the $900 billion-plus number is there's a tremendous amount of room to grow for us." ] }, { "name": "Karen Short", "speech": [ "OK. That's helpful. And then with respect to your '22 guidance on sales growth basically growing in line with EBIT, I mean if there's a sharp slowdown in sales at some point, can you just talk a little bit about what levers you have to remain within your EBIT guidance? And then just on that also, can you just remind us what you think your comp leverage point is now versus pre-pandemic?" ] }, { "name": "Richard McPhail", "speech": [ "Well, again, it depends on the circumstance we find ourselves in. That's why we've created plenty of financial flexibility in our model. In a scenario where sales are decreasing, we have variable expense that decreases with sales. We have a degree of fixed expense that can be reduced.", "We have a degree of discretionary expense that can be reduced. But all of these things are levers that we have to consider in the moment. As far as a flex point, we've historically been able to drive operating expense leverage in low single-digit comp environments. We feel confident that we have the financial flexibility to continue to do that." ] }, { "name": "Ted Decker", "speech": [ "And you've heard us say this before, Karen, but our largest operating expense is hourly payroll and having activity-based model. If sales drop off, transactions, units, etc., our labor model adjusts to that, and you reduce your labor expense." ] }, { "name": "Richard McPhail", "speech": [ "Manage it real time. Yes, pretty real time as well." ] }, { "name": "Karen Short", "speech": [ "Right. OK. And my congratulations to Craig and Ted as well." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Liz Suzuki with Bank of America. Please proceed with your question." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you. So I was hoping you could give an update just on the One Supply Chain strategy that you had discussed back at the Analyst Day in 2019. And what were you ultimately able to get done in those last two years adding FDCs, RDCs, MDOs.", "I mean there were a lot of facilities that were planned in the capex outlook. I'm sure there was some disruption due to COVID. So just curious how much of that capex outlook for '22 might include some of those One Supply Chain investments." ] }, { "name": "Craig Menear", "speech": [ "Yeah. I'll give a bit of context on the One Supply Chain rollout, and then I'll let Richard comment on the capex. As Ted called out, our supply chain is an important component of the ecosystem we are building to better serve our customers and drive productivity. As you know, the intent of our supply chain transformation was to build the fastest, most efficient, and reliable delivery network for home improvement products, reaching approximately 90% of the population with same- or next-day service for parcel, big and bulky and flatbed deliveries.", "Our original supply chain investment plan called for approximately 150 new facilities. And while many of these facilities will be complete by the end of 2022, some will take a bit longer due to the constraints we've seen as it relates to COVID and also taking into account our recent acquisition of HD Supply. In terms of our market delivery operations or MDOs, we expect to have approximately 85 of the 100 that we plan fully operational by year-end. In terms of our market delivery centers, we have a handful open today, but I expect those will take a bit more time to roll out given the acquisition of HD Supply, which we required that we briefly pause the rollout in order to determine how legacy HD Supply assets would factor into our broader supply chain plans.", "This led us to a decision to rethink the scope of our MDC facilities, which were originally intended to carry the most delivered store SKUs as well as MRO SKUs. We decided that we would leverage the legacy HD Supply network for our MRO fulfillment, freeing up capacity in our MDCs so that we can better operate as a local, direct fulfillment center for store-based SKUs. Lastly, in terms of our flatbed distribution centers, we expect to end the year with approximately 15 or about half of our intended goal. The FDC in Dallas was the first we stood up.", "It has been operating for just over two years, and we really like what we're seeing out of this facility. But what we've learned is that it takes time to assort, optimize and really commercialize these buildings. So we're very pleased with the progress that we made regarding our One Supply Chain strategy but still have more work to do." ] }, { "name": "Richard McPhail", "speech": [ "And so just some clarification on the capex, the capex to complete One Supply Chain is embedded in our expectations for capital expenditures around 2% of sales. I think it's also really noteworthy to think that while there were some delays and some great opportunities we took after the acquisition of HD Supply to further optimize what these assets could mean to our end markets, we still grew by $40 billion over two years. And so while we're really sort of early days of One Supply Chain, it's one part of an ecosystem that has created tremendous market share capture and top-line growth. We're excited to keep investing and -- as we are the rest of the ecosystem." ] }, { "name": "Ted Decker", "speech": [ "Now I often say, Liz, that we talk here about running the business and changing the business with our new capabilities. And the supply chain team had to run the business during a pandemic and change the business. So they've done just a tremendous job." ] }, { "name": "Isabel Janci", "speech": [ "And Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Dennis McGill with Zelman and Associates. Please proceed with your question." ] }, { "name": "Dennis McGill", "speech": [ "Hi. Good morning. Thank you. First question, I just want to go back to -- you mentioned a couple of times the storm-like situation in the stores and that if you had more inventory or when you get the inventory, you're able to sell it pretty quickly.", "And yet transactions are down. So I just wanted to clarify, are you implying that transactions are down because you don't have the right in-stocks? Or are those two things unrelated?" ] }, { "name": "Craig Menear", "speech": [ "There's certainly transaction pressure as a result of levels of inventory in certain categories. One of the pressured areas in the business over the last year and a half, if you will, has been in electrical. Our merchants did a phenomenal job, as Ted called out, I can't remember the last quarter or the quarter before on capturing more capacity in terms of getting goods, with the Carlon boxes becoming exclusive to The Home Depot. I mean we literally have seen the volume go up significantly.", "In-stock hasn't improved one iota because it moves off the shelf as fast as we get it. And so part of what's happening with our Pro customers, when they see goods, they're buying it. Where in the past, they might have bought it closer to a job and actually shop more frequently, they're actually grabbing what they see when they see it on the shelf." ] }, { "name": "Dennis McGill", "speech": [ "OK. That's helpful. And then longer term, on the market share side, as you think out over the next two or three years, are there certain categories in the store or departments in the store that you're most excited about share gain opportunity?" ] }, { "name": "Ted Decker", "speech": [ "Well, I mean, truly, it's across the store, Dennis. You've heard me go on before about innovation. We literally have innovation in every bay of the store. We remain a project business and I can't say anyone project today, Jeff, your thoughts, is driving the business more than any other." ] }, { "name": "Jeff Kinnaird", "speech": [ "Yes, it's across the store. If you think about the lumber business and composite decking; if you think about build materials in terms of the drywall and insulation and roofing categories. If you look at flooring, we talked about luxury vinyl tile and the LifeProof strategy, other hard surface flooring opportunities. If you look at Pro Paint and the opportunity we have there with PPG and BEHR.", "If you look at power tools in Milwaukee and RYOBI and other programs that we're driving across the 25-tool department; 26, 27, the plumber, and the electrician. I mean, Ted, in 28, the outdoor garden category, it goes across the business in terms of market share opportunities to name a few." ] }, { "name": "Ted Decker", "speech": [ "Yes, Dennis, so let me just build on Jeff's comment on Pro Paint. I mean we have just seen a tremendous growth in our paint business. With BEHR, we've had the one consumer brand and highest-rated consumer brand for some time. And in working with each of PPG and BEHR to put together a very formidable Pro go-to-market strategy, we -- BEHR has formulated Pro-specific paint that's in our store.", "They also have, as you've heard us mention before, outside sales force, working with our outside sales force and our stores too, again, get that larger Pro planned purchase in paint. And we're doing this exact same thing with PPG. PPG has very large external sales force. They are now introducing their PPG-branded paint.", "So think of SpeedHide paint. This is the specced paint for the Pro market that PPG is introducing in our stores for the very first time, and then also leveraging their stores and their outside sales force. We're absolutely thrilled with our two supplier go-to-market proposition and getting these Pro brands and external sales forces. We're just -- we couldn't be happier with what we're building in Pro paint." ] }, { "name": "Dennis McGill", "speech": [ "OK. Thank you, guys. I appreciate the answer." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and thank you all for joining us today. We look forward to speaking with you on our first-quarter earnings call in May." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2018-11-13	[ { "description": "-- Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "-- President, Chief Executive Officer", "name": "Craig Menear", "position": "Executive" }, { "description": "-- Executive Vice President, Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "-- Chief Financial Officer, Executive Vice President, Corporate Services", "name": "Carol Tom", "position": "Executive" }, { "description": "-- Senior Vice President, Store Operations", "name": "Marc Brown", "position": "Executive" }, { "description": " -- -- Executive Vice President, US Stores", "name": "Ann-Marie Campbell", "position": "Executive" }, { "description": "-- President, Online and Chief Marketing Officer", "name": "Kevin Hoffman", "position": "Executive" }, { "description": "-- Executive Vice President, Outside Sales and Service", "name": "Bill Lennie", "position": "Executive" }, { "description": "-- JPMorgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "-- UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "-- Oppenheimer -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "-- Gordon Haskett Research -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "-- Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "-- Barclays -- Analyst", "name": "Matt McClintock", "position": "Analyst" }, { "description": "-- Guggenheim Securities -- Analyst", "name": "Steve Forbes", "position": "Analyst" }, { "description": "-- Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "-- RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "-- Bank of America Merrill Lynch -- Analyst", "name": "Elizabeth Suzuki", "position": "Analyst" }, { "description": "-- Jefferies -- Analyst", "name": "Jonathan Matuszewski", "position": "Analyst" }, { "description": "-- Wolfe Research -- -- Analyst", "name": "Scott Mushkin", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Please standby. We're about to begin. Good day, and welcome to the Home Depot Q3 2018 earnings call. Today's conference is being recorded. If you would like to ask a question during today's call, please press the * key followed by the digit 1 on your touchtone phone. At this time, I would like to turn the conference over to Isabel Janci. Please go ahead, ma'am." ] }, { "name": "Isabel Janci", "speech": [ "Thank you and good morning, everyone. Joining us on our call today are Craig Menear, Chairman, CEO, and President; Ted Decker, Executive Vice President of Merchandising; and Carol Tomé, Chief Financial Officer and Executive Vice President, Corporate Services. Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our Investor Relations department at 770-384-2387.", "Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's discussion will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel. And good morning, everyone. We are pleased with our results in the quarter. Sales for the third quarter were up 5.1% from last year to $26.3 billion. Comp sales were up 4.8% from last year. And our US comps were positive-5.4%. Diluted earnings per share were $2.51 in the third quarter. From a geographic perspective, sales were strong across the US. All but one of our 19 regions posted positive comps. The exception was our Gulf region which faced tough compares associated with the anniversarying of Hurricane Harvey. Recall that we are lapping almost $300 million of hurricane-related sales from the third quarter of last year. While this quarter brought Hurricanes Florence and Michael, the scope of devastation was more compact from a geographical perspective than what we experienced in prior-year. Nonetheless, these storms did inflict significant damage in our community, and our thoughts and prayers are with them as they begin the recovery efforts.", "Our thoughts and prayers also go out to all those who are currently being impacted by the deadly fires in California. Internationally, both Canada and Mexico posted positive comps in local currency. As Ted will detail, both ticket and transactions grew in the quarter. Pro sales once again outpaced DIY sales. But we continue to see a healthy balance of growth from both Pro and DIY customers as they shop across the store. We believe this is a testament to the overall strength of demand in the home improvement market. Our digital business continues to be another source of growth. Online traffic growth was healthy. And third-quarter online sales grew approximately 28% from the third quarter of 2017. Customers continue to respond to ongoing investment and enhancements we are making to drive a frictionless interconnected customer experience. For example, Buy Online Ship to Store and Buy Online Pickup in Store sales both grew faster than the overall online sales growth rate for the third quarter.", "Another key component of the best-in-class interconnected shopping experience centers on enhanced delivery and fulfillment options. As you know, we are in very early stages of a five-year investment journey in the One Home Depot supply chain to enable the fastest, most efficient delivery network in home improvement. Today, we can reach approximately 95% of the US population in two days or less with parcel shipping. The anticipated end state of the One Home Depot supply chain will enable us to reach 90% of the US population with same day or next day delivery capability for an extended SKU offering that includes big and bulky goods. In order to get there, we must invest in a number of different facilities to offer greater depth and breadth of SKU availability. We told you that 2018 would be the year of the pilot as we test and learn with new fulfillment centers.", "I am pleased to report that we are on track with our plan, and we are live with our first few pilot facilities with additional pilots scheduled to open throughout the rest of this year and early next year. As we work on our long-term initiatives, we are also focused on meeting our customers' immediate delivery needs. We have made great progress with our store delivery enhancements as our car and van express delivery options now enables same day delivery of store goods. Since rolling out car and van delivery to over 40% of the US population, we have seen increased utilization from both our Pro and DIY customers. As we continue to work toward the 2020 goals that we laid out for you in December of 2017, let me update you on some of our investments, all of which focus on delivering exceptional customer service, driving productivity, and simplifying operations. We have implemented our wayfinding sign and store refresh package in approximately 700 stores, ahead of our initial plan.", "We continue to make progress on the rollout of our redesigned front-end areas and pickup lockers among other investments. We are also working to remove friction for our customers while helping our associates to be more productive with their time. An example of this is the deployment of our new overhead management application. As you've heard say before, customer service starts with being in stock. But beyond just having the product in stock, it has to be on the shelf for our customers to purchase, not stored in an overhead. Prior to the rollout of the overhead management application, the only way an associate could locate product in our overheads was to manually look for it. This new application on FIRST phones helps associates locate product in overheads quickly and accurately, saving them time, improving the customer experience, and enabling better inventory management. Turning to our outlook, as Carol will discuss in more detail, we are updating our sales and earnings guidance for the year.", "We now expect fiscal 2018 sales growth of approximately 7.2% and diluted earnings per share of $9.75. We faced the headwinds from last year's storm-related sales in the fourth quarter. But we believe the drivers of home improvement spend are supportive of our business. We remain excited about the investments we are making to ensure that we deliver the best customer experience in home improvement. I wanna close by thanking our associates for their hard work and continued dedication to our customers.", "Our associates not only work hard to serve our customers in our aisles, but their efforts extend to the communities in which we operate. This quarter marked our eighth annual celebration and service campaign in which our associates volunteered over 100,000 hours in support of veteran housing needs. In fact, our associates and non-profit partners have been hands-on in transforming over 40,000 veteran homes and facilities since 2011. We are very proud of our associates who live our values every day. And given that Veteran's Day was earlier this week, let me take this opportunity to thank those that have served our country. And with that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig. And good morning, everyone. We were pleased with our results in the third quarter. The core of our store continues to perform well. And we saw growth with both our Pro and DIY customers. Looking at our departments, comps in appliances, electrical, plumbing, tools, décor, and flooring were above the company average. All of our other departments but lighting were positive but below the company average. And the comp in lighting was essentially flat. In the third quarter, comp average ticket increased 3.5%. And comp transactions increased 1.2%. Commodity prices were volatile in the quarter while inflation in lumber, building materials, and copper positively impacted average ticket growth by approximately 61 basis points in the quarter. Today, lumber prices are below 2017 levels. In addition, foreign exchange rates negatively impacted average ticket growth by approximately 43 basis points. We continue to see strength in big-ticket prices during the quarter.", "Big-ticket sales or transactions over $1,000.00 which represent approximately 20% of US sales were up 9.1% in the third quarter. A few drivers behind the increase in big-ticket sales were vinyl plank flooring, windows, appliances, and water heaters. Once again, we saw strong performance in many Pro-heavy categories as Pro sales grew faster than the company's average comp. Pro-heavy categories like power tools, concrete, and several plumbing, electrical categories all had comps above the company average. We also continue to see a healthy and growing DIY customer as they engaged with us across the store. Categories like safety and security, vanities, lawnmowers, ceiling fans, and interior and exterior paint showed strong growth in the quarter. In the third quarter, we hosted several events that helped drive traffic and create excitement in our stores. We were pleased with our annual Halloween harvest and Labor Day events which recorded solid growth year-over-year.", "As we continue to focus on enhancing the in-store experience for our customers, I'd like to highlight some recent initiatives we have been working on with MET, our merchandising execution team. This seasoned team manages set integrity and executes resets throughout the store, bringing best-in-class feed to market. That leverages advanced analytics and proprietary technology to drive productivity and efficiency in our stores. We use real-time data to understand what categories require attention and leverage our FIRST phones to direct the work activity of our MET associates. We want to thank our supplier partners who continue to see the power of partnering with the Home Depot. Our suppliers entrust us with many exclusives in innovative product launches, in large part because of our 400,000-plus orange-blooded associates and the enthusiasm they bring to our aisles every day. Two recent additions to our portfolio of exclusive brands are Stanley hand tools and Troy-Bilt outdoor power equipment.", "Adding Stanley to our lineup of Milwaukee, Dewalt, Huskey, Crescent, Empire, Whisk, Bessey, and Klein exclusive brands makes us the No. 1 destination for hand tools. And Troy-Bilt complements our leading lineup of exclusive outdoor power equipment brands including Ryobi, Toro, Honda, Cub Cadet, Echo, Ego, Dewalt, and Milwaukee. In fact, 14 of the 15 top-rated gas, self-propelled lawnmowers in the market are big box exclusives to the Home Depot. Looking to the fourth quarter, we are excited about the upcoming holiday season. In addition to our comprehensive holiday décor offerings, we are thrilled with our 2018 gift center. This gift center is our best yet and features a number of special buys from our leading tool and power tool accessory brands that are also exclusive to the Home Depot, including Ryobi, Ridgid, Milwaukee, Makita, Diablo, and Huskey. With that, I'd like to turn the call over to Carol." ] }, { "name": "Carol Tom", "speech": [ "Thank you, Ted. And good morning, everyone. In the third quarter, total sales were $26.3 billion, an increase of 5.1% from last year. Recall that at the beginning of fiscal 2018, we adopted a new accounting standard pertaining to revenue recognition. The new standard changes the geography of certain items on our income statements but has no impact on operating profits. In the third quarter, the change in accounting positively impacted sales growth by $64 million. Further, during the third quarter, a strong US dollar negatively impacted total sales growth by approximately $110 million, or .4%. Our total company comps were positive-4.8% for the quarter with positive comps of 6.7% in August, 4.1% in September, and 3.8% in October. Comps in the US were positive 5.4% for the quarter with positive comps up 7.5% in August, 4.7% in September, and 4.2% in October. The cadence of our monthly comps is due in large part to hurricane-related sales.", "In the third quarter of fiscal 2017, we experienced approximately $282 million of hurricane-related sales. And the majority of those sales occurred in September and October. In the third quarter of this year, we had approximately $150 million of sales related to both the 2017 and 2018 hurricanes. These sales were more equally spread across the quarter. We estimate that hurricane-related sales positively impacted US comps by 60 basis points in August but negatively impacted US comps by 80 basis points in September and 120 basis points in October. In the third quarter, our growth margin was 34.8%, an increase of 23 basis points from last year. The year-over-year change in our gross margin reflects the following factors. First, the new accounting standard drove $147 million of gross profits or 47 basis points of gross margin expansion. Second, higher supply chain and transportation costs caused approximately 23 basis points of gross margin contraction.", "And finally, the net impact of all other drivers of gross margin resulted in one basis point of contraction. For the year, we now expect our gross margin rate to expand by approximately 37 basis points. In the third quarter, operating expense as a percent of sales increased by 23 basis points to 20.1% due to the following factors. First, we experienced 90 basis points of expense leverage in BAU or business as usual expenses. Our strong leverage in the core of our business was driven by good expense control but also reflects some year-over-year benefit due to certain hurricane-related expenses that did not repeat this year. Second, the new accounting standard resulted in a $147 million increase to our operating expenses and caused 51 basis points of operating expense deleverage. And finally, expenses related to our strategic investment plan of roughly $164 million resulted in approximately 62 business points of operating expense deleverage.", "For the year, we now expect our fiscal 2018 operating expenses to grow at approximately 131% of our sales growth rate. Our operating margin for the third quarter was 14.7%, essentially flat with last year. Interest and other expense for the third quarter decreased by $23 million to $224 million, largely due to tax settlements that occurred in the quarter. In the third quarter, our effective tax rate was 21.4% and for the year-to-date was 23.3%, lower than last year and our guidance. The lower rate reflects tax reform and a few other discrete items that were reported in the quarter, including a reconcilement of the provisional tax charge we reported in the fourth quarter of last year. For fiscal 2018, we now expect our effective tax rate will be approximately 24%. Our diluted earnings per share for the third quarter were $2.51, an increase of 36.4% from last year. Total sales per square foot for the third quarter were approximately $434, up 5.2% from last year.", "Compared to last year, inventory dollars grew by $1.3 billion to $14.8 billion. And inventory turns remained at 5.2 times. The growth in our inventory versus last year reflects the investments we are making to accelerate merchandising assets, higher in-stock levels than we had one year ago, and some pull forward of planned inventory purchases. In the third quarter, we repurchased $2.5 billion, or approximately $12.6 million of outstanding stock. We also received approximately 1 million shares related to an ASR program we initiated in the second quarter. Year-to-date, we have repurchased approximately $5.5 billion of our outstanding shares. And we now expect to repurchase approximately $8 billion of our outstanding shares for the year. We plan to fund our fourth quarter share repurchases with cash on hand and with proceeds from incremental debt. In the fourth quarter, we intend to replace $1.15 billion of senior notes that came due in September.", "And we may raise additional long-term indebtedness which will take us closer to our targeted adjusted debt to EBITDA ratio of two times. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 42.2%, 970 basis points higher than the third quarter of fiscal 2017. Turning to our outlook for the remainder of the year, remember that we have a directionally correct but imperfect model that we use to forecast sales growth. It starts with GDP growth which is strong. Consumer sentiment remains near all-time high. And unemployment is the lowest it has been in nearly 50 years. Housing-related metrics are moderating, but the drivers of home improvement spend are supportive of our outlook. Home prices continue to appreciate. The housing stock is aging. Households are being formed. And housing continues to turnover.", "And while we see healthy home improvement demand, it is important to note that in the fourth quarter, we are up against approximately $380 million of hurricane-related sale. Today, we are updating our fiscal 2018 sales guidance to reflect our year-to-date outperformance. We are also listing our earnings per share guidance to reflect our expectations for fiscal 2018 gross margin, operating expense, share repurchases, and tax rates. Remember that we guide off GAAP. And recall that fiscal 2018 will include a 53rd week. So, the fourth quarter of fiscal 2018 will consist of 14 weeks. For fiscal 2018, we expect sales to increase by approximately 7.2% with positive comp as calculated on a 52-week basis of approximately 5.5%. For earnings per share, we expect fiscal 2018 diluted earnings per share to grow approximately 33.8% to $9.75. With that, I would like to thank you for your participation in today's call. And Rochelle, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please press * followed by the digit 1. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, * 1 to ask your question. And our first question today will come from Christopher Horvers with JPMorgan." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning. So, there are a lot of questions on the consumer and the home environment and housing. If you look at your fourth quarter guide, it seems like inflation after some remnant benefit in the third quarter may be flat, maybe a headwind. You also have a harder compare on the hurricane front. So, you're still guiding to about four and a half for the fourth quarter assuming that the US is gonna be better than that because of FX. So, what are you seeing in the business? What gives you the confidence to give you that level of a guide?" ] }, { "name": "Craig Menear", "speech": [ "First of all, I'll give you a high level and let Carol walk you through the details. Again, we see, overall, the environment for home improvement is solid. We're clearly up against significant hurricane numbers. But as we see it, basically, two-year stack comps would be comparable in the first half and the second half of the year as we look forward. And that's really based on the strength that we see for not only the home improvement factors but what we have lined up for the back half of the year in terms of events and merchandise and great gift center that Ted talked about, we're excited about, we have going in the back half." ] }, { "name": "Carol Tom", "speech": [ "That's right, Chris. And we get comfort from our guidance not only from what we're seeing in the macro environment but from what we're seeing in our extreme sell. And we are pleased with how the quarter has begun." ] }, { "name": "Christopher Horvers", "speech": [ "Excellent. So, I wanna fast-forward a little bit on tariff risk. You had the experience with appliances. It looked like you largely passed through those price increases. But as you think about a more broad potential tariff risk to next year, how would you just size up your potential risk? And can you also talk about how you think about investment in share? Some companies have commented that they would try to maintain the gross margin rate. How would you think about balancing gross margin rate versus, let's say, in certain categories, maybe flooring, trying to go after share and drive gross profit in dollars?" ] }, { "name": "Craig Menear", "speech": [ "So, Chris, I'll start and let Ted jump in here. We have seen, as you mentioned -- we had tariffs impact in laundry, for example. The tariffs that have come through to date represent about 1% of US purchases. And we see more happen in January. And who knows what's gonna happen? But if the 25% were to go in place, that's gonna represent about 3.5% of US purchases. And clearly, we'll work to mitigate as much of that as possible. But as you saw in laundry, we'll see some impact in prices. The comment that I would make as it relates to the second part of your question is we run this business on a portfolio basis. And we will do everything we can to mitigate pressure on the customer to the best of our ability. But don't think of us taking cost in one area and that's where necessarily retail gets applied. It's a portfolio approach. We're in a project business." ] }, { "name": "Ted Decker", "speech": [ "Yeah. I would add to that, Craig. It's manageable is the term I'm using, Chris. Certainly, what we've seen today is more than manageable, particularly in the light of that portfolio approach that Craig described. A couple comments of good news. You look at what happened with Laundry. And that's generally a map-priced industry. So, the industry did take that price, largely attributable to tariffs. We also had steel cost in that as well as just the straight laundry tariff. And while there was an initial reaction to unit productivity, as we've now cycled through that several months, our laundry sales and unit productivity is on par if not slightly better than the average of our overall appliance business. So, we were able to cycle through that and would expect to see the same, again, given the strength of demand in other categories as well." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, everybody." ] }, { "name": "Operator", "speech": [ "And next, we'll move on to Michael Lasser with UBS." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. So, it sounds like your view is that home improvement demand has and will be coupled from housing. How long do you think that can persist? And what level of home prices and housing turnover would make you rethink that view?" ] }, { "name": "Carol Tom", "speech": [ "So, Michael, I think I and we would phrase that a bit differently. We have this directionally correct but imperfect model that we use to forecast our sales outlook. As I mentioned, it starts with GDP. And to that, we add the benefit from a number of different housing metrics including household formation, home price appreciation, the age of the housing stock and housing turnover. And if we look at those drivers, we think they all bode well for our outlook. Now, our outlook would suggest that our fourth quarter cost will be lower than what we reported in the third quarter. But that's because we are up against almost $400 million of hurricane-related sales. And while we do expect to get hurricane-related sales in the fourth quarter, we don't expect to get $400 million worth of hurricane-related sales. So, we factor that into our outlook. In terms of decoupling, there's one metric that's gotten a lot of attention recently. And that's housing turnover.", "And if you look at housing turnover, housing turnover is lower than we thought it would be at the beginning of the year when we put together our directionally correct but imperfect model. So, we went back and calculated what we believe the impact of a lower housing turnover than what we had projected at the beginning of the year, what the impact has been to our outlook. And based on our model, which is not perfect, but based on our model, the impact has been 13 basis points. And then one other correlation number to share with you, at least through the way that we look at the world, we correlate it housing turnover with transaction. And we don't do a smoothing approach. We do look at the actual data on a one-month lag basis. If you look at historical correlations from 2000 to now, the correlation coefficient was .53. Okay. But if you go and run it again from 2010 to now, it's .4. And if you run it from 2015 to now, it's .33.", "So, it's decoupled a bit we think in large part because of the housing shortage in the US. The way that we're talking about housing metrics, it's a bit like a Rubik's Cube. And you've just gotta turn it and turn it and turn it until you form a point of view on what it means for home improvement spend." ] }, { "name": "Michael Lasser", "speech": [ "And Carol, that's helpful. And because you've guided for the next few years that comps will grow in the 5-ish% range. So, should we think about if housing turnover continues to decline at a similar rate and home prices start to moderate that the risk to that forecast would be in this 13 basis point type range? So, it would not be as significant as what would be implied by the headlines from that whole outlet?" ] }, { "name": "Carol Tom", "speech": [ "Again, it's a Rubik's Cube. You can't just look at turnover when you're turning the cube around. We would need to refresh our point of view on home price appreciation as well because that's been a big driver of our sales growth for sure. We've seen since 2011, homeowners have had a 140% increase in their equity, now up to $124,000.00 per unit. So, real wealth has been created. Home prices are projected to increase in 2019, albeit not at the rate that we've seen this year. So, we are refreshing our point of view. We're not taking our sales growth targets down because we feel very comfortable with the targets that we laid out a year ago. But in February, we will give you the specific numbers for 2019." ] }, { "name": "Michael Lasser", "speech": [ "And my follow-up question is there's been a lot of well-documented pressure on many of the home improvement vendors. And you've been vocal about seeing an increase in the requests for price increases for those that sell products into you. So, putting aside the commodity inflation, are you starting to see an increase in product price inflation associated with the 90% of your sales that are relate to product? And do you expect that that's gonna continue to increase from here?" ] }, { "name": "Craig Menear", "speech": [ "We are still seeing cost out. But we are seeing a net cost in that we haven't experienced in the last several years. And we are seeing an increase in supplier request per cost in. But again, I'd say they're facing some of the same costs that Carol called out. People are facing transportation cost. That's what we hear universally. Again, outside, as you said, commodity or tariff, things like transportation is universal. And who knows what happens going into '19? But that seems to be the theme for the cost request for ' 18." ] }, { "name": "Michael Lasser", "speech": [ "And Craig, just a follow-up on that. Since you quantified the impact that commodity inflation provides to your ticket, could you quantify the impact that non-commodity inflation provides to your ticket?" ] }, { "name": "Craig Menear", "speech": [ "What we've seen to date, it's less than ticket, than the commodity that we called out, the 61 basis points." ] }, { "name": "Carol Tom", "speech": [ "It's less than that." ] }, { "name": "Michael Lasser", "speech": [ "Understood. Thank you very much." ] }, { "name": "Operator", "speech": [ "And next, we'll move to Brian Nagel with Oppenheimer." ] }, { "name": "Brian Nagel", "speech": [ "Hi. Good morning. Thank you for taking my questions. So, I think I wanna follow-up a bit -- at the risk of beating a horse here -- on the macroenvironment, a follow-up to Michael's question. So, Carol, when you talk about your algorithm -- which the detail you gave so far is very helpful. Thank you. Particularly, with regard to the housing turnover metrics, it sounds to me like you're talking more from a coincident standpoint in how shifts in these metrics impact sales at Home Depot and within real time. Have you done any work around or any insights into how the lead/lag relationship? So, if we are seeing this somewhat slower housing turn data now, who knows if that's gonna persist or not? But could that have a larger impact upon sales at Home Depot at some point in the future?" ] }, { "name": "Carol Tom", "speech": [ "Well, the correlation coefficients that I shared with you on turnover were based on a one-month lag. And we haven't done a lot of leading/lagging work yet because the environment is so very different than it's been in prior cycles. So, there's a lot of conversation, for example, on affordability. And we look at affordability too. But what happened last time around when affordability started to, if you will, slow down, is the underwriting standards loosened up dramatically. And that's what led to the housing crisis, as we all know. Well, that's not gonna happen again because of Dodd-Frank.", "And so, you can't look at history, necessarily, to understand what's gonna happen in the future. You gotta look at the future and what's happening. And as we look at the future and what's happening, fundamentally, you gotta look at the economy. And the economy's good. People are employed. They have more income. They've got more to come with tax reform. So, fundamentally, we feel very good about just the drivers of the spend in our business." ] }, { "name": "Brian Nagel", "speech": [ "Got it. And then a follow-up question. There's been a lot written about, talked about -- there's certain markets within the United States where you've seen pronounced weakness in home sales as a result of either supply issues or housing prices, whatever. And I think you've discussed this on prior calls. But as you look at your business and whether there's areas in the northeast, west coast, whatever, in those type of markets, are you seeing any impact upon Home Depot sales?" ] }, { "name": "Carol Tom", "speech": [ "Yeah. So, we believe, like you, that housing is very local. And when you get into the areas of home price appreciation and affordability, it's really local. So, we went market by market to see, \"Are we seeing any measurable impact on our sales?\" And we just can't see it. Now, we're hopefully smart enough to understand that you gotta stay really on top of the data because one watch-out, of course, is will affordability with rising home prices and rising interest rates at some point set a market clearing price for all home price appreciation and home price appreciation stall? We're not there. And in fact, home prices are projected to increase next year. But we're watching this. I'll just give you one example without giving you the numbers because we don't wanna get into a habit of calling out performance by market. But if you look at LA, the affordability and index in LA is terrible. It's 59. It's the worst it's been since 2008. And our sales in LA are very good." ] }, { "name": "Brian Nagel", "speech": [ "Helpful, as always. Thank you." ] }, { "name": "Operator", "speech": [ "And next, we'll move on to Chuck Grom with Gordon Haskett." ] }, { "name": "Chuck Grom", "speech": [ "Hey. Thanks a lot. Good morning. Just again on the housing front, Realogy spoke last week about a pretty significant slowdown in October, transactions down 6%. And it looks like your October comps were 11.2% on the stack adjusted for the hurricane, say, up 12.4. Still a little bit of a slowdown year-to-date. Just wondering when you look at the month of October, was there anything significant from a volatility or where the customer was buying or how they were buying?" ] }, { "name": "Craig Menear", "speech": [ "Overall, again, when you think about what happened in last year's hurricanes, as Carol called out, there was more hurricane pressure that we faced in October than in September. And clearly, September and October combined were much more significant from a pressure standpoint than the beginning of the quarter." ] }, { "name": "Carol Tom", "speech": [ "And even if you ignore hurricanes, there wasn't anything dramatically different in the business other than the volatility and commodity prices. At the end of the quarter, we saw lumber prices fall precipitously. But I think, Ted, that actually was, in some ways, a good news story." ] }, { "name": "Ted Decker", "speech": [ "No, that's very good news. If you look at some of the cost pressures we're seeing on the one hand with certain commodities in tariff, we've seen a dramatic decrease in wood fiber costs. So, we went down -- at one point of the year, we were 40% above the prior year. We're now 24-ish% below prior-year. And as those lumber prices have come down, unit productivity has moved dramatically and, we believe, kick-starting more project business which is obviously great for us." ] }, { "name": "Carol Tom", "speech": [ "And one reason why we really aren't concerned about the fourth quarter from a commodity perspective is because we see this unit productivity." ] }, { "name": "Chuck Grom", "speech": [ "Okay. That's very helpful. And then just to switch gears, inventory levels relative to sales, they widened a bit more than the past couple of quarters. Curious if that was intentional as maybe you look to bring in some items ahead of the tariffs. Or was it the spillover from October? Maybe just frame out how you feel about currency and where you think you'll end the year on the inventory front." ] }, { "name": "Craig Menear", "speech": [ "From an inventory standpoint, Marc's your LNM. Talk just maybe a little bit. We feel good about the overall quality of the inventory that we had. And the growth in inventory is really, by design, given a few factors." ] }, { "name": "Marc Brown", "speech": [ "Yeah. We continue to expect to see inventory productivity here at the Home Depot. But customer service begins with in-stock. So, we really focus mostly on our in-stock. We have implemented tiered replenishment strategies that really provide focused investments to drive sales in in-stock where it matters the most. And the results we're seeing from that are really very good. We've actually reduced the number of out-of-stocks per store by 24% in our top-selling SKUs and talks bringing that to life with the new in-store processes. We feel great about our shelf availability there. On top of that, we improved our direct fulfillment center in-stocks and service levels to the customers and setting new records in terms of in-stock there. So, pleased with our in-stock levels and the investments we've made there." ] }, { "name": "Craig Menear", "speech": [ "The other part of that is we've pulled forward some merchandising resets. And obviously, we've invested in that as well. And then, to your point, we did pull some planned purchases forward to get ahead of any potential tariffs." ] }, { "name": "Chuck Grom", "speech": [ "Okay. Great. Thank you very much." ] }, { "name": "Operator", "speech": [ "And next, we'll move to Simeon Gutman with Morgan Stanley." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning. If we add back some of the hurricane impacts that you called out, you get to somewhere in the 5% to 6% range. And I'm keeping inflation in there for now. I just wanna know is that number consistent with markets that have not been affected by any weather that year-over-year there's no benefit or headwind. And then anything changing with consumers and opening price points opting for something lower ticket? Anything on the consumer side that shows any cracks?" ] }, { "name": "Carol Tom", "speech": [ "Well, we always look at the spread of performance by our 19 US region. And if you throw out the high and the low because those are hurricane-related -- one was negative, and one was double-digit positive. If you throw out the high and the low, the spread was the narrowest it's been in a long time. It was 6.8%." ] }, { "name": "Ted Decker", "speech": [ "And on the product purchase, we continue to see both Pro and consumers trading up with all the innovation, the great product and brands we're offering in the stores. So, that was extremely healthy. And that progression of comp as you go up price points -- in fact, if you look at our increase in ticket of the 3.5%, the vast majority of that is driven by mix in innovation." ] }, { "name": "Simeon Gutman", "speech": [ "Right. Okay. My follow-up, just two quick parts. The extra inventory, can you tell us what categories you're investing deeper in? And then just a point of clarification. This may have been mentioned in the prepared remarks. The Q4 EBIT looks a little bit below the street. Is that freight cost continuing? Or is there some shift of expenses that go from third quarter into fourth?" ] }, { "name": "Carol Tom", "speech": [ "Well, should I answer that first? Based on the guidance that we've given you, the expense growth factor in Q4 should be lower than what we reported in Q3. And the gross margin expansion should be higher. That's a bit because of the 53rd week. So, maybe there's some issue with the 53-week modeling. I don't know. But we can certainly offline help you with your models." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. And the inventory?" ] }, { "name": "Craig Menear", "speech": [ "As far as inventory categories, we're not gonna get specific about where we invested for a number of reasons." ] }, { "name": "Simeon Gutman", "speech": [ "No worries. Thank you." ] }, { "name": "Operator", "speech": [ "And Matt McClintock with Barclays will have our next question." ] }, { "name": "Matt McClintock", "speech": [ "Hi. Yes. Good morning, everyone. I'd actually like to ask two quick questions. The first one is on car and van delivery increased utilization for both Pro and DIY. Are you seeing outsize gains in either Pro or DIY relative to the other as you roll this out and build awareness?" ] }, { "name": "Marc Brown", "speech": [ "With car and van, we're pleased with the rollout there. As Craig mentioned, we're up to 41% of the population with car and van available. So, very pleased with that rollout. As the trucks get bigger, the Pros get more engaged. So, if you think about it, our big, flatbed deliveries, that's very pro-focused. As you work your way down to car, that's more and more consumer focused. We're pleased to have that option out there for all our customers, though. It's an important part of the portfolio of delivery options. And we think those options are important across the range to meet our customers' needs in any given occasion." ] }, { "name": "Matt McClintock", "speech": [ "Thanks. That's helpful. And then as a follow-up, just on home décor, I've seen the catalog this year. Are you leaning into that category in any way different than what you did last year? Is there any build there? Or is it more of the same?" ] }, { "name": "Craig Menear", "speech": [ "As we outlined in our investor conference at the end of last year, we said we were gonna lean into home décor. And we've been doing that with the catalog and online. This is an online and direct play for us. And we're foreseeing nice results. The customer's engaging with the Home Depot in home-related décor categories. And we'll continue that through next year, certainly." ] }, { "name": "Matt McClintock", "speech": [ "On the back-end of that, is there anything specific to the holiday that you think about with that category relative to the rest of the year?" ] }, { "name": "Craig Menear", "speech": [ "No. We do our holiday décor set in the stores. Obviously, that continues to be an incredibly strong business. In fact, it's the success in that business that gave us confidence that we could move a little more décor-oriented -- not product we'd wanna bring into the store but perfectly appropriate to engage the customer online." ] }, { "name": "Matt McClintock", "speech": [ "Perfect. Thank you very much." ] }, { "name": "Operator", "speech": [ "And we'll move on to Steve Forbes with Guggenheim Securities." ] }, { "name": "Steve Forbes", "speech": [ "Good morning. I wanted to start with the expense growth factor if you can. Can you help us break down the components in the third quarter, I think accounting, strategic investments, business as usual? And then as part of that, maybe just update us with your thoughts on the appropriate business as usual run rate given the year-to-date performance. Is it still that 90% at 4.5% comp and 75% at 6%? Looks like you're doing a little better than that year-to-date." ] }, { "name": "Carol Tom", "speech": [ "Well, I think what I'll do for you is break down the components for the full year because I'd given you the dollars for the quarter. And you can do the math. We're guiding an expense growth forecast of 131% for the full year. The breakdown of that is BAU is 42%, invest is 51%, and the change in accounting is 38%. And then in terms of the longer-term view of our guidance, nothing has materially changed." ] }, { "name": "Steve Forbes", "speech": [ "And then just a quick follow-up. Given the buildout plans within the supply chain, maybe just update us with your views around hiring and retaining employees given the competitive workforce dynamic and obviously, your initiative on that front. Are you having trouble? Or are you still finding the availability of employees to meet that upcoming need, that future need?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. We were able to hire over 80,000 associates for our spring selling season this year. Candidly, we had a long concern as to whether or not it would be more challenging. But we really didn't find that to be the case. And Marc, I don't think you've seen anything different right now on supply chain." ] }, { "name": "Marc Brown", "speech": [ "No. It's been pretty much the same there. We've had no real issues there." ] }, { "name": "Steve Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "And we'll move on to Seth Sigman with Credit Suisse." ] }, { "name": "Seth Sigman", "speech": [ "Thanks. Hey, guys. A couple of follow-up questions. Just to go back to housing, as you mentioned, the consumer is obviously very healthy right now. On the housing front, there's a lot of talk about just the lack of urgency as it relates to turnover. Not actual demand, but there's a lack of agency. And I realize turnover on its own is a small part of the business. But I'm curious from a behavior perspective, are you seeing any signs that the consumer is maybe taking more of a wait and see approach as it relates to bigger projects, similar to how they're approaching purchasing a home?" ] }, { "name": "Carol Tom", "speech": [ "Not seeing that. And Ted called out the strength in our big ticket categories which grew more than 9% in the quarter. One hypothesis is that with rising interest rates, consumers are incented to stay in their home. And they have wealth in their home. And their home is aging. And so, they're spending money on their home. The other thing I would like to say about the consumer because we've done a lot of work in this regard and just thought we'd share it because there was some interest about what does the impact of tax reform really mean on consumers' wallet. And I think we all know that tax reform is really good for consumers. It's projected that $1.1 trillion will flow to consumer tax filers over the next ten years. The way that's playing out in 2018 is about 43% of that benefit is flowing into paychecks today. The remaining 57% of the benefit will be realized when filers actually file their tax return next year. And it's still the claim credits. And that's how they get their benefits.", "The only way they could receive that benefit today is if they have adjusted their withholding. So, we looked at 300,000 Home Depot associates to see whether or not they had adjusted their withholding. And only 3,000 of those associates had adjusted their withholding. So, we believe that many consumers are gonna have a nice tax surprise next year. Now, if you are a high earner in a high state and local tax state like California or New York or Connecticut, well, that won't be the case. But high earners are actually those of $500,000.00 or more. Those folks, well, they're gonna have a bit of a tax bill. And if they haven't prepared for it, it's gonna be a negative surprise. But we went to our consumer insights team and said, \"Hey, what's the average income of our customer?\" 97% of our customers' average income is less than $250,000.00. So, we think the health of the consumer continues into 2019." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Thanks, Carol, for that color. Appreciate it." ] }, { "name": "Operator", "speech": [ "And we'll move on to Scot Ciccarelli with RBC." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. Scot Ciccarelli. So, are there any markets or even product categories where you're starting to see some trade-down activity? And related to that, how do you think that would play out in a rising price environment because of tariffs and maybe you'll grant some of the price increase requests that you're getting from your vendors?" ] }, { "name": "Craig Menear", "speech": [ "So, I'll start with a comment and turn it to Ted. Even in the downturn of 2008 which was obviously the most difficult since the Depression, customers were willing to spend for new innovative products." ] }, { "name": "Ted Decker", "speech": [ "Yeah. It's Ted, Scot. We haven't seen it yet. It's something I'm looking at very closely. We're looking at unit productivity by opening price point, good, better, best, premium, making sure we're priced right at the opening price point level and making sure inventory levels are ready to go to see that dynamic that you just referenced. And we have not seen it. Now, whether that comes, we'll be ready for it. But to date, as Craig said, people are trading up for the new innovative product." ] }, { "name": "Craig Menear", "speech": [ "A classic example of that is you take a category like vinyl flooring. Vinyl flooring was almost on its deathbed. And then innovation came along. And you now have vinyl plank flooring that is flying out the stores at a premium price. It's a great value to the customer. It's easy to use. It's simple for the Pro to install. And that's a classic example of why innovation drives sales." ] }, { "name": "Scot Ciccarelli", "speech": [ "And to be clear, on the market front, Carol, you already mentioned the LA market, for example. Any markets where you're starting to see trade-down activity? Maybe particularly if you could focus on overheated housing markets to where what you would view as where affordability isn't great?" ] }, { "name": "Craig Menear", "speech": [ "Haven't seen anything like that at all." ] }, { "name": "Carol Tom", "speech": [ "Haven't seen it." ] }, { "name": "Scot Ciccarelli", "speech": [ "Okay. Thank you, guys." ] }, { "name": "Operator", "speech": [ "And we'll move on to Elizabeth Suzuki with bank of America Merrill Lynch." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Thanks. Can you give any additional detail on the performance in Canada on a constant currency basis? I think you guys mentioned that the comps were positive. Just curious how strong it was there." ] }, { "name": "Craig Menear", "speech": [ "Canada posted positive comps in local currency. Clearly, there are pressures in Canada. From a housing standpoint, the government has made a conscious decision to slow down housing in Canada. And you see that in the numbers. But they delivered a great performance. We're seeing terrific online growth in Canada as the Canadian customer embraces e-commerce as well." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. And was there any impact in the quarter from competitive pricing from other large players as they rationalized some inventory this quarter?" ] }, { "name": "Craig Menear", "speech": [ "We've certainly seen much more promotional activity as folks have made decisions to close stores and liquidate inventory." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Okay. Would you say that had a material impact on your sales this quarter? Or was it not enough to call out?" ] }, { "name": "Craig Menear", "speech": [ "We don't --" ] }, { "name": "Carol Tom", "speech": [ "I don't know how to measure that." ] }, { "name": "Craig Menear", "speech": [ "We don't have a clue how to measure that." ] }, { "name": "Elizabeth Suzuki", "speech": [ "All right. Thanks." ] }, { "name": "Operator", "speech": [ "Next, we'll move to Jonathan Matuszewski with Jefferies." ] }, { "name": "Jonathan Matuszewski", "speech": [ "Great. Thanks for taking my questions. Just to start off, last quarter, you mentioned some cross-functional teams focused on improving the experience online for customers. So, maybe just expand on that. What do you see as your competitive advantage today online relative to peers? And with personalization a big push, have you seen a benefit in terms of average order values or transactions when the sites customized based on prior purchases?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. Overall, absolutely. We're very pleased with the results from our initiatives as part of our investment strategy that we laid out. Supply chain's obviously a very big component of that. But leaning into our online investment's also a large piece of that. And we've started to do a lot of work with our category refreshes. So, think of this as a virtual reset online. A lot of work on our search efficacy. A lot of work with the supply chain team as they've gotten sharper on delivery and our delivery windows. We call it dynamic ETA. So, when you're checking out, we would put before a broad brush, seven to 10 days for delivery. Now, by zip code, we can put the day that you'll be getting that product. All of these things have led to much better traffic. We had one of our strongest traffic quarters that we've seen in a number of years. Our absolute increase in visits was our single largest growth in the quarter in visits. And then it all resulted in the comp sales of 28%.", "And that's also due to increased conversion. So, we're getting people to engage into the site. The experience is getting to the right product. We're getting to the right close. All of this while more and more of the traffic moves to our mobile app and mobile devices and where we're seeing double-digit increases in conversion rates and modest increase in average ticket. So, very pleased with all the initiatives." ] }, { "name": "Ted Decker", "speech": [ "And clearly, the customer is engaging, obviously, in the digital world. 48% of the orders in the quarter were picked up in store at the customers' choice. So, this is truly an interconnected experience going forward, leveraging all the capabilities and assets of the Home Depot in both the digital and physical world." ] }, { "name": "Jonathan Matuszewski", "speech": [ "Great. That's helpful. And then just a quick follow-up. Can you give an update on the store labor pilot? I believe you pointed to a sales lift in 2Q from the pilot. Maybe better conversion and whatnot. So, maybe just discuss any potential uplift in sales from 3Q from the labor pilot and what's the trajectory for rolling that out ahead? Thanks." ] }, { "name": "Carol Tom", "speech": [ "It's easy for us to quantify the productivity that we enjoyed off of the new labor model which Ann-Marie has put our stores. We saw 46 basis points of payroll leverage in the third quarter, and a large part because of that new labor model." ] }, { "name": "Ann-Marie Campbell", "speech": [ "And we're fully rolled out across the company. So, we'll get the full benefit in 2019." ] }, { "name": "Isabel Janci", "speech": [ "Rochelle, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question today will come from" ] }, { "name": "Scott Mushkin", "speech": [ "Hey, guys. Thanks for fitting me in. So, I just wanted to ask Carol, if you look at the business, obviously, we had a very sharp housing turn down in 2008. But if we looked at the business, let's just assume we get a downturn because that's what almost every investor seems to think. How do you think the business performs through an average downturn? Have you guys looked at that? And then also, would you guys ever consider using your balance sheet more aggressively if we got into a situation like that? So, that's my first question." ] }, { "name": "Carol Tom", "speech": [ "So, what we've done is look through the last recession which was just a crazy recession and went back to 2000 time frame when the country was in a fairly mild recession. And our comps at that point were flat. So, we modeled flat comps to say that's a reasonable downturn. I don't know if it's reasonable, but I think it's reasonable. And staying true to our investment plan because there's a financial strength that the company can stay true to our investment plan, it would take our operating margin down a little over 12%." ] }, { "name": "Scott Mushkin", "speech": [ "I'm sorry, could you say that? You cut out a little bit." ] }, { "name": "Carol Tom", "speech": [ "Oh, I'm sorry. It would take our operating margin down to a little over 12% in a flat comp environment, staying true to the investment. And we fully scale as a competitive advantage. We use it every day. As Ted mentioned, we've got lots of people coming knocking on our doors asking for things. And we're working through that. The power of the Home Depot." ] }, { "name": "Scott Mushkin", "speech": [ "And then as far as using the balance sheet a little bit more aggressively? Have we gotten to that downturn situation?" ] }, { "name": "Carol Tom", "speech": [ "Yup. That's our scale. We had the opportunity to do that. Yup." ] }, { "name": "Scott Mushkin", "speech": [ "All right. Perfect. Thank you for taking my questions." ] }, { "name": "Isabel Janci", "speech": [ "Well, thank you for joining us today. We look forward to speaking with you on our fourth quarter earnings call in February." ] }, { "name": "Scott Mushkin", "speech": [ "More HD analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
HD	2019-08-20	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, Chief Executive Officer and President", "name": "Craig Menear", "position": "Executive" }, { "description": "Executive Vice President of Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "Chief Financial Officer and Executive Vice President-Corporate Services", "name": "Carol B. Tome", "position": "Executive" }, { "description": "Marie Campbell -- Executive Vice President-US Stores", "name": "Ann", "position": "Executive" }, { "description": "Executive Vice President-Supply Chain & Product Development", "name": "Mark Holifield", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Gordon Haskett -- Analyst", "name": "Charles Grom", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Guggenheim -- Analyst", "name": "Steve Forbes", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to the Home Depot Second Quarter 2019 Earnings Conference Call. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions]", "It is now my pleasure to introduce your host Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you and good morning, everyone Joining us on our call today are Craig Menear, Chairman, CEO and President; Ted Decker, Executive Vice President of Merchandising; and Carol Tome, Chief Financial Officer and Executive Vice President, Corporate Services. Following our prepared remarks, the call will be opened for questions. Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get your question during the call, please call our Investor Relations Department at 770-384-2387.", "Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures, reconciliation of these measures is provided on our website.", "Now let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel and good morning, everyone. Sales for the second quarter were $30.8 billion, up 1.2% from last year. Comp sales were up 3% from last year with US comps of positive 3.1%. Diluted earnings per share were $3.17 in the second quarter. We are pleased with these results. We overcame a tough May and continued lumber price deflation to deliver accelerating comp performance throughout the core. Looking at our results geographically, all of our US divisions posted positive comps. 17 of 19 US regions also posted positive comps with the exceptions being our Gulf and Florida regions, which delivered high storm-related comps last year.", "Internationally, Mexico posted high-single digit positive comp and Canada posted low-single digit positive comp, both in local currency. We saw broad-based growth across the stores; both comp ticket and transactions grew. With the exception of lumber, all of our merchandising departments posted positive comps. We saw a healthy balance of growth among both Pro and DIY categories, with Pro sales outpacing our DIY business in the US. As Ted will detail, we continue to invest in a portfolio of service offerings to deepen our level of engagement with the Pro. We know that the more dimension our relationship is with this customer, the more they spend.", "From a strategic perspective, I'm encouraged by the progress we are making to deliver the One Home Depot experience, a seamless interconnected shopping experience for our customers. Our in-store investments are focused on ease of navigation and improved speed to checkout. We have implemented our wayfinding sign and store refresh package in over 1,400 of our US stores. And customer service scores in the category of neat and clean have increased 140 basis points. Our front-end store investments now in over 400 stores are designed to get customers in and out stores faster and they are doing just that. Customer service scores and checkout time satisfaction have increased over 450 basis points versus last year.", "While our stores remain the hub of our business, we know that many of our in-store sales are influenced by online visits and approximately 50% of all online US orders were picked up in our stores during the quarter. Our customers continue to blend the channels of engagement and we are investing to remove the friction as they do so. We continue to roll out automated pickup lockers for online orders with over 1,100 stores completed and have seen a 250 basis point increase in checkout scores for stores with lockers versus those without. Our investment in the digital price labels for our appliance department has enabled us to incorporate ratings and reviews from the digital world into the store shopping experience, enhancing the overall customer experience in the category.", "As we invest to address the unique demands of an interconnected customer experience in stores. We also continue to invest in our website and mobile applications to further enhance the digital customer experience. Our focus on improving search capabilities, site functionality, category presentation and product content has yielded higher traffic, better conversion and continued sales growth. Second quarter online sales grew 20% from the second quarter of 2018. We also continue to leverage our digital platforms to drive incremental growth from new categories as we've lean into adjacencies like HD Home, pool and workwear. The traction we are seeing from the investments across our digital and physical assets are encouraging not only from a customer experience standpoint, but they are also driving productivity throughout the business.", "Our front-end investments are optimizing labor and merchandising space productivity. Digital appliance labels enable associates to be more productive with their time. Instead of spending multiple hours manually changing price signs, our associates can reallocate their time to engage with customers in a high touch category. The virtuous cycle of productivity at the Home Depot has been a hallmark of our operational excellence over the years and continues as we move forward. Our focus on enhancing the customer experience and end-to-end productivity extends to the supply chain investments as well.", "During the quarter, we completed the retrofit of our Hagerstown facility into a parcel direct fulfillment center, which expands our one day delivery capabilities or stock parcel goods from approximately 30% to approximately 50% of the US population. We also drove productivity and cost out through our mechanization efforts in our upstream supply chain. We are on track with our plans to create the fastest most efficient delivery network in home improvement and are pleased with the progress that we have made thus far.", "Turning to our outlook for the remainder of the year, the building blocks of our financial model remain in place. As Carol will detail, we are lowering our sales guidance for the year, mostly to reflect the impact of lumber price deflation, as well as some conservatism to account for the recently announced tariffs. We now expect this fiscal 2019 comp sales growth of approximately 4% and reaffirm our expectation for diluted earnings per share of $10.03.", "I want to close by thanking our associates for their hard work, which resulted in the highest quarterly sales in our Company history. And with that let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig and good morning, everyone. While we had a slow start to the second quarter, we were pleased to see demand accelerate throughout the quarter, as we help our customers tackle a variety of interior and exterior projects. Looking at our departments, comps in appliances, tools, decor and storage, indoor garden, building materials, paint, outdoor garden, hardware and plumbing were above the Company average. All other departments with the exception of lumber were positive, but below the Company average.", "Lumber reported a high-single digit negative comp due to commodity price deflation. Second quarter comp average ticket increased 2% and comp transactions increased 1%. Lumber prices remain depressed during the second quarter and as a result lumber negatively impacted our average ticket growth by approximately 110 basis points. Last quarter, we talked about a 4x8 sheet of OSB selling for about $8, more than 50% below the price a year ago.", "During the second quarter, the price for that same sheet of OSB fell further to an average of about $7.60. During the second quarter, big ticket comp transactions, or those over $1,000, which represent approximately 20% of US sales, were up 3.7%, reflecting in part, the impact of hurricane-related sales last year and lumber price deflation. Excluding hurricane-related markets only, big ticket transaction costs were nearly 5%. During the quarter, we saw strong performance in big ticket categories like appliances, vinyl plank flooring and patio.", "Last quarter, we talked to you about opportunities in our flooring business. While vinyl plank has been and continues to be one of the strongest performing product categories across the store, we identified a need to refine our assortment within our other flooring categories. For example, in special leather carpet, we've recently taken several actions. We upgraded all of our showrooms and reset the category to reflect the latest styles and trends while offering a simply shopping experience showcasing a good, better, best line structure. Given the associate engagement, it's extremely important for this category, we also enhanced our in-store training efforts to drive better customer shopping experience. While early days, we're pleased with the results.", "During the second quarter, we saw growth in both our Pro and DIY customers with Pro sales outpacing DIY sales in the US. We continue to focus on our suite of Pro initiatives because we know that the more we engage with them, the more they spend with us. We've equipped our store associates with a number of tools and to better understanding their top Pro customers. Our my view system allows our Pro sales associates to access customer data and information, so they can proactively work with our Pro customers and determine how we can better serve them. We continue to simplify the Pro shopping experience and expand engagement through services like tool rental, delivery and our new B2B online experience.", "While May was another wet month, we saw project demand in outdoor categories rebound as weather improved. Categories like concrete, exterior paint and stains, live goods and mulch had comps above the Company average. In addition, we continue to see customers respond to our industry-leading brands and the innovation they are bringing to market. In our outdoor power equipment business, we are seeing strong customer demand and continued trade up to cordless tools like blowers, trimmers and even lawnmowers. Exclusive cordless product for brands like Ryobi, Milwaukee, DEWALT and EGO provide our customers with superior functionality and run time to keep their yards looking great.", "Switching gears, as you heard from Craig, we are happy with the progress we are making with our investments to deliver best-in-class interconnected shopping experience. Looking at our likelihood to shop again metric, 87% of our customers gives a best-in-class score of 5. Our strategic investments include accelerated merchandising resets focused on upgrading showrooms, improving visual merchandising and refining assortments to drive a better in-store shopping experience. For example, we are rolling out a new color solutions center in our paint department, which simplifies the color selection process to our customers, while emphasizing our price, color and satisfaction guarantee. And our new project Color App and updated online experience allows our customers to seamlessly explore the inspired and shop color online whenever or wherever they want. Another example is in pipe and fittings. We are resetting all of our base, reconfiguring them to better showcase the assortment in freeing up space to add new product categories for our customers.", "Now, let's turn our attention to the back half of the year. As the number one retailer of ladders, we are pleased to announce an expansion of our partnership with Werner, the number one brand for Pro's. Multi position ladders are the fastest growing segment in the ladder category and we are now the exclusive big box retailer of Werner multi-position ladders. We are also happy to announce an exciting new partnership with Louisville Ladder, as their exclusive big-box retailers starting in the fourth quarter. Combining Warner with our exclusive Louisville ladder and Gorilla brands, we are the leading destination for top Pro brands in the ladder category. Our merchants have worked hard to put together events and special buys for our customers in the third quarter. We are excited about our customers' continued appetite for home improvement projects and in just weeks, we will host our Annual Labor Day event followed by our Halloween Harvest event.", "With that, I'd like to turn the call over to Carol." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you, Ted and good morning, everyone. As you will recall, fiscal 2018 had a 53rd week, which shifted our fiscal 2019 calendar. Our comp sales are reported on a like-for-like basis, but total sales growth is reported on a fiscal year basis. In the second quarter, total sales were $30.8 billion, a 1.2% increase from last year, reflecting the shift in our fiscal calendar, as well as the impact of deferred sales. Our total Company comps were positive 3% for the quarter with positive comps of 0.2% in May, 4.1% in June and 4.6% in July.", "Comps in the US were positive 3.1% for the quarter, with positive comps of 0.6% in May, 4.1% in June and 4.7% in July. Versus last year, a stronger US dollar negatively impacted comp sales growth by approximately $29 million or 0.1%. As you just heard from Ted, during the second quarter lumber prices remain depressed versus last year, this lumber price deflation negatively impacted our comp sales growth by approximately $340 million or over 100 basis points.", "In the second quarter, our gross margin was 33.8%, a decrease of 19 basis points from last year. The year-over-year change in our gross margin reflects the following factors. First, higher shrink than last year resulted in approximately 9 basis points of gross margin contraction. Second, changes in the mix of products sold drove approximately 8 basis points of gross margin contraction. And finally, we have 2 basis points of gross margin contraction in our supply chain, driven primarily by start-up costs associated with our One Home Depot supply chain initiatives.", "In the second quarter, operating expense as a percent of sales at 18% was essentially flat compared to last year. Our operating expense performance reflects the impact of our strategic investment plan and good expense control during the quarter. Specifically expenses related to our strategic investment plan of $242 million increased by approximately $28 million from last year and resulted in approximately 8 basis points of operating expense deleverage. This deleverage was offset by productivity in BAU or business as usual expenses, which drove 7 basis points of operating expense leverage. Our operating margin for the second quarter was 15.9%, a decrease of 21 basis points from last year.", "Interest and other expense for the second quarter grew by $37 million to $283 million, due primarily to higher long-term debt levels than one year ago. In the second quarter, our effective tax rate was 24.6% compared to 24.7% in the second quarter of fiscal 2018. For the year, we now expect our effective tax rate to be approximately 25%. Our diluted earnings per share for the second quarter were $3.17, an increase of 3.9% from last year.", "Now moving to some additional highlights. During the quarter, we opened two new stores, one in the US, and one in Mexico. For an ending store count of 2,291. Selling square footage at the end of this quarter was 238 million square feet. Total sales per square foot for the second quarter were $510, up 1.1% from last year. At the end of the quarter, inventory turns were 5.1 times, down from 5.4 times last year reflecting in part a load in of inventory in support of our strategic initiatives. For the year, we now expect our inventory turns to slow slightly from what we reported in fiscal 2018.", "Moving on to capital allocation. In the second quarter, we repurchased $1.25 billion or approximately 6.3 million shares of outstanding stock. We plan to repurchase approximately $2.5 billion of outstanding shares in the second half of the year, bringing fiscal 2019 share repurchases to $5 billion in line with our guidance. Further during the quarter, we took advantage of an attractive interest rate environment and raised $1.4 billion of long-term debt, of which $1 billion was used to repay senior notes that came due in June. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 43.7%, 580 basis points higher than the second quarter of fiscal 2018.", "Now turning to our outlook for the remainder of the year, while global economic pessimism has increased due to geopolitics, currently the US consumer remains healthy. Consumer confidence is near record high level and wages are up over 3% from last year. Housing metrics are in line with the assumptions we used to build our 2019 financial plan. Nonetheless, what we didn't expect when we built our plan was the significant lumber price deflation we've experienced. We are now more than halfway through the year and lumber prices are below the levels we saw in the first quarter of fiscal 2019. Additionally, the US consumer is facing the impact of tariffs, while trade discussions are fluid, consumer demand could be impacted.", "Today, we are updating our fiscal 2019 sales and earnings per share of growth guidance to reflect these changes. Remember that we guide off GAAP, So fiscal 2019 guidance will launch from our reported results for fiscal 2018, which includes sales and earnings associated with the 53rd week. For fiscal 2019, we now expect comp sales is calculated on 52-week basis to increase by approximately 4%, that's down 100 basis points from the 5% growth rate we planned at the beginning of the year, reflecting for the most part, lower lumber prices, as well as some potential impact to the US consumer from recently announced tariffs.", "With this, we now expect sales to increase by approximately 2.3%, reflecting the compare of 53 weeks Last year. We are also reaffirming our earnings-per-share growth guidance for fiscal 2019. For earnings per share, we expect fiscal 2019 diluted earnings per share to grow approximately 3.1% to $10.03. We are able to hold our earnings per share guidance to what we initially planned, as lumber is a lower margin category and because we are projecting a lower tax rate than our original plan.", "We thank you for your participation in today's call. And Christine, we are now ready for questions." ] }, { "name": "Isabel Janci", "speech": [ "Christine, before we open the call up for questions, I'd like to turn the call back over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you,, Isabel. As I mentioned on our last earnings call, Carol Tome will be retiring as our CFO at the end of this month after 24 years with the Company. She has served as our Chief Financial Officer for the past 18 years. And in the fact today's call is the 73rd consecutive quarter she has reported our financial results to the market. I'd like to thank Carol for her deep commitment to our associates, the investment community and our shareholders. Carol has set the standard for excellence and transparency during these calls, reflecting not only her in-depth knowledge of our business, our operating environment, the economic environment, but also her dedication to our values. So Carol, let me say thank you for your leadership and through your partnership in your 24-year career at Home Depot. You will definitely be missed. Christine?" ] }, { "name": "Carol B. Tome", "speech": [ "Thank you, Craig. And we will try to get some questions without me crying." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. That's a hard lead-in to ask a question off of and Carol..." ] }, { "name": "Craig Menear", "speech": [ "Sorry about that, Carol." ] }, { "name": "Michael Lasser", "speech": [ "All good. Carol, congratulations and best of luck." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Michael Lasser", "speech": [ "And you to Richard, good luck in following in those very large footstep." ] }, { "name": "Craig Menear", "speech": [ "They certainly are..." ] }, { "name": "Michael Lasser", "speech": [ "So my first question is, we have assumed that about three quarters of the reduction in your full year comp guidance is due to the lumber price changes and the remainder is still about a quarter of a comp point is due to the macro. There's obviously been a lot of concern on the macro recently given the yield curve inverting a large education institute -- institution that's calling for a significant slowdown in remodeling activity, and then as you pointed out, the tariff uncertainty. So do you think a quarter point reduction in your comp guidance sufficiently considers all of those uncertainties?" ] }, { "name": "Craig Menear", "speech": [ "So Michael, let me make a couple of comments and I'll turn it over to Carol. So first of all, when you look at the overall macro factors that we think are critical to how we line up our business. Those are largely remain unchanged. And so we feel good about the fact that the consumer has wages up about 3% year-over-year, consumer confidence is still high, so the general trend that we see in the macro-based on how we did our plans really hasn't changed much and we feel pretty good about that. And then when you think about going forward in the business, when we looked at commodity, hurricane, May and then compared that to where we were at the end of the quarter, we feel good about the guidance that we have." ] }, { "name": "Carol B. Tome", "speech": [ "Yeah. Let me give -- sure, I'll give you a little bit more color there, Michael. So the implied back half comp and the guidance that we just gave you was around 5%. If you look at our reported comp in the second quarter in US, it was a 3.1% comp. If you add back the impact of hurricane-related sales, that was 50 basis points of hurt. If you add back the weather driven demand, softness that we saw in May, that was 40 basis of hurt -- 40 basis points of hurt. And then you've heard us talk about commodity, I think 100 basis points. So when you add that back, actually the normalized comp in the second quarter was 5%.", "Then you heard Craig [Phonetic] talk about the comp cadence that we exited July quite strong on an unadjusted basis, the comps in the US was 4.7%. And then, I look at our -- how we're performing relative to plan and we're on our plan. So you add up all the data points and it suggests that this -- is just -- the comp guidance is very achievable. And the other way to look at it is, it is stack the comps. If you stack the comps for the first half of this year against last year, back to second half what we reported and what we're guiding to, the stacked comp is about the same in both of the halves. So every way we look at it, we feel very good about the guidance that we've given." ] }, { "name": "Craig Menear", "speech": [ "Michael, I guess the last comment that I have on it, if consumer softened in anyway, I'll bet on this team all day long to go after the business." ] }, { "name": "Michael Lasser", "speech": [ "No doubt. And Carol you mentioned you're on your plan, do you mean you're on your plan where you stand quarter-to-date such that you really haven't seen any impact from the tariffs flowing through to the consumer as of yet?" ] }, { "name": "Carol B. Tome", "speech": [ "Yeah. That's exactly what I mean. The beauty of our business is that we see sales on our phone. We can know exactly how we're doing by the minute. So that's very different than that leading indicator of remodeling activity report that you just mentioned, which is based on a biennial survey of housing data coming out of [Indecipherable]. We have real data at our fingertips. So we feel good about the performance." ] }, { "name": "Michael Lasser", "speech": [ "You might want to remove that app by the end of the month. And then my last question is on as you look at your guidance for the back half of the year, how should we model gross margin and SG&A, particularly between the third and the fourth quarter recognizing that it's not so straightforward given that you'll be lapping the extra week in the fourth quarter of last year?" ] }, { "name": "Carol B. Tome", "speech": [ "Yeah. So if [Indecipherable] would talk to expenses, and as we told you we expect our expenses on existing a 52-week to 52-week basis, excluding the writedown that we took for some trade names that we're no longer using, we told you that our expense growth factor would be 90% for the year. For the first half, it was around 73%. So it will be a little bit higher rate in the back half. And quarter-over-quarter expect Q4 to be higher than Q3." ] }, { "name": "Michael Lasser", "speech": [ "That's helpful. Thanks again and best of luck." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you. Good morning,, everyone. And well done Carol congratulations. My first question is on the second half. I know you don't provide quarterly guidance, but can you share some cadence around the second half comp guidance and it's dependencies? And I'm thinking about macro dependencies and strategic initiatives, and if you can share with us part of it on the strategic initiatives, which ones are expected to contribute to the most of the second half comps?" ] }, { "name": "Carol B. Tome", "speech": [ "A couple of things to think about the second half comps. First, as you know, we're lapping $800 million of hurricane-related sales, of which $500 million occurred in the first half, $300 million in back half. So the hurricane sales overlap if easier. Secondly, on lumber price deflation, let's assume a number of $800 million to make it simple; about $500 million of that occurred in the first half. So, $300 million will occur in the back half. So it is easier too. Then we have the impact of our strategic initiatives [Technical Issues]." ] }, { "name": "Craig Menear", "speech": [ "Yeah. And so on the initiatives, when you think about the Pro, first is the B2B website that we have launched, and we are seeing Pros that have been migrated onto the website, react very positively from a sales standpoint. We are on track for the million Pros in 2019, as a matter of fact, with the tail end of this quarter, we added a significant number of Pros to the website. As Ted detailed My View capability that we've given to our associates in-store to better understand how we can engage with the Pro customer is delivering the results as well.", "And then, we've believe significant investments in our rental business, which we know is an important aspect for the Pro. 25% of the Pros rent from us today, we know that 90% of Pros rent tools. So we have an opportunity as we invest in this business to continue to grow. And then in the digital investments, our HD Home program as we expand categories to fulfill rooms in the home, as well as the investments we're making in search capabilities, category updates are all leading to improved sales and conversion in the business.", "And then the number of investments that we've made in the store as well whether that's our overhead management, which is driving productivity in the store, our interconnected lockers which is enhancing the pickup experience for our customers or our merchandising resets are paying off in a nice way. I don't know, if you want to give a little more color on the reset." ] }, { "name": "Ted Decker", "speech": [ "Yeah. On the resets, we've been working on our appliance resets and our tool crowds [Phonetic] for some time. Those two businesses are continued to post incredibly strong results, and we don't see that changing in back half. More recently, we've been working through our pipe aisle reset, which is going extremely well to about half the chain this year and that adds holding power and room for some new assortment programs.", "And then soft flooring, I mentioned in our prepared remarks, for a while [Indecipherable] soft flooring losing all ground to hard surface flooring what we've seen in solid floor vinyl and tile. But resetting all of our soft carpet showrooms those are done, we simplified our brand structure, we simplified our line structure and pricing structures that has continued to accelerate through the quarter and exited the quarter at much higher than the Company comps. So we're happy with what we're seeing in soft flooring.", "And then lastly, our largest reset to comp, which we've just launched in the last several weeks and we will finish the entire chain by the end of this year is our new color solution center in our paint department, where we'll be highlighting our Behr and PPG products and really pleased with that the timing could be better with a number of recent consumer surveys and consumer testing agencies release the new winners for this year and Behr captured the top three paint products in the entire industry at the best value and PPG posted the two top stain products at the best value. So we're very excited about all those resets, Craig?" ] }, { "name": "Carol B. Tome", "speech": [ "And Craig, just to add a couple of points from just driving new customer experience as well. Number one, you mentioned the rental, we are continuing to see growth accelerate from half to half. So the investments we're making there are really driving exponential value and so we're going to continue to lead in there. To the points about driving the events in the second half, when we think about our comp cadence. Craig talked about overhead management and our ability to find a product and get or on shelf availability to a very, very high level is driving incremental performance.", "And for us, as we think about the investments, not only to get into product on the shelf, it's how do we get the customers to the store. So we have done 450 front-end transformation. We have heard the numbers that we have seen just the customer experience grow across the board. We're going to have over 800 by the end of the year. And so we're able to deliver this performance by not only transforming our business but making sure that we're focused a simple and direct and drive into where the customer expects us to be. So we will continue to drive through that in the second half of the year and leverage the events to drive exponential differentiated performance." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you. That was very comprehensive. Can I -- I'm going to ask my follow-up. A year ago, when rates were rising, we went through this hypothetical scenario, if we saw a recession. I think we talked about a scenario in which Home Depot would comp flat and margins could go to 12%, if you made all the investments as part of your plan. I think, we're now -- one year forward you're making progress on margins. Can you provide us another update with your margin end up better than that 12% given that you're closer now to some of your goals?" ] }, { "name": "Carol B. Tome", "speech": [ "Well, Simeon we haven't updated that recession model. Productivity is a virtuous cycle at the Home Depot. But for modeling purposes, I would use the same numbers that we shared with you before. And just on the sort of the state of the economy and when a recession might happen, we certainly can't predict that. But we know a few things, we are in the longest economic recovery in our nation's history. And yet the amount of growth during this recovery is still under the average of every other recovery industry. So this is one reason why it's been in a long dated cycle. Further, the share of housing as a percent of GDP has dropped. Its about 90% of GDP. Back in 2006, it was about 22% of GDP. So whenever that downturn comes. Then simply it is cyclical [Indecipherable] is about. Whenever that downturn comes, it's not going to be like it was before. So we're very well positioned just to manage through all that." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you, again and best of luck." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with RBC. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. I had another follow-up on the investments that you're making, despite the pretty comprehensive answer you already provided. Can you help us better understand the cadence of the comp growth improvement that you're expecting, both in the back half of this year and that flows into next year front, specifically targeted to these investments?" ] }, { "name": "Craig Menear", "speech": [ "Well, we said in earlier statements that we believe that we will achieve about 1% impact in the back half of the year from the investments that we're making. When you took GDP, the housing benefit and then added in the investments that's how we got to our growth overall. And the only thing that's changed [Indecipherable] inflation in a moment." ] }, { "name": "Scot Ciccarelli", "speech": [ "Just to clarify, I think it was one point for the year, all of which is kind of loaded into the back half or did I misunderstand that?" ] }, { "name": "Carol B. Tome", "speech": [ "You're right. It's loaded into the back half and the way that we've modeled it, based on events as well as the completion of resets that you've heard from Ted, is that the fourth quarter comp will be fine [Phonetic] limited." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. And we should presume that because of the changes in that customer interaction, lot of these improvements should flow into next year or is there a point where you start to anniversary and it levels off? Thanks." ] }, { "name": "Craig Menear", "speech": [ "Yeah. It will definitely flow into next year. We'll get to that guidance later in the year." ] }, { "name": "Scot Ciccarelli", "speech": [ "Understood. All right. Thanks guys." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with JPMorgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, everybody. And I certainly echo Craig's comments and wish you Carol, the very best of fortune in the next stage of your life. In terms of my questions and just still follow-up on the macro. On the housing front rates moved around a lot moved down quite a bit. I'm about to reset perhaps, perhaps personally and but pricing has moderated and existing home sales are now picking up. So, is that what you were expecting? And then what are you seeing out there in terms of the -- in the market, say, some of the coastal markets [Indecipherable] that's really driving the deceleration in pricing and pricing coming down versus other parts of the country. And then related to that on the consumer front, are you seeing anything difference in the consumer around the type of projects that they are taking on or perhaps the trade up versus the value orientation?" ] }, { "name": "Carol B. Tome", "speech": [ "On the macro model -- yeah, things are moving around a little bit, but it's just on the margin. So there's no material change to the -- as of the inputs that create the output and drive our sales plan. To your question about the coastal markets, I'll just give you some data. Let's take San Francisco down the coast, the comp was higher than the company average. Let's take San Diego, a little bit further south, comp was at the company average, Let's take New Jersey, which is the high [Indecipherable] comps were higher than the company average. And then let's just land in Dallas. Dallas has seen a 54% increase in home prices since 2006, and the comp is at the company average. So you can see things are performing the way that we thought they would." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. And then a couple of detailed model questions. First, any comment on your expectation for the US comp for the year versus the 4% total guide? And can you help us a little bit more about, on the SG&A in 4Q, right, you gave this 52 to 52-week comparison perhaps how much incremental SG&A dollars there were in 4Q '18 related to that 53rd week?" ] }, { "name": "Carol B. Tome", "speech": [ "So I don't think about answering those questions because we don't like to give too much quarterly information." ] }, { "name": "Craig Menear", "speech": [ "So the one comment I'd make as it relates to kind of [Indecipherable] we're expecting positive comps in Canada for the year, if that helps." ] }, { "name": "Carol B. Tome", "speech": [ "Yeah. The question is what happens to the US dollar and we plan it currency-neutral. So here, you can model what you think, it's going to happen to the dollar and do that in our calculation." ] }, { "name": "Christopher Horvers", "speech": [ "Got it." ] }, { "name": "Carol B. Tome", "speech": [ "On the expense side, on a reported basis, because of the extra week that expense growth guidance on a GAAP basis look [Indecipherable] that's still we have explain, it's going to look really below and we are going to ignore that extra week. I think the best thing to do is just work within the annual guidance that we given you and look at it on a 52 basis and you can back into what the fourth quarter looks like." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. Very helpful. Thanks so much." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Charles Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Charles Grom", "speech": [ "Hey. Thanks. Good morning. Carol, congrats again. So the front half of the year is not been kind on the weather front, we all know that at this point. I'm just curious in the past and you've seen this type of pattern. Do you typically see the release of that demand or do some of the projects just get postponed or canceled altogether?" ] }, { "name": "Craig Menear", "speech": [ "It's by category. So there is some categories that have the ability to extend and we're seeing that in the business right now and so you capture that. There is some or you don't recover all of that business, you might get part of it, but not all of it. So it really varies by category. So if you think about depending on when the weather takes place, you may or may not get a pre-emergent business back, for example. And this year, we didn't get that back." ] }, { "name": "Charles Grom", "speech": [ "Okay. Great And then just on the change in the comp guide, when you look ahead to your -- the long-term sales targets of $114.7 billion to it, I believe around $120 billion. I'm just wondering if that changes did that outlook at all or maybe perhaps bring it to the lower end of the [Indecipherable] equation." ] }, { "name": "Craig Menear", "speech": [ "Yeah. It definitely goes to the lower end, but it doesn't change the range of guidance." ] }, { "name": "Charles Grom", "speech": [ "Okay. And then just one follow-up on the gross margins, Carol. All of last year transportation was a pretty big headwind, you didn't call it up. This quarter, I don't believe you called it out last quarter. Just curious, if it's actually helping you guys at this point?" ] }, { "name": "Carol B. Tome", "speech": [ "Well, certainly it has moderated from what we saw last year. What we are very excited about is the productivity that we are seeing in our upstream supply chain. Our supply chain team has done a great job of mechanizing our upstream facilities. We actually -- well, I called out two basis points of pressure in the gross margin comp supply chain, upstream we leveraged. We leveraged 6 basis points. So tremendous productivity in supply chain." ] }, { "name": "Charles Grom", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey. Good morning, Craig you specifically called out some conservatism in your guide from the potential impact of tariffs. Curious if you could quantify the assumptions here in a little more detail. Maybe talk us through how you think about the balance in the back half of raising prices and the potential down tick in volumes as a result?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. I mean, the uncertainty is what the total impact on the customer is economically overall. When we look at it specifically as it relates to Home Depot. If you think of China tariffs list one to four, four being at 10%, that's about a $2 billion or 2% of sales kind of cost impact. And so the way you have to think about tariffs is there's really two sites that you work on this. There is the actual cost side and there is a number of initiatives under way there. And then there is the potential of the impact to the customers that relates to the project.", "And I can -- I'll let Ted, talk about the cost side. Then we have a number of initiatives under way as it relates to how we flow things through to the customer. We use our portfolio approach. We think about this business as a project business, which it is. And there is clearly ups and downs in elasticity, but we are pretty good tools for the merchants to use our [Indecipherable] and we've actually been able to cover the top line. But Ted, if you want to talk about the cost side." ] }, { "name": "Ted Decker", "speech": [ "Yeah. I'd say, on the cost side, I couldn't be happier with our partnership with finance team, the accounting team, our assortment planning team. We have data of country of origin and potential tariff impact literally down to skew. So we know exactly, what are on the various list, then the tariff impacts will hit. We even know that through our retail accounting into when the impacts hit in our P&L. So thank you very much to the great partnership with the finance team.", "As Craig said, on a macro perspective, through Phase 4 only being at 10%. It's a potential impact of about 2% of our US sales. Now with a number of activities that we're working with the merchants between negotiations, with our supplier base taking into account things like currency, transfer pricing in the United States, value engineering we're embarking upon with our suppliers with customer backed research if you have marginal dollar to put into the product, where you put it, the best customer value. And then, we're starting to see significant supply chain.", "I would say, on the margin, I'm not aware of a single supplier who is not moving some form of manufacturing outside of China. So we have suppliers moving production to Taiwan, to Vietnam, to Thailand, Indonesia and even back into the United States. So when you net all of that out, we see this 2%-ish impact being much, much less call it something like 1%. And then, as Craig said, it's up to the merchant team to work with our overall portfolio approach to the business and project approach to the business to see how best if at all, there we pass on any of those net impacts to our customers." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And then on the paint category, seems to have gotten a little more promotional so far this year. Could we talk through some of the dynamics here. What do you think is driven the elevated activity more so overall demand or weather environment? And maybe also talk through your process when deciding how you respond when you typically see changes out there in the pricing environment?" ] }, { "name": "Ted Decker", "speech": [ "So, I first -- I'd answer with exterior stains. So Behr is -- the weather improved and we did the reset quickly last year and much more comprehensively this year again with the number one and number two rated exterior staying with PPG product. We saw a great performance in our exterior stains business. On interior paint, interior paint has gotten more promotional in the marketplace. We have folks out there advertising in print, on media as much as 40% off. At Home Depot, we have, as was just released with the third-party agencies. We have the absolute best paint in the marketplace. Behr paint holds the top three slots and it's ratings again two different surveys.", "And we are not going to fall into a high-level promotional trap, when we have the best product at the best everyday value. And as you know in the finance community, just speaking of promotional cadence, I can remember there was a lot of talk about breaking the buck in the money market world. And we have had a 3 times a year promotional cadence in paint of $10 off a gallon and $40 off 5 gallons in the major holidays of the year. Well some of our competitors chose to break the buck and we're not going to do that." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Appreciate the color and best of luck to you. Carol. Thanks again." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks for taking my question. I just -- question on tariffs in general. So , I think last quarter you commented that on price -- raising prices as it relates to tariffs impacted pricing, you initially had negative units on appliances and then demand picked up a bit. Maybe a little color on what you're seeing in terms of the consumer reaction to higher price points? And then I just had a clarification question on the gross margin." ] }, { "name": "Craig Menear", "speech": [ "Yeah. It's -- as we -- as I mentioned, we have a number of models that we're working right now. And it varies by category, there is elasticity variance by category. And that changes over time as well, but in the work that we've done, we've been able to actually cover the total top line sales in the models that we have out there. And when you think about laundry, because we have referenced that from the past. As time has gone by laundry was actually our highest unit comping category in appliances last quarter." ] }, { "name": "Karen Short", "speech": [ "Okay. That's helpful. And then on the gross margin front, I mean obviously lumber would have been a benefit to the gross margin this quarter. Could you quantify that and then help -- walk us through how lumber may impact gross margin in the second half?" ] }, { "name": "Carol B. Tome", "speech": [ "I'm happy to. With a lower penetration of lumber in the second quarter, it gave us 15 basis points of margin expansion. But that was absorbed by growth in lower margin categories like appliances, as well as portable power. We love our portable power sales, but we don't make a lot of money on it. So as we..." ] }, { "name": "Ted Decker", "speech": [ "I think it started to recovery in general." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you. Yeah. Absolutely, Ted. Thank you for that. So as we look to the back half of the year, we would expect lumber to stay down as we've talked about, not as much, as we saw in the first half but down, which will give us some benefits for the back half as well as for the year." ] }, { "name": "Karen Short", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from Steve Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steve Forbes", "speech": [ "Good morning. I wanted to revisit the tool rental business and really whether you expect the B2B website experience to augment this initiative. And as I sort of think about it, maybe you could just expand on how you view the interplay between those two initiatives and the potential impact to Pro engagement trends. You mentioned sort of positive, but can you provide some additional color?" ] }, { "name": "Craig Menear", "speech": [ "So I'd say, first comment I'd make, I'll turn it over to Ann, is right now our initiatives aren't around necessarily connecting the B2B website to that from a digital experience that will come at later date. This is all about the investments that we're making right now in the physical locations." ] }, { "name": "Ann-Marie Campbell", "speech": [ "Yeah. And just to support Craig on that, number one, the first thing we're doing is investing capital in the business. To your point, there is when we invest in fleet, we are able to drive more engagements with the Pro because we have product available. So that's the first thing we're doing is, making sure that we have the right assortment for Pro. Number two thing, we are doing there as well to drive the experience. We have had just tremendous success with the labor model we introduced in the stores last year and was able to drive higher level of engagement by having our associates at the right time to engage our customer and so we're going to continue to lean into that.", "And within the tool rental area, we are also making sure that we are addressing our labor model to ensure as well that we are having a high level of engagement as well there. And then, last but not least, as we think about how do we ensure that we expand our offering and we are able to push into areas at this point to delivery service and so forth. We are exploring hub locations for tool rental as well. So we're going to continue to push there. We are seeing tremendous growth. We are seeing higher levels of engagement and we believe as we continue to expand it will certainly be a complement for Pros and drive loyalty within the Home Depot." ] }, { "name": "Steve Forbes", "speech": [ "Thank you. And then just a quick follow-up, maybe just a modeling question here, right? You called out the strategic investment dollar impact for the quarter and year-to-date. But are you still on track to expense -- I think it was $550 million for D&A for the year. Maybe just give us an update on where you are and what the full year outlook incorporates." ] }, { "name": "Carol B. Tome", "speech": [ "Yes. We are on our plan with regard to both the expense and capital in support of our strategic investments." ] }, { "name": "Steve Forbes", "speech": [ "Perfect. Thank you." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Hey, guys. Thanks for taking the question and Carol, all the best to you. I wanted to follow up on deflation. You discussed the lumber impact, I'm just curious about net deflation, if there were any positive commodity price movements, and I guess just how are you thinking about that as part of the new full year comp guidance?" ] }, { "name": "Carol B. Tome", "speech": [ "So lumber deflation, I said, was 110 basis points and then we had another 10 basis points of inflation, if you will, from the other commodities and categories that we call out from time to time." ] }, { "name": "Seth Sigman", "speech": [ "Got it. Okay. And then ex the deflation, your average ticket actually accelerated in the quarter versus last quarter, so I guess, outside of commodities, how do we think about the average price increase that you're seeing across the store. I guess on a same SKU basis? And then tying it in with the gross margin to the extent that you are seeing higher retail prices. Is that a benefit to the gross margin initially, until the higher cost actually start to flow through COGS, like, how do we think about that? Thanks." ] }, { "name": "Craig Menear", "speech": [ "So on the price side, I'll let Ted give details. The innovation that comes into assortment certainly has a positive impact overall on our business as it relates to the ticket." ] }, { "name": "Ted Decker", "speech": [ "Yeah. I would say from a taking aside lumber and tariffs, from a pure commodity standpoint, we had quite a bit of pressure back half of last year, first part of this year that subsided so commodity prices generally versus a year ago, when you think of steel and resin, base metals, etc., are actually down. So that pressure on the outfit has subsided. To Craig's point, most of our pricing increases our mix driven in the sense that customers are trading up more innovative higher priced goods. We break out the components of our average unit retail increase, which has increased by far the largest driver of that in Q2, as well as the past several quarters is from new product introductions, which are higher price points because of innovation, think of cordless lawnmowers versus push gas mowers. On tariffs, we have a number of tests going on across the country, nothing of any sort of magnitude to say this we're taking price broadly at this point because of tariffs. But we are testing a number of things [Technical Issues]" ] }, { "name": "Craig Menear", "speech": [ "And to your question that its impact to margin, as we sell more innovative product and the customer steps themselves off that line structure it drives a higher gross margin dollar. It may not change rate, but it drives a higher gross margin dollar which is, what the most important thing is." ] }, { "name": "Carol B. Tome", "speech": [ "And we're probably not giving you information that maybe you wanted. But I think it's an interesting statistics to look at the acceleration in our big ticket. This has been an underlying sign of health in the business. This is unadjusted, big ticket grew 1.5% in May, 4.1% in June and 5.3% in July." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Thank you for the color. Appreciate it." ] }, { "name": "Isabel Janci", "speech": [ "And Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question will come from the line of Greg Melich with Evercore. Please proceed with your question." ] }, { "name": "Greg Melich", "speech": [ "I made it in. So Carol, thank you. Really, really helped through all the years, and [Indecipherable] the break you get. We'll continue to annoy you as best we can. The -- I had a follow-up on tariffs and inflation, and then also digital. If that description you gave before of list one to four, does that assume a 10% tariff on everything or 25%, or is it 25% analysts one to three, and then the potential of 10 on list four?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. That's exactly, right. It's the 25 a one to three and then 10 on four." ] }, { "name": "Greg Melich", "speech": [ "Perfect. And so to tie into that, is that a reason why inventories might have been up 5% year-over-year a contributing factor." ] }, { "name": "Craig Menear", "speech": [ "Yeah. Our inventory is all about the investments that we're making in the accelerated resets for the large part, so it has nothing going to do with that." ] }, { "name": "Greg Melich", "speech": [ "Got it. And then last on digital I know up 20%, continues to grow nicely, is that around 9% of sales. And it did decelerate, so I'm wondering did Amazon's move to next day. Did you see any impact on that? And do you think that was a factor in the deceleration, or is there something else going on?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. We actually we're very pleased with our growth is 8.9% penetration in the quarter, up from 7.5% a year ago. And we've actually accelerated our capabilities in same day delivery. Mark, I don't know, if you want to share the details on that." ] }, { "name": "Mark Holifield", "speech": [ "Yeah. As was noted earlier, we have expanded our next day parcel coverage, we're over 50% of the population now in next day parcel coverage. We've expanded our car delivery also to a greater than 50% out of our stores. So we're pleased with the time, we're taking out of our lead-time to customer. We continue to take lead time out with every move we make in the supply chain and each time we do it improves conversion." ] }, { "name": "Carol B. Tome", "speech": [ "Just on the point on deceleration, it's a fiscal calendar shift, right . So that's on a comp number, that's a growth number." ] }, { "name": "Greg Melich", "speech": [ "Got it. That's great. Well, good luck, everybody, and thanks again, Carol." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Ms. Janci, we have reached the end of the question-and-answer session. I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine. And thank you everyone for joining us today. We look forward to speaking with you on our third quarter earnings call in November." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
HD	2020-02-25	[ { "description": "Vice President of Investor Relations and Treasurer", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, Chief Executive Officer and President", "name": "Craig Menear", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "Chief Financial Officer & Executive Vice President", "name": "Richard Mcphail", "position": "Executive" }, { "description": "Executive Vice President-Supply Chain & Product Development", "name": "Mark Holifield", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "RBC -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Gordon Haskett -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "JP Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "JPMorgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Nomura -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Oppenheimer -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Elizabeth Suzuki", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Zack Fadem", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings, and welcome to The Home Depot Fourth Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]", "It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, and good morning, everyone. Joining us on our call today are Craig Menear, Chairman, CEO and President; Ted Decker, Executive Vice President of Merchandising; and Richard McPhail, Executive Vice President and Chief Financial Officer. Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question and one follow-up. If we are unable to get to your question during the call, please call our Investor Relations department at 770-384-2387.", "Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission.", "Today's presentation also includes certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and good morning, everyone. Fiscal 2019 was another record year for our business, as we achieved the highest sales in Company's history. Excluding the extra week in 2018, fiscal 2019 sales grew 3.5% to $110.2 billion. Diluted earnings per share were $10.25.", "As expected, we finished the year with our strongest comp performance in the fourth quarter. Comp sales were up 5.2% from last year, and our U.S. comps were positive 5.3%. Sales for the fourth quarter were $25.8 billion, and diluted earnings per share were $2.28. We saw broad-based growth across all geographies and merchandising departments in the quarter. All 19 of our U.S. regions posted positive comps. And internationally, both Canada and Mexico reported positive comps in the fourth quarter.", "As Ted will detail, both comp ticket and transactions grew in the quarter, and we saw growth with both our Pro and DIY customers. We had strong holiday season with record-setting sales on Black Friday and during Cyber Week. These results reflect solid execution by our stores, our merchants, our supply chain teams, as well as our vendor partners, and demonstrate the overall health of the consumer.", "I'm proud of the results in fiscal 2019 as the team successfully navigated a number of external headwinds by maintaining a relentless focus on our customer. 2019 was also a pivotal year in our transformation to create the One Home Depot experience. We are now two years into our multi-year investment, and are realizing benefits. We have more conviction than ever that these strategic initiatives are creating a value proposition that is unique to the marketplace and will extend our leadership position for years to come.", "The majority of our U.S. stores have a new look and feel, and we address customer pain points around navigation and checkout. Our enhanced signage and store refresh package, along with investments in the front end of our stores, have improved the customer experience and driven associate productivity. These store investments are driving higher customer satisfaction scores, which we believe is translating into market share gains.", "As a complement to our store investments, we are investing to strengthen the competitive advantages that we have built through the blending of our physical and digital platforms into a more seamless interconnected experience. For example, our chainwide rollout of digital appliance labels connecting ratings from the digital world to the physical world enhancing the in-store shopping experience.", "Additionally, homedepot.com continues to be an engine for growth for our overall business, driving increased traffic online and additional footsteps to our stores. Because of this, we continue to invest in search functionality, category presentations, product content and enhanced fulfillment options to remove friction from the online shopping experience.", "Excluding the extra week last year, online sales grew 20.8% in the quarter and 21.4% for the year. And over 50% of the time, our customers choose to pick up their order in a store. This is the power of the interconnected retail strategy. We have also expanded our digital capabilities by investing on a B2B website experience, tailored specifically for the needs of our Pro customers. We have now on-boarded over 1 million Pro customers.", "Additionally, during the quarter, we completed the integration of our third-party best-in-class CRM system for all of our Pro sales and services teams. This enhances our visibility, enabling us to better serve our customers. I'm excited about the opportunities ahead, as we continue to build capabilities to engage with the Pro, no matter when, where or how they want to interact.", "Another key component of the best-in-class interconnected shopping experience centers on the enhanced delivery and fulfillment options. In 2019, we continued our multi-year journey to create the fastest, most efficient delivery network in home improvement. We are now live with at least one of each type of facility that we are building. Though it is early days, we are pleased with the initial results.", "For example, we have opened a dozen market delivery operations or MDOs that have enabled us to transition 20% of our clients' deliveries from an outsource model to one in which we control more of the customer experience. This is translated to meaningful improvements in our customer satisfaction scores for clients' deliveries. Our supply chain build out will continue to ramp from here with the largest number of new facilities coming online in 2021 and 2022.", "Turning to 2020, Richard will take you through the details, but we expect another year of growth with both sales and top growth ranging from approximately 3.5% to 4% and diluted earnings per share of approximately $10.45. Today, our Board approved a 10% increase in our quarterly dividend to $1.50 per share, which equates to an annual dividend of $6 per share. We remain committed to maintaining a disciplined approach to capital allocation to create value for our shareholders.", "I'm incredibly proud of the progress our teams made as we transform ourselves into the One Home Depot of the future. While we define our sales growth in percentage terms, we capture share in dollar terms. And through the second year of our One Home Depot investment program, we have grown sales by over $9 billion. The level of growth unmatched in our market.", "As we look forward to 2020, I'm more excited than ever about the opportunities ahead. We are investing to unlock the power of a truly interconnected customer experience by enhancing our already strong foundation to further extend our leadership position into the marketplace. As with any transformation, the work we are doing is complex, and I'm proud of the way our associates continue to execute at high levels and focus on what's most important in our business, our customers.", "I want to close by thanking our associates for their hard work and dedication in the fourth quarter and throughout the year. For the second half of the year, 100% of our stores will receive Success Sharing, our bonus program for our hourly associates. We look forward to continuing our momentum in 2020.", "And with that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. We had a strong finish to the year with fourth quarter sales exceeding our expectations. We saw growth across the store at both our Pro and DIY customers. All of our merchandising departments posted positive comps, but by our appliance department, which posted double-digit comps in the quarter. Comps in decor and storage and tools were also above the Company average. All other merchandising departments were positive, but below the Company comp of 5.2%.", "In the fourth quarter, comp average ticket increased 4.4% and comp transactions increased 0.8%. The strength in our comp was partially driven by a shift in our event timing, which Richard will talk through in a moment. In addition, we had an excellent response to our Black Friday and holiday events. And our customers continue to trade up to new and innovative items. After experiencing significant deflation in lumber and copper during the first three quarters of 2019, commodity prices had a more neutral impact in the fourth quarter. During the fourth quarter, big-ticket conference actions are those over $1,000, which represent approximately 20% of U.S. sales were up double digits. The strength in our big ticket sales was driven in part by the shift in our event timing, as well as strong performance in a number of other big ticket categories.", "During the fourth quarter, big ticket categories like appliances, vinyl plank flooring and our installation services business, all posted comps above the Company average. Consumer demand is strong, and this was evident during our annual Black Friday, gift center and decorative holiday events. The partnership and collaboration between our merchants and supplier partners helped in the fantastic line of the great deals and special buys and categories like smart home, power tools, hand tools, and decorative holiday. Our unique assortment together with excellent customer service and execution led to incredible results. Black Friday was a record sales day for our company, and our gift center event grew double digits versus last year.", "We also saw our customers tackle a variety of projects around the house. During the fourth quarter, we saw comps above the company average in several kitchen and bath categories, special order window coverings, cleaning and exterior paint. We also saw significant growth in our online-only home decor categories, which we call HD Home, as we build awareness around these high-quality, style-forward assortments.", "Sales to our Pro customers were healthy, driven by strength in categories like pneumatics, concrete, hand tools and cocks; all of which grew faster than the company average. Looking back at 2019, our team continued their unwavering commitment to serve our customers with great everyday values and innovative product. And we did this, while investing in a customer-backed store and interconnected experience to ensure that we continue to be the product authority in home improvement for years to come.", "At our Investors Conference back in December, we talked about investments we are making across our business. We also shared our new ad campaign and tag line, How Doers Get More Done, that we launched to highlight our investments into these new experiences and capabilities. We believe it is important to signal to our customers that the Home Depot is evolving as their needs change. While it is still early in our campaign, we see customers responding to our enhanced capabilities, giving us credit for saving them time and helping them complete their projects. In response to our campaign, we saw one of our largest single base of downloads of our award-winning mobile app and double-digit growth in usage of mobile tools like product locator and image search.", "As we look forward to 2020, we will continue our investments to better meet our customers needs and drive a great shopping experience. One of the investments, you will see in the first half of the year, is a reset to our outdoor power equipment base. We know the marketplace for outdoor power tools is transitioning to cordless technology. And we learned in our tools department that once a customer adopts a battery platform, they see tremendous value in sticking with that platform.", "Similar to what we have done in our tools department, we are in the process of resetting our outdoor power equipment base to showcase our assortment by brand, highlighting EGO, Toro, Milwaukee, RYOBI, DEWALT and Makita, many of which can only be found at the Home Depot.", "Through this new presentation, customers can clearly see and easily shop the value proposition that these cordless platforms bring, including being more environmentally friendly, safer and easier to use, all with the power and run time to get the job done. These powerful brands now have the lion's share of batteries in the marketplace with hundreds of millions of batteries in customers' homes and job sites today. We currently offer over 1,000 cordless power tools and that number will continue to grow as our supplier partners are introducing innovative product all the time. Our comprehensive and unique assortment of outdoor power equipment resulted in double-digit comps in fiscal 2019.", "With spring right around the corner, we are gearing up for another busy season. Our stores are stocked with new and innovative product and we just recently announced we are hiring 80,000[Phonetic] new associates to help us serve our customers during our spring selling season.", "With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard Mcphail", "speech": [ "Thank you, Ted, and good morning everyone.", "Before we begin, let me take a quick moment to remind everyone that fiscal 2019 consisted of 52 weeks, while fiscal 2018 consisted of 53 weeks. This extra week added approximately $1.7 billion in sales to the fourth quarter of fiscal 2018. When we report our comparable sales or comps, we report them on a 52-week to 52-week basis by comparing weeks one through 52 of fiscal 2019 with weeks two through 53 of fiscal 2018.", "In the fourth quarter of 2019, total sales were $25.8 billion, a 2.7% decrease from last year, reflecting the compare against the extra week in 2018. Our total company comp sales in the fourth quarter increased 5.2% and comps in the U.S. increased 5.3%.", "Because of last year's 53rd week and the resulting calendar shift, our monthly comps are distorted, due to the timing of our annual Black Friday and Cyber Monday events this year versus last year. Our reported monthly comps for the total company were positive 1.2% in November, 9.9% in December and 5.7% in January. Our monthly comps in the U.S. were positive 1.1% in November, 10.4% in December and 5.8% in January. Given the distortion in our monthly comps caused by the calendar shifts, we believe it is more appropriate to look at November and December on a combined basis.", "For the combined two months of November and December, our total company comp was 5%, followed by 5.7% in January. For the year, our sales totaled a record $110.2 billion. If we exclude the sales from the 53rd week in fiscal 2018, we grew sales by approximately $3.7 billion in fiscal 2019, a level of growth unmatched in our market. For the year, total company comp sales increased 3.5% and U.S. comp sales increased 3.8%.", "In the fourth quarter, our gross margin was 33.9%, a decrease of 20 basis points from last year. Similar to last quarter, the change in our gross margin was primarily driven by higher shrink and the mix of products sold compared to last year. For the year, our gross margin was 34.1%, slightly higher than our guidance at the beginning of the year.", "In the fourth quarter, operating expense, as a percent of sales, decreased by 64 basis points to 20.7%, slightly better than our plan. During the quarter, we saw approximately 77 basis points of leverage as we lapped the fiscal 2018 impairment of certain trade names and the 53rd week last year.", "This leverage was partially offset by expenses related to our strategic investment plan of approximately $280 million, which increased approximately $25 million from last year and cost 12 basis points of deleverage. Fiscal 2019 operating expense, as a percent of sales, was 19.7%, a decrease of 28 basis points from last year. Our fiscal 2019 expense performance was better than our initial expectations, driven by productivity initiatives in our core business. During the year, we spent approximately $1 billion of investment expenses related to our strategic initiatives, in line with our plan. Our operating margin for the fourth quarter was approximately 13.2%, and for the year, was approximately 14.4%.", "Interest and other expense for the fourth quarter grew by $27 million to $292 million, due primarily to higher long-term debt levels than one year ago. In the fourth quarter, our effective tax rate was 20.3%, and for fiscal 2019, it was 23.6%. The lower-than-expected effective tax rate in the fourth quarter and for fiscal 2019 was driven primarily by several discrete tax items. Our diluted earnings per share for the fourth quarter were $2.28, an increase of 9.1% from last year. For fiscal 2019, diluted earnings per share were $10.25, an increase of 5.3% compared to fiscal 2018.", "Moving on to some additional highlights. We ended the year with the store count of 2,291, while retail selling square footage was approximately 238 million square feet. For the fiscal year, total sales per retail square foot were $455, the highest in our company's history. At the end of the quarter, merchandise inventories grew $606 million to $14.5 billion, and inventory turns were 4.9 times, down slightly versus last year. The growth in our inventory, versus last year, reflects the investments we are making to accelerate merchandising resets and higher in-stock levels than we had one year ago.", "Moving on to capital allocation. In fiscal 2019, we generated approximately $13.7 billion of cash from operations and used that cash as well as the proceeds from $2.4 billion of net debt issuances to invest in our business, pay dividends to our shareholders, and repurchase our shares. During the year, we invested approximately $2.7 billion back into the business through capital expenditures. Further, we paid $6 billion in dividends to our shareholders.", "Finally, during the year, we repurchased approximately $7 billion or about 32.8 million of our outstanding shares, including roughly $3.25 billion or 14.5 million shares in the fourth quarter. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 45.4%, 60 basis points higher than the end of fiscal 2018.", "Today's press release includes our guidance for fiscal 2020 and I want to take a few moments to comment on the highlights. Remember that we guide off of GAAP. So, fiscal 2020 guidance will launch from our reported results for fiscal 2019.", "At our Investor Conference in December of 2019, we shared with you some preliminary thoughts for 2020 and we are reiterating that guidance today. The economy is strong and the U.S. consumer is healthy. The foundation of our sales plan starts with GDP, and our 2020 sales guidance assumes U.S. GDP growth of slightly less than 2% in 2020.", "To GDP, we add the impact that we think we will see from the housing environment, including demand driven by home price appreciation, housing turnover, household formation and the age of the housing stock. As we look at these metrics, we see an environment that is healthy and stable. Our 2020 sales guidance also assumes that we will continue to gain share in the marketplace. For fiscal 2020, we expect both sales growth and total company comp sales growth of approximately 3.5% to 4%.", "Fiscal 2020 represents the peak year of our investment program. And as a result, we expect our fiscal 2020 operating expenses to grow at 1.2 times the rate of our expected sales growth.", "For the year, we expect to grow operating profit dollars to $16 billion, giving us an operating margin of approximately 14%. For fiscal 2020, we assume our effective tax rate will be approximately 24%. We expect fiscal 2020 diluted earnings per share to grow approximately 2% to $10.45. For the year, we project cash flow from operations of approximately $13.5 billion. We plan to invest $2.8 billion of this cash back into the business in the form of capital expenditures. We also plan to use this cash to pay $6.4 billion of dividends and repurchase at least $5 billion of outstanding shares.", "Before I close, I would like to update you on how we're thinking about one of our capital allocation principles. With regards to our dividend, in lieu of using a 55% payout ratio, we will look to grow our dividend every year as we grow our earnings, as we have for the last 11 years. This morning, we announced that our Board increased our quarterly dividend by 10%, which equates to an annual dividend of $6 per share.", "With that, I want to thank you for your participation in today's call, and Christine, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conducting a question-and-answer session.", "[Operator Instructions]", "Thank you. Our first question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question, it's on any potential supply disruption coming out of Asia. What have you factored in, what's the current status of your supply chain? Have you seen any issues with getting product from Asia at this point? And if this extends for a meaningful period of time, how do you size the potential impact to your sales and earnings over the next few quarters?" ] }, { "name": "Craig Menear", "speech": [ "So, Michael, let me -- I'll start it off, and then, I'll hand it over to Mark Holifield.", "First of all, the guidance that we've provided, obviously, does not include any guidance update for the situation. It's a great fluid situation that we're monitoring closely and all of our goods for Q1 are essentially onshore or on their way. So, we're feeling pretty good about that situation.", "And Mark, you might want to provide on update on?" ] }, { "name": "Mark Holifield", "speech": [ "Well, sure, Craig.", "Yeah. As you mentioned, it does change every day. Our Q1 merchandise is already here or on the way, and Q2, the picture is still developing there. For our direct import, our sourcing offices in Asia are in touch with our top factories, as they're returning to operations. For our domestic vendors, we're working with them to understand and mitigate any potential impacts in their supply chains. Our team is working with all of our suppliers, both domestic and import and our logistics service providers on a PO-by-PO, container-by-container basis to understand what the impacts to our product flow are and they're taking appropriate action. We are encouraged that we're seeing factories coming back to work, provinces coming back to work in China. But it is a fluid situation and it's highly variable in terms of what's the current state." ] }, { "name": "Michael Lasser", "speech": [ "And just to clarify, based on what you know today, do you think that there will be an earnings hit over the next couple of quarters, based on any supply disruptions, even if things get back to normal in the very near future? Or do you have time to adjust, based on what you know at this point?" ] }, { "name": "Craig Menear", "speech": [ "Michael, based on what we know today, we couldn't say that there would be a hit. Again, the teams are working this day to day, as Mark said, PO-to-PO, container-to-container. We're also putting plans in place to mitigate any risk going forward." ] }, { "name": "Michael Lasser", "speech": [ "[Speech Overlap]" ] }, { "name": "Craig Menear", "speech": [ "In spite of what we do is domestic[Phonetic]." ] }, { "name": "Michael Lasser", "speech": [ "Okay, thanks. And my follow-up question is, you just wrapped up your second year in a row with about 1% comp growth in traffic after many years of higher traffic than that. Is 1% growth in traffic the new norm? And how do you think the implementation of your strategic investment plan is going to impact traffic in the next few years?" ] }, { "name": "Ted Decker", "speech": [ "Hey, Mike, the objective of what we're doing on the investment plan is to position ourselves to be able to continue to grow faster than the market. I think some of the growth that we saw in years past was a result of an accelerated recovery from a very difficult spot. What we've always focused on is how do we balance ticket and transactions, and that's really where our focus is. And the market will determine what level that's at." ] }, { "name": "Michael Lasser", "speech": [ "Okay, thank you very much and good luck." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with RBC. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. I actually had a follow-up on Michael's question first. I guess the question is, given the delta that we've seen in transactions and average ticket, what would you guys point to regarding, kind of, what's driving that divergence? I mean, and you just referenced, you had a recovery phase. But I would think that recovery phase actually would help both sides of that ledger, not just one." ] }, { "name": "Craig Menear", "speech": [ "Yes. So, I think, we had some opportunity areas that we've invested in to continue to grow, that has accelerated our ticket growth, largely being -- we put significant investment in appliances that has paid back in a very big way in terms of the accelerated growth we've seen in that business. Same thing would hold true for what Ted referenced, as it relates to the Lithium technology and the average ticket growth we've seen in power tools and now in outdoor power equipment. So, I think there is some innovation and investment factors that have helped drive ticket, maybe, even above and beyond, as we took share in those categories.", "But we've been pretty pleased with the consistency of our traffic growth over time. And like I said, we'll work to balance traffic and ticket. We always want to make sure there is a reasonable balance there." ] }, { "name": "Scot Ciccarelli", "speech": [ "So, when you think about -- I'm sorry, go ahead." ] }, { "name": "Ted Decker", "speech": [ "I was just going to add -- Scott, I'd add to that. Q4, very much have been driven our gift center, decorative holiday, and as Craig said, appliances and those all performed incredibly well. So, that contributed to the ticket, and as we see consumers continue to trade up to the new innovative product that we're offering.", "And while we're happy with transactions, they were a little bit depressed with the lack of cold weather. So, if you think, during winter, you get a lot of people stopping in for ice melts, for that smaller pick-up, even car washer fluid, etc. And with the more mild winter, lot of the --- biggest suppression, there of transactions, were those quick cold weather pick-up items." ] }, { "name": "Scot Ciccarelli", "speech": [ "Okay, that's helpful. And I guess when you think about all the investments you guys have been making in the business and supply chain and technology, should we continue expect kind of the pattern that we've seen here to continue? Or does it have a more balanced impact as we go forward? Thanks." ] }, { "name": "Ted Decker", "speech": [ "I mean, I think, again, we look for kind of balance in that. We will be perfect, one way or another now, but we would look for balance." ] }, { "name": "Scot Ciccarelli", "speech": [ "Okay, thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, good morning. Long-term question first. So, thinking, again, about the payback from investments, it sounds like we'll see some cost moderate next year. So, that will be good to margin. But in terms of the top-line lift, I realized you're probably not going to quantify much, but can you tell us where the place is, we'll start to see better comps, is it the Pro wallet share, is it MRO categories, DIY? So, what are some of the KPIs that won't be as apparent as comps that you're seeing that tells you that since[Phonetic] these investments are beginning to pay off?" ] }, { "name": "Ted Decker", "speech": [ "First of all, our investments are targeted for all the above, that you just rolled out. Probably you think MRO, you think consumer, our intent is to grow in all of those spaces. But what we're really trying to set ourselves up to do in the investment is to be able to position the Home Depot to grow faster than the market growth on a consistent basis, no matter what that environment is. That's really what we're trying to get done." ] }, { "name": "Simeon Gutman", "speech": [ "And does that require waiting for the supply chain investment to finish rolling out or now that should stagger as all these other investments are taking place?" ] }, { "name": "Craig Menear", "speech": [ "The supply chain is a part of the overall component. As we've shared with you, we have investments that span across our business, whether that's in investments in the store, whether that's investments in the digital world, in our marketing elements, in our product development, as well as the supply chain. And we'll see the -- as we put more and more of these capabilities in place, as the supply chain continues to expand as we open more facilities in '21 and '22, the bulk of those, we'll see that continue to grow as we put more capabilities against the market." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. And then my follow-up is, in the fourth quarter, it looks like the business performed a little better than planned. Can you parse out underlying housing signs that just may be improving versus some of the seasonal, it sounds like December was a big month. I don't know if that's more holiday, but at the same time, you didn't have as much weather impact. So, if you can just talk about underlying housing versus other drivers." ] }, { "name": "Richard Mcphail", "speech": [ "Sure, Simeon. This is Richard. So, from a housing perspective, all housing indicators wound up really, sort of, where we expected them. And so, we don't think that that had any material impact on our business. You mentioned December, there is a little bit of a timing shift there in the calendar from November to December. But overall, it was really the strong execution across the quarter.", "And Ted, maybe you want to go a little bit more into the strength of the quarter." ] }, { "name": "Ted Decker", "speech": [ "Yeah, I think, as I said in my comments, we like the balance of ticket and transaction, and we certainly like the balance of consumer and Pro. And our Pro was strong in Q4, but we really saw an engaged consumer in what are more discretionary categories, and terrific artificial Christmas tree business, our gift center, record sales and growth in our gift center, and appliances. As I said, double-digit comps in appliances. It's not always just refrigerator that's broken and being replaced. It's increasingly discretionary purchases. So, we just saw a very strong consumer." ] }, { "name": "Simeon Gutman", "speech": [ "Great, thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey, thanks, and a nice quarter. Normalizing for the event shift, sales were pretty consistent across the quarter. I'm just wondering how we should think about the cadence of comps by quarter in 2020? And then, I'm wondering if you could offer some thoughts on how February started out." ] }, { "name": "Craig Menear", "speech": [ "Well, thank you, Chuck. So, we don't provide quarterly guidance, but we would say that 2020 will see a relatively even spread across the two halves of the year, with respect to the comp sales. And with respect to what we've seen so far in 2020, our guidance is based on the best information we have of the moment. And so, our results, to date, are consistent with that guidance." ] }, { "name": "Chuck Grom", "speech": [ "Okay, great. And then, just bigger picture, I was wondering if you guys could just amplify on the opportunity that you have with the Pro as you on-board more of them onto the B2B website, particularly now that there is going to be the CRM aspect included. Thanks." ] }, { "name": "Ted Decker", "speech": [ "Yeah. I think when we think about the Pro customer, we're actually building an ecosystem for our Pro customers that encompasses product and brands and delivery and credit services and our digital capabilities with B2B tool rental and a whole lot more. Obviously, all of that coming together allows us to be able to service our Pro customers in a more holistic way and it allows us to continue to grow with larger, more complex customers. And so, when we look at the Pro business, we think we are in 15% to 17% range, and we'd love to see that be much more in line with consumer concentration of share that we have, as we go forward, which is why we're making these investments." ] }, { "name": "Chuck Grom", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with JPMorgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, good morning everybody. So wanted to -- a couple of follow-ups. So, first on the seasonal business and the impact of the weather overall, how would you assess the weather impact last year? And December was really wet. I think you called out 85 basis points of headwind a year ago. You also had warm weather in January against polar vortex at the end there last year, but at the same time, you didn't get the snow melt and the snow blower. So, how would you assess the overall impact of weather?" ] }, { "name": "Ted Decker", "speech": [ "Chris, this is Ted. I'd say neutral. It's just, as you said, extended season in some markets with grounds not freezing, etc, that Pros could stay at work. But then, on the other hand, you didn't get all your cold weather categories. So, our merchants in the chore and snow and in ice smelters aren't as happy as some of our other merchants. But I would say, on balance, little impact neutral." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And then on the gross margin. So, sequentially, the performance was better relative to the third quarter. You mentioned shrink and mix were still headwinds. And that, obviously, you talked about the Analyst Day, they persisted into '20, but it did get a little bit better. What was the -- what shifted in the sands there and helped offset that? Or did one of those factors mitigate and does it change your view as you think about 2020?" ] }, { "name": "Craig Menear", "speech": [ "Shrink was consistent with what we had observed through the year and we are taking steps to address that in 2020, as we discussed. We had some great benefit, as we've had all year, from some of the supply chain investments we're making in productivity and supply chain, but shrink was consistent." ] }, { "name": "Christopher Horvers", "speech": [ "And so the delta versus last quarter, anything to call out there?" ] }, { "name": "Craig Menear", "speech": [ "It's really -- it's a consistent trend, and as I said, we are looking to address it during 2020." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Thanks so much. Have a great spring." ] }, { "name": "Craig Menear", "speech": [ "Thanks, Chris." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Baker with Nomura. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "Hi, thanks. A couple here. So one, the comp outlook for next year, 3.5% to 4%. This year, you comped at 3.5%, but you were hurt by at least 50 basis points from lumber. So, essentially, you're guiding to a slowdown next year and, in fact, the slowest comp in a number of years when you adjust for inflation. Yet, housing seems to be getting better. So, just curious, a disconnect there? Is it just sort of setting up for some potential upside?" ] }, { "name": "Craig Menear", "speech": [ "I mean, like -- our methodology that we use hasn't changed, and it's not a perfect model. But, Richard, you want to just walk through the details?" ] }, { "name": "Richard Mcphail", "speech": [ "Yeah, sure. We stay consistent with our methodology providing sales guidance. And if you look at the elements of that methodology from GDP assumptions to what we're thinking with respect to support from housing to the expectation that we will continue to take share, none of the assumptions behind those elements have changed significantly since December and so that's why we are reconfirming that outlook." ] }, { "name": "Craig Menear", "speech": [ "And one comment, I guess -- people have always tried to think about our business as it relates to interest rates. Just so you know, we have never been able to correlate sales to interest rates. So that doesn't come into our thinking as a result." ] }, { "name": "Michael Baker", "speech": [ "But I guess, to follow up on that, you would think that your business correlates to housing, right, which I guess in turn correlates with interest rates. Is that a fair statement?" ] }, { "name": "Craig Menear", "speech": [ "It's a fair statement. We end -- Certainly, we've seen some of the indicators in the very recent time period tick up a bit. But we're not going to adjust guidance based on short-term fluctuations or observations in housing. We think housing is healthy and stable, it's going to continue to provide positive support for our business." ] }, { "name": "Michael Baker", "speech": [ "Okay, that makes sense. If I could follow-up, as I recall, the third quarter was hurt a little bit by the timing of Black Friday. So presumably that helped the fourth quarter. I get the shift in the months within the quarter, but third quarter versus fourth quarter, did that help fourth quarter at all? And if so, by how much?" ] }, { "name": "Craig Menear", "speech": [ "Yeah, it was roughly a 35 basis point shift both ways. So it hurt Q3 about 35 basis point. It shifted back to Q4 about 35 basis point." ] }, { "name": "Michael Baker", "speech": [ "Okay, thank you. If I could slide in one more, you said you don't change your methodology in how you do comps, but you are changing the methodology on the dividend. Just wondering why you're changing that? Is it just a new CFO and a different way to think about it, or is there something -- some other reason we should think about?" ] }, { "name": "Craig Menear", "speech": [ "Look, we are maintaining our policy of wanting to increase our dividend every year as we grow earnings. We're not going to tie to a specific payout ratio. But I think that this year's increase of 10% is a great example of our intention to continue to increase the dividend and also a reflection of our confidence in the business." ] }, { "name": "Michael Baker", "speech": [ "Okay. It makes sense. Appreciate the time." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi, thanks. Actually just a follow-up on that comment on the dividend. So is there a specific relationship we should think about as it relates to EPS growth versus dividend growth? Because obviously as you said a 10% increase is very impressive given that in 2020, you're kind of only looking for, call it, a 2% increase in earnings, and presumably earnings growth will accelerate in 2021." ] }, { "name": "Craig Menear", "speech": [ "Look, our general philosophy around capital allocation hasn't changed at all in terms of -- first and foremost, we're going to invest what we need to into the business to continue to position this business to win for the long-term. Then based on excess cash, we look at whatever opportunities might exist out there, and we are committed to increasing our dividend on an annualized basis as we grow earnings. And then we'll continue to look for ways to return dollars to the shareholders, down any other opportunities through share repurchase. So, those are the fundamental basics that we hold true in this business. We still want to -- we didn't want to control ourselves to a percentage basis." ] }, { "name": "Karen Short", "speech": [ "Okay. Thanks. That's helpful. And then on the 14% operating margin guidance. Obviously, you came in a little bit higher this year at 14.4%. Is there anything to call out there in terms of the 40 basis point decline versus the prior 30 basis point?" ] }, { "name": "Craig Menear", "speech": [ "No, it's really just a reflection of outperformance in Q4 and sort of rounding up to a 14.4%, rather than our expectations around 2020, which have not changed. But you know what, great execution across the business from sales to gross margin to operating expense, it was a team effort and we're proud of the results we delivered." ] }, { "name": "Karen Short", "speech": [ "Okay. And then just last one from me. Is there any update you could provide on additional personalization and functionality on the B2B? And maybe any color you could provide on behavior with the Pros and/or conversion, with respect to the ones you've on-boarded?" ] }, { "name": "Craig Menear", "speech": [ "Look, we continued to drive engagement with the Pros that we've on-boarded to the B2B website. We like what we see as those Pros accelerate their engagement. But again, it's -- we are also -- as I mentioned before, we're building a complete ecosystem around the Pro. The B2B website is one portion of that experience, but it encompasses all the things that I laid out before." ] }, { "name": "Karen Short", "speech": [ "Okay. Great. Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Brian Nagel", "speech": [ "Thank you for taking my question. Nice quarter." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Brian Nagel", "speech": [ "So I wanted to just take a step back a bit. So at the meeting in December, we spent a lot of time talking about the investment initiatives, and then you had highlighted the benefits of some of these were not coming as quickly as you initially thought, but they were still coming. I guess, I want an update there. I mean, as we look at the business now, you had a very nice quarter. You seem excited about the initiatives. Have you seen more progress on that front than was articulated in December?" ] }, { "name": "Craig Menear", "speech": [ "Well, I think, as we shared in December that we would continue to see the investments have a payback as we move forward. And that is what we're seeing. I think the quarter, in particular, as Ted called out, was a combination of the strength that we see in terms of the events that we put in place, the product offering that we brought to the market, the continued development of our initiatives and all those things coming together, that actually delivered on this quarter. So, yeah, we're pleased with the continued growth that we see in the initiatives. But at the same time, really proud of the team.", "The execution by our stores was outstanding, the supply chain team did a great job, our suppliers gave us outstanding products and values, and the customers' ability to start that shopping experience in the digital world and research product and-or purchased product there, all of that is leading to the kind of performance that we saw in the fourth quarter." ] }, { "name": "Brian Nagel", "speech": [ "Got it. And then my follow-up, Craig. I guess, a similar type question is on shrink, another topic we spent a lot of time discussing in the December Analyst Meeting. How much of a swing factor could shrink be here in 2020 to the extent that you were able to improve the performance versus what we saw in 2019?" ] }, { "name": "Craig Menear", "speech": [ "I think as we shared in December, we are in the process of implementing our initiatives to mitigate the impact from shrink. It will take time for us to actually realize the benefit as that flows through the P&L, because we basically do the inventory in the stores." ] }, { "name": "Richard Mcphail", "speech": [ "And it's a phased rollout." ] }, { "name": "Craig Menear", "speech": [ "Right." ] }, { "name": "Richard Mcphail", "speech": [ "We piloted approaches. We feel very confident about those results, but we still learn as we go. We feel confident. And as Craig said, not only do you have the rollout, but you also have the actual recognition in the P&L, which is on a lag basis as we take inventories." ] }, { "name": "Brian Nagel", "speech": [ "Alright. Well, thank you, and good luck for the spring." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Richard Mcphail", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Elizabeth Suzuki with Bank of America Merrill Lynch. Please proceed with your question." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Thank you. Regarding the margin guidance for 2020, can you talk about what assumptions you're making for product margin and the mix impacts on gross margin?" ] }, { "name": "Richard Mcphail", "speech": [ "Sure. For competitive reasons [Speech Overlap]." ] }, { "name": "Ted Decker", "speech": [ "Yeah, we wouldn't do that." ] }, { "name": "Richard Mcphail", "speech": [ "Yeah." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Okay. So on -- and -- but there is no expectation that mix could be negative, given that appliance sales have been so strong, for example, or is there anything built into your gross margin assumption in terms of mix?" ] }, { "name": "Craig Menear", "speech": [ "Well, there is. And as we had outlined in December, if you think about the walk to the 14% guidance, you start with the fact that we're going to generate operating expense leverage on the business as usual basis, sort of underlying everything. But then recall this is the peak year of investment of our three-year investment program. So, that will put pressure on margin.", "And then we see the impact from shrink, which, as we said, we are taking steps to address, and also from mix. But the mix pressure is a good pressure. This is the pressure that reflects the fact that we are taking share in categories like appliances, like power tools, like outdoor power. And so while we do think that there is mix pressure there, our objective is to grow incremental market share, incremental sales and incremental operating profit dollars. And we do that through attacking our market opportunities in front of us." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Got it. Okay. And has there been products that have been excluded from tariffs retroactively, where you're now getting refunds, and are those refunds a positive offset to your cost of goods sold?" ] }, { "name": "Ted Decker", "speech": [ "Yes, I would say, first off, a huge thank you for our combined merchandising, finance, supply chain, global sourcing team as they worked through this tariff issue all year. I mean, we've put a lot of effort on it and the teams did an exceptional job. That follows into the exclusions, because that's a whole body work that -- excuse me, you need to follow what's being submitted and requested to be excluded and literally, get it down to the SKU identifier and then file all the requisite paperwork to get the approvals that a massive body of work that the team is currently undertaking. And one big category -- a huge growth category for us that has been excluded now is luxury vinyl plank in the flooring business. That's probably the single biggest one, and we're actively working to get that refund back from tariffs previously paid." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Okay. So, those -- and have those refunds impacted your fourth quarter at all, or are they more -- going forward, you're likely to see some of that impact in the first half of the year?" ] }, { "name": "Richard Mcphail", "speech": [ "There were some of that. There was some benefit. But ins and outs to the quarter, we feel great about the overall performance in the business." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Okay. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zack Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zack Fadem", "speech": [ "Hey, good morning. Curious if you could speak specifically to the outlook for your e-commerce business in fiscal 2020. And given all the initiatives around fulfillment in Pro, curious whether you expect that 20% growth handle to continue, whether you're still adding any categories and what you think the 2020 drivers could be?" ] }, { "name": "Richard Mcphail", "speech": [ "We're excited about our e-commerce business as part of a whole interconnected retail strategy. We believe that the front door of our store is not on the customers' pocket, it's on the job site that most of our customers' shopping experience actually starts in the digital world, even if the potential is in the physical world. As Ted has talked about, we have expanded our assortments into more categories online around the home. We think that is a continued opportunity as customers have shared with us that they -- they believe that we can bring great value in these home categories and they trust us to bring that value. So we think that our digital business continues to be an engine for growth both in the digital world and in the physical world" ] }, { "name": "Craig Menear", "speech": [ "And it's not a separate business. It is managed by our merchandising team, our one merchandising team, right? And so rather than think about it as a separate business, you have to think about it as a capability." ] }, { "name": "Zack Fadem", "speech": [ "Got it. And on the appliance category, curious if you could talk a little more about the impact of taking home delivery in-house. And considering your share gains in the category over the past several years, could you comment on how much you think, share wise, is still up for grabs and where you think it's coming from?" ] }, { "name": "Mark Holifield", "speech": [ "Yeah. We're really pleased -- excuse me, it's Mark. We're really pleased with the work we've done in our market delivery operations or MDOs. Those are staffed with orange-aproned Home Depot associates, who are ensuring that the freight comes into those locations and is this flashed promptly to the customer damage-free. And they are also working to ensure that there is a great customer experience there, working with the delivery teams. So, really pleased with the progress there. As Craig mentioned in his comments, we've got a dozen of those up, we have another dozen or so leases signed and we're going to continue to roll those out through 2020. And as we do, we continue to see an improvement to our on-time performance, our reschedule rate and our customer satisfaction." ] }, { "name": "Richard Mcphail", "speech": [ "And I'd say an opportunity to keep growing. There's still lots of participants regional, super regionals, even mom and pop furniture stores that have appliance offering, so we think there's still lots of share out there. I mean, clearly, Sears had been a donor over the years and very markedly diminished store base. But we still see just a huge market that we've had a disruptive attitude in this space for a long time, and that's continuing to pay dividends as we take share." ] }, { "name": "Zack Fadem", "speech": [ "Got it. Appreciate the time." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Great. Hey, guys. Thanks for squeezing me in. A couple of follow-ups here. First on the guidance, and specifically, the cadence. Richard, I think you gave us comp cadence similar throughout the year. How should we be thinking about gross margin in SG&A, and, I guess, just the cadence of investments? Should we be thinking about more pressure on the operating margin in the first half relative to the second half?" ] }, { "name": "Richard Mcphail", "speech": [ "Firstly, we think about it in halves, and we don't provide specific half guidance. We are looking at a relatively balanced year across the house." ] }, { "name": "Seth Sigman", "speech": [ "Got it. Okay. And then just a follow-up on the exit rate, January being a better month here. Should we be thinking about any sort of pull-forward because of weather, or do you think it's some combination of your initiatives and just solid demand overall? And then just some related piece here around the macro. It sounds like you're maintaining a relatively conservative view. I guess, my question is really, are you seeing any sort of improvement or divergence in maybe markets that were slowing last year and are starting to get a little bit better? Any change in performance there that would maybe lead you to believe that the housing backdrop is just better for the business right now? Thanks." ] }, { "name": "Richard Mcphail", "speech": [ "Yeah. I'd say, first of all, regional variability this past quarter was one of the narrowest we have seen in recent times, and we don't see any widespread variability. It's really early to determine how the business plays out for the first half. We've always talked about this in terms of halves because anything can happen from a weather standpoint that could either accelerate or delay the spring. And then you generally work to capture that in the first half. That's really our approach. We're not seeing anything that would have us thinking any differently than that whatsoever." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Understood. Thanks a lot." ] }, { "name": "Operator", "speech": [ "Thank you. We have reached the end of our allotted time for questions. Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Great. Thank you, Christine. Thank you for joining us today. We look forward to speaking with you on our first quarter earnings call on May." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
HD	2019-02-26	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, President, and Chief Executive Officer", "name": "Craig Menear", "position": "Executive" }, { "description": "Executive Vice President of Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President, Corporate Services and Chief Financial Officer", "name": "Carol Tom", "position": "Executive" }, { "description": "Senior Vice President, Store Operations", "name": "Marc Brown", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scott Ciccarelli", "position": "Analyst" }, { "description": "Gordon Haskett -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Guggenheim Securities -- Analyst", "name": "Steve Forbes", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zachary Fadem", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good day and welcome to the Home Depot Fourth Quarter 2018 Earnings Call. Today's conference is being recorded. If you would like to ask a question during today's call, please press \"*1\" on your touchtone phone. At this time, I would like to turn the conference over to Isabel Janci. Please go ahead, ma'am." ] }, { "name": "Isabel Janci", "speech": [ "Thanks you, Christine, and good morning, everyone. Thank you for joining us today on our fourth quarter earnings call. Joining us on our call today are Craig Menear, Chairman, CEO, and President; Ted Decker, Executive Vice President of Merchandising; and Carole Tomé, Chief Financial Officer and Executive Vice President, Corporate Services.", "Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors and, as a reminder, please limit yourself to one question and one follow-up. If we are unable to get to your question during the call, please call our Investor Relations department at 770-384-2387.", "Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission.", "Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and good morning, everyone. Fiscal 2018 was another record year for our business, as we achieved the highest sales and net earnings in company history. Fiscal 2018 sales grew $7.3 billion to $108.2 billion, an increase of 7.2% from fiscal 2017, while diluted earnings per share grew 33.5% to $9.73.", "And although fiscal 2018 was a record year for our business, our fourth quarter comp sales were slightly below our expectations, as the quarter experienced some unfavorable weather. Sales for the fourth quarter were $26.5 billion, up 10.9% from last year. Comp sales were up 3.2% from last year and our U.S. comps were positive 3.7%. Diluted earnings per share were $2.09 in the fourth quarter. Internationally, Mexico posted another quarter of positive comps in local currency, while Canada was essentially flat.", "As we mentioned on last quarter's call, our fourth quarter faced tough comparisons given the prior year's approximately $400 million in hurricane-related sales that would not repeat and we planned for this in our outlook. But as Carol will detail, what we did not plan for was the extent of the unfavorable weather we experienced in all regions throughout the quarter. It was cold, it was snowy, and perhaps worst of all, it was wet. Wet weather delays projects and this was evidenced in our sales performance in the quarter.", "In fact, as Carol will detail, ex-weather, our business performed in line with our expectations. As Ted will discuss, both ticket and transactions grew in the quarter and we saw growth in both pro and DIY categories. Pro sales once again outpaced DIY sales in the quarter and the work that we're doing to enhance the service capabilities for our pros continues to resonate.", "I am very proud of our associates for continuing to do what they do best: serving our customers. Our merchants, store teams, supplier partners, and supply chain teams did an outstanding job of delivering value and service to our customers throughout the quarter, both in stores and online. In fact, several key accomplishments took place during the quarter. We set record performances on Black Friday and during Cyber Week. Our holiday décor offering and gift center events set new all-time highs and during the quarter, we reached a new watermark of approximately 2 billion annual visits on homedepot.com, with many of these visitors indicating that their next stop is a Home Depot store.", "In fiscal 2018, we made progress with regard to the One Home Depot investment plan but we are still in the early days of our journey. Our strategic effort to drive an enhanced, interconnected customer experience through investments in both the physical and digital worlds are yielding solid returns. We also continue to focus on productivity as a virtuous cycle by leveraging technology and improving processes throughout the value chain of our business. Fiscal 2018 provided a lot of great learnings and momentum that we will continue to build on in 2019.", "I'm particularly excited about the investments we're making for our pros. In the quarter, we announced the consolidated go-to-market approach for our pro customers under the banner \"Home Depot Pro\" and we continue to invest in a more personalized offering for our pro customers with a new B2B website experience. We have now onboarded over 100,000 pro customers and the reception has been positive. Our plan is for continuous enhancements, with new features and capabilities. For example, in response to customer feedback, we are adding the ability for businesses to enhance account management and ordering capabilities with improved tools. Our intent is to roll out this new pro online experience to over 1 million pros in 2019.", "Beyond B2B personalization, we continue to make great strides in driving our digital experience. This year, we invested in our website and mobile applications, improving search capabilities, site functionality, and product content. This ongoing investment in our digital properties has increased traffic and conversion. Versus prior year on a like-for-like basis, online sales grew 22.7% in the fourth quarter and 24.1% in fiscal 2018, now representing 7.9% of our total sales.", "While we are seeing significant growth in our online sales, these online shoppers see the relevance of our stores, as approximately 50% of our online U.S. orders are picked up in our stores, a testament to the power of our interconnected retail strategy. We continue to roll out automated lockers in our stores to make picking up an online order easier and more convenient. To date, approximately 1,000 stores have lockers, with more to come in 2019. Customer response to the lockers has been very positive, as almost 94% of customers rated their locker pickup experience a 5 out of 5 stars.", "We fundamentally believe that when a customer comes to one of our stores, it has to be a great experience. With our investment program, approximately 40% of our U.S. stores now have a new look and feel and customer response has been very positive. The store investments are not just about the customer response, as we are also seeing increased associate engagement and higher productivity.", "Another key component of a best-in-class interconnected shopping experience centers on enhanced delivery and fulfillment options. Fiscal 2018 was the year of the pilot, as we kicked off our $1.2 billion investment journey to create the fastest, most efficient delivery network for home improvement goods. We are now live with a number of these pilot facilities. We look to fiscal 2019 as a year to take what we have learned in pilot and begin the rollout that we expect to complete by 2022.", "As a demonstration of the confidence in the business going forward, today our board announced a 32% increase in our quarterly dividend to $1.36 per share. The board also authorized a new share repurchase program with $15 billion, replacing our existing authorization. We remain committed to maintaining disciplined capital allocation to create value for our shareholders.", "Turning to 2019 and beyond, I'm excited about the opportunities that are ahead of us. Carol will take you through the details but we expect 2019 to be another year of growth, with sales growth of approximately 3.3%, comp sales of 5%, and diluted earnings per share of approximately $10.03. Our strong performance in fiscal 2018 also positions us well with respect to our 2020 financial targets and, today, we are reaffirming those targets.", "It's an exciting time to be a part of the Home Depot and we look forward to the work ahead as we continue our journey to create the One Home Depot experience. There's a great deal of change being introduced throughout the business but as they always do, our associates are rising to the occasion, meeting new challenges head-on without losing the passion to serve our customers that has made the Home Depot what it is today.", "I want to close by thanking our associates for their hard work and dedication to our customers in the fourth quarter and throughout the year. For the second half of the year, 100% of our stores will receive success sharing, our bonus program for our hourly associates. We look forward to continuing our momentum in 2019.", "And, with that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. When we look through the unfavorable weather we experienced in the fourth quarter, we were pleased with how the business performed.", "Looking at our departments, comps in tools, appliances, décor, indoor garden, building materials, outdoor garden, hardware, and paint were above the company average. Electrical, plumbing, flooring, millwork, and kitchen and bath were positive but below the company average. Due primarily to price deflation, lighting and lumber reported low to mid-single digit negative comps. In the fourth quarter, average ticket increased 2.3% and comp transactions increased 0.9%.", "The fourth quarter finished what was a volatile year in many commodity markets, particularly lumber. For example, during the second quarter, we saw lumber prices that were more than 40% higher than they were in the year prior. These prices fell significantly during the third and fourth quarter and now sit approximately 25% below last year's prices. While this deflation pressures sales, we have seen strong unit growth as prices have come down and this unit productivity drives activity across the store.", "During the fourth quarter, deflation in lumber negatively impacted average ticket growth by approximately 41 basis points. However, this deflation was largely offset by inflation in other core commodity categories for a net impact to average ticket from core commodities of negative eight basis points.", "During the fourth quarter, big ticket transactions, or those over $1,000.00, which represent approximately 20% of U.S. sales, were up 4.8%. A number of factors served as headwinds to big ticket sales in the fourth quarter, notably unexpected wet weather across the U.S. and lapping last year's hurricane-related sales. Excluding hurricane-effected markets, we see that January's big ticket comp was up almost double digits, in line with what we saw throughout 2018. Big ticket categories like vinyl plank flooring, roofing, and appliances all had comps above the company average in the fourth quarter.", "We saw growth with both our pro and do-it-yourself customers in the fourth quarter, with pro sales growing faster than the company's average comp. We continue to see strong performance in pro-heavy categories, like power tools, water heaters, and commercial and industrial lighting. Sales to our DIY customers grew year-over-year, as our customers completed a variety of interior projects. Categories like hard window coverings, safety and security, and cleaning all posted strong growth in the quarter. We also saw record performance with our annual gift center and holiday sets. Additionally, the combination of outstanding values from our suppliers, the right assortments from our merchants, and phenomenal execution in our stores led to the single highest sales day in our company's history on Black Friday.", "As part of our journey to enhance the One Home Depot experience, we are significantly investing in our digital assets to provide a frictionless, interconnected shopping experience. Earlier this year, we formed approximately 50 cross-functional squads focused on agile development to improve our online customer experience. These teams have accomplished a great deal in a short period and are driving results. In 2018, we hit a milestone of approximately 2 billion online visits and our ongoing efforts to improve the interconnected customer experience have led to a consistent improvement in our conversion rates throughout the year.", "However, our work is not done. In 2019, we will continue to roll out enhancements across our digital assets. As you heard from Craig, we are excited to be rolling out a new B2B online experience for our pro customers to provide a more tailored, personalized offering. And for consumers, we will continue to focus on improving the way we bring our assortments to life in the digital world.", "As we look to 2019, we are excited to build on our momentum. We are the No. 1 retailer for product authority in home improvement and, together with our supplier partners, we will work to offer the best products at the best value for our customers every day.", "A great example of our strong partnerships is in our paint business. Our exclusive partners, Behr and PPG, bring the two highest-rated consumer paint and stain brands to the Home Depot. These strong brands, along with the great execution in our stores, help drive paint comps above the company average in the fourth quarter. We were particularly pleased with our sales to our pro painters, as our investments and initiatives are gaining traction.", "In addition to having the best products, we are investing to improve the in-store paint experience for our customers. In 2019, we plan to roll out a new color solutions center to all stores and will do a full reset in exterior stains. We were thrilled with the results we are driving in our paint business and look forward to building on our momentum in 2019.", "Product innovation is resonating with our customers, as we see them trade up to new features and innovation across the store. One example where we are seeing this is with Traeger in our grill category. Traeger is one of the fastest growing brands in the grilling category. In their innovative pellet grills, Traeger offers the versatility and convenience of being able to grill, smoke, bake, roast, braise, or barbecue all on the same grill. Given the strong sales, we are introducing Traeger's new lineup of WiFIRE grills. This technology connects the grill directly to your smartphone so you can monitor your grill or adjust the temperature remotely. We are excited to be Traeger's exclusive partner in the big box home improvement channel.", "Another example of innovation is in our pro-heavy roofing category. Over the last several years, we have seen both residential and commercial roofers trade up for innovative products that same them time and money. In the residential space, we have seen a significant shift from strip shingles to laminate architectural shingles. These laminate shingles last longer, have a lifetime warranty, are easier to install, and offer dramatic color contrast and dimension, which is important from a decorative perspective. In the commercial segment, the trend has shifted from asphalt and aluminum roof coatings to elastomeric roof coverings that are more water- and dirt-resistant. A great example of this is Henry Tropi-Cool Silicone, an exclusive to the Home Depot in the home improvement channel. No primer coat is needed so the one-coat application saves time and money.", "We are excited about the year ahead, particularly with the spring selling season right around the corner. Our investments in localized assortments and innovative product at an everyday low price will continue to position us as the product authority in home improvement.", "With that, I'd like to turn the call over to Carol." ] }, { "name": "Carol Tom", "speech": [ "Thank you, Ted, and good morning, everyone. In the fourth quarter, total sales were $26.5 billion, a 10.9% increase from last year. And for the year, our sales totaled a record $108.2 billion, a 7.2% increase from last year.", "Fiscal 2018 included a 53rd week, which added approximately $1.7 billion in sales to the fourth quarter and the year. The extra week is not included in our comp sales calculation. Our fourth quarter results also include the impact of a new revenue recognition standard that we adopted at the beginning of the year. In the fourth quarter, the change in revenue recognition positively affected sales growth by $86 million.", "Our total company comps were positive 3.2% for the quarter, with positive comps of 3.1% in November, 3.1% in December, and 3.3% in January. Comps in the U.S. were positive 3.7% for the quarter, with positive comps of 3.4% in November, 3.5% in December, and 4.1% in January.", "There were a few notable factors that affected our comp performance in the quarter. First, a stronger U.S. dollar negatively impacted total company comp sales growth in the quarter by approximately $96 million or 0.4%. Second, the commodity price inflation we experienced in the first three quarters of the year disappeared in the fourth quarter. Finally, as you know, we were up against nearly $400 million of hurricane-related sales. We expected that but we did not expect such a wet winter. Sometimes weather-driven demand can help sales growth and sometimes hurt. Relative to our expectations, we estimate weather-driven demand negatively impacted fourth quarter comp sales by roughly 85 basis points.", "In the fourth quarter, our gross margin was 34.1%, an increase of 19 basis points from last year. The year-over-year change in our gross margin reflects the following factors. First, the new accounting standard drove $168 million of gross profit, or 53 basis points of gross margin expansion. Second, higher supply chain and fulfillment expense caused approximately 19 basis points of gross margin contraction. Third, higher shrink than one year ago resulted in 10 basis points of contraction. And, finally, changes in the mix of products sold drove five basis points of contraction. For the year, we experienced 29 basis points of gross margin expansion.", "In the fourth quarter, operating expense as a percent of sales increased by 79 basis points to 21.3% due to the following factors. First, we experienced 152 basis points of expense leverage in BAU, or business as usual, expenses. The strong leverage in the core of our business was driven by solid expense control but also reflects certain expense items that did not repeat this year, most notably a one-time bonus of $117 million that was granted to our hourly associates last year.", "Our BAU expense leverage was offset by the following. First, as we called out in our press release, as we move forward with our B2B experience, we recognized an impairment loss of $247 million, or 93 basis points of expense de-leverage, related to the write-off of several trade names associated with Interline Brands. Second, the new accounting standard resulted in a $168 million increase to our operating expenses and caused 63 basis points of operating expense de-leverage. And, third, expenses related to our strategic investment plan of roughly $198 million resulted in approximately 75 basis points of operating expense de-leverage.", "Fiscal 2018 operating expense as a percent of sales was 20%, an increase of 49 basis points from last year. Our fiscal 2019 expense performance was better than our initial expectations, driven by productivity and BAU. For the year, we incurred almost $700 million of expenses related to our strategic initiatives, in line with our plan.", "Our operating margin for the fourth quarter was 12.8% and for the year, it was 14.4%. Interest and other expense for the fourth quarter grew by $19 million to $265 million, reflecting, for the most part, a loss on the sale of a non-strategic asset. In the fourth quarter, our effective tax rate was 24.7% and for fiscal 2018 was 23.6%. Our effective tax rate for the quarter and the year reflects the close-out of the provisional charge we took last year related to tax reform and certain positive audit settlements.", "Our diluted earnings per share for the fourth quarter were $2.09, an increase of 37.5% from last year. For the year, diluted earnings per share were $9.73, an increase of 33.5% compared to fiscal 2017. Our fourth quarter and fiscal 2018 diluted earnings per share were negatively impacted by approximately $0.16 due to the impairment charge recorded in the fourth quarter.", "Now, moving on to some additional highlights, during the year, we opened three new stores, including one in the U.S. and two in Mexico, for an ending store count of 2,287. Selling square footage at the end of the year was 238 million square feet. For the fiscal year, total sales per square foot increased 7.2% to $447.00, the highest in our company history.", "At the end of the quarter, merchandise inventories grew $1.2 billion to $13.9 billion and inventory turns were 5.1 times, flat with last year. The growth in our inventory versus last year reflects the investments we are making to accelerate merchandising resets and higher in-stock levels than we had one year ago.", "Moving on to capital allocation, in fiscal 2018, we generated approximately $13.3 billion of cash from the business and used that cash, as well as the proceeds from $2.2 billion of net debt issuances and cash on hand, to invest in the business, pay dividends to our shareholders, and repurchase our shares. During the year, we invested approximately $2.4 billion back into the business through capital expenditures. Further, we paid $4.7 billion in dividends to our shareholders. And, finally, during the year, we repurchased approximately $10 billion, or about 54.3 million of our outstanding shares, including roughly $4.5 billion, or 27.5 million shares, in the fourth quarter.", "Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 44.8%, 1,060 basis points higher than the end of fiscal 2017.", "Today's press release includes our guidance for fiscal 2019 and I want to take a few moments to comment on the main points. Remember that we guide off GAAP so fiscal 2019 guidance will launch from our reported results for fiscal 2018, which includes sales and earnings associated with the 53rd week. When we report our quarterly comp sales results, we will compare weeks 1-52 in fiscal 2019 against weeks 2-53 in fiscal 2018.", "So, with that, turning to our sales growth projections, as you know, we use a directionally correct but imperfect model to project our sales growth. It starts with GDP. While we are in the 10th year of economic recovery, U.S. GDP is expected to grow in 2019 and for our model, we are using 2.6% GDP growth. To GDP, we add the expected spending impact from key housing metrics, including home price appreciation, housing turnover, household formation, and the age of the housing stock.", "As we look to 2019, most housing metrics are trending positive, albeit heading toward stability. Two of these metrics worth highlighting are home equity, which is a function of home price appreciation, and the age of the housing stock. Home equity has more than doubled since 2011 and 52% of the homes in the U.S. are greater than 40 years old.", "And you will recall that the three-year sales target we established in 2017 started with a base comp of 4%. The sales forecasting model that we built for 2019 doesn't move us materially off that base. For 2019, we are planning a 5% comp, which includes our base model plus growth emanating from our strategic investments. For fiscal 2019, we expect total sales growth of approximately 3.3%, reflecting the compare to 53 weeks last year.", "Two more comments for your models. First, when you are thinking about the shape of the year, we would expect the comps for the first half of 2019 to be about 250 basis points lower than the second half of the year because of the hurricane-related sales overlap. On a two-year stack basis, we expect that our first half and second half comp will be relatively similar. Second, because of the shift in the year and the seasonality of our business, our 2019 comp sales will not match our sales growth rates in three of four quarters.", "During the year, we plan to open five net new stores, four in the U.S. and one in Mexico. For fiscal 2019, we are projecting our gross margin rate to be approximately 34%, in line with the 2020 target we set forth during our December 2017 investor conference. At this time, we are not expecting further gross margin contraction in fiscal 2020.", "We expect our fiscal 2019 operating expenses to grow at approximately 53% the rate of our sales growth. On a 52-to-52 week basis and ignoring the impairment charge we recorded in the fourth quarter of fiscal 2018, we expect our fiscal 2019 operating expenses to grow at approximately 90% of the rate of our sales growth.", "For the year, we expect that our operating margin will be essentially flat with what we reported in fiscal 2018. For fiscal 2019, we estimate our effective tax rate to be approximately 25.5%. We expect fiscal 2019 diluted earnings per share to grow approximately 3.1% to $10.03. Our earnings per share guidance includes our plan to repurchase approximately $5 billion of outstanding shares during the year.", "For the year, we project cash flow from the business of roughly $14 billion. We will invest $2.7 billion of this cash back into the business in support of our strategic initiative. We also plan to use this cash to pay $6 billion of dividends. As Craig mentioned, we just announced a 32% increase in our quarterly dividend, which equates to an annual dividend of $5.44, in line with our targeted dividend ratio of 55% of earnings. Finally, we plan to repurchase $5 billion of outstanding shares using excess cash.", "At our last investor conference in December 2017, we shared with you our long-term financial targets and our strategy to create the One Home Depot. By the end of fiscal 2020, we are aiming to grow our sales to a range of $115 billion to $120 billion, with an operating margin range of 14.4% to 15% and return on invested capital of more than 40%. As evidenced by our fiscal 2018 results and our guidance for 2019, today, we are reaffirming our long-term targets.", "Thank you for your participation in today's call and, Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. The question-and-answer session will be conducted electronically. If you would like to ask a question, please press \"1\". If you are using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, \"1\" to ask your question.", "Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning. My first question is two parts on gross margin. So, getting to the 34% level in 2019, was that always part of your plan and the Street maybe just looked like it was mis-modeling or is something changing on your investment cadence? And then the second part of that gross margin question is can you split the -- it looks like about 30 basis points of contraction into fixed versus variable cost and how much would gross margin flex if comps are better or worse than 100 basis points of your forecast?" ] }, { "name": "Craig Menear", "speech": [ "Simeon, I think the first comment I'd have is, as it relates to the margin rate and was it different than what we anticipated, a little bit more sustained pressure in supply chain maybe than what we had initially anticipated in 2017." ] }, { "name": "Carol Tom", "speech": [ "But as we look at our model, both for '19 and '20, let me break apart the gross margin performance for you in our expectations. First, as you know, productivity is a virtuous cycle at the Home Depot and we have productivity in our cost of goods. And we project productivity into '19 and '20. Offsetting the productivity in '19 is some pressure that I mentioned in supply chain, as well as our supply chain rollout. There's a little bit of shrink pressure in 2019 but we're going to cover that off with productivity. And then there's a mix pressure, mix that was always in our plan, as we see relative outperformance of growth in lower margin categories. So, as we look through '19 into '20, nothing comes to our attention, at this point, that the margin will contract further because productivity will continue into '20.", "On the second part of your question, in terms of fixed/variable nature of our gross margin or of our cost of goods, we actually don't look through that lens. But I will tell you, within the performance in the fourth quarter, there were a few surprises relative to the guidance that we gave at the end of the third quarter. First, the supply chain contraction of 19 basis points was a bit higher than we had anticipated. We had three basis points of fuel pressure come through and about five basis points of higher fees related to third-party delivery agents. And then we had a bit higher shrink than we anticipated. Hopefully, that's helpful." ] }, { "name": "Simeon Gutman", "speech": [ "Yeah, it's helpful. My follow-up is on the demand side. Can you tell us if there were any markets that were \"normal,\" not meaning ex-weather? Did they perform in line or did they perform better than you thought? And then you told us in the past, where housing turnover markets have been soft, you've called out that the business has been solid. Just checking if that's still the case." ] }, { "name": "Carol Tom", "speech": [ "Yes. We saw great performance in areas that had good weather. I must say the weather was across the country but you can find pockets of relative outperformance. And if you look at the housing-related markets, let's take Seattle as an example. Seattle is talked about a lot as a place where there's been huge home price appreciation. The comp in Seattle for the fourth quarter was at 6.3%. Let's take Dallas. Dallas is another area of the country where home prices have seen significant home price appreciation. The comp in Dallas was in line with the company average. So, we're not seeing any impact to our performance in a negative way because of the housing environment." ] }, { "name": "Craig Menear", "speech": [ "If you looked at a market like L.A., when the weather shifted, we see a 1,400 basis point swing week-to-week based on weather. So, when the weather was positive, it was lift of 1,400 basis points." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. Thank you." ] }, { "name": "Operator", "speech": [ "And our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. You noted that your comp guidance is based on 4% growth from underlying economic conditions and housing. Is there a way that you could size the potential downside if GDP doesn't meet 2.6% and we see a continued deceleration from the key housing metrics?" ] }, { "name": "Carol Tom", "speech": [ "Well, clearly, our base model starts with GDP. And the forecasts for GDP next year, there's a wide range. We landed on 2.6%. We think that's the right number to use. We added to that about one point coming from the various housing metrics that we look at. So that takes our base comps to 3.6% and, candidly, we rounded up to 4% because we're just not that good at it.", "We really wanted to call out two things that are important in our model. And one is home equity. There's $15.4 billion -- what am I saying -- $15.4 trillion of home equity out there. Home equity has more than doubled since 2011. And if you look at the home equity per owner-occupied household, that equity is $193,000.00 and has not been extracted. So, we think that bodes well. It's a wealth effect but that bodes well into 2019.", "The other aspect of the housing market is just the age of the housing market. Fifty-two percent of the homes are older than 40 years. We know that spend for homes that are 40 years and older is 30% greater than spend on homes less than 10 years." ] }, { "name": "Michael Lasser", "speech": [ "And my follow-up question is on the contribution from your initiative. Shouldn't we expect that the contribution, which we sized at 100 basis points, shouldn't we expect that that's going to build over the course of the year as you've had more time to benefit from what you've put in place over the last 12-18 months? And what's the upside risk from those initiatives driving more than 100 basis points of contribution to your comp?" ] }, { "name": "Craig Menear", "speech": [ "Michael, it will build as we go forward. You're thinking about that the right way. And so we definitely see it building throughout 2019 and then beyond." ] }, { "name": "Carol Tom", "speech": [ "Michael, I mentioned the back half comp would be greater than the first half comp. Part of that is due to the hurricane overlap but part of it is due to the build." ] }, { "name": "Michael Lasser", "speech": [ "And what leading indicators are you looking at within the business that give you confidence that it's going to contribute the 100 basis points that you're expecting." ] }, { "name": "Craig Menear", "speech": [ "Well, when we look at the initiatives that we've begun to put in place, whether that is the amount of store refreshes that we have done, whether it is the interconnected experience with the automated lockers that we've put in place which is driving, obviously, a great response from the customers, these are things that we tested, we piloted, and as we roll, we've begun to see a benefit as a result and feel comfortable that those are going to be the driver behind that point of initiative growth." ] }, { "name": "Carol Tom", "speech": [ "We're also seeing outsized growth in our pro business. And as we continue to add pros to our website, to our pro experience, if you will -- we are adding over a million customers this year, we see spend with those customers increasing." ] }, { "name": "Michael Lasser", "speech": [ "Okay. Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scott Ciccarelli with RBC. Please proceed with your question." ] }, { "name": "Scott Ciccarelli", "speech": [ "Good morning, guys. Scott Ciccarelli. So, can you help us understand maybe the investment pace a little bit better? It sounds like there may be some shifts between your original expectations between 2019 and 2020, just from a timing perspective, No. 1. No. 2, could we end up facing a scenario where the absolute investment amounts, what you're doing with the supply chain and in the stores, etc., maybe exceeds your prior views? Almost every company out there, their investment plan seems to be a moving target." ] }, { "name": "Carol Tom", "speech": [ "Well, I'm happy to take you back to December of '17 when we laid out our investment plan. You'll recall, we announced an $11.1 billion investment plan, which was $5.4 billion over what we would have spent in a BAU basis. And this is the cash look of the investment, so it's both expense and capital. Then we shared with you a chart back in 2017 that broke that spending down by year. We said we would spend $1.4 billion in '18, $1.9 billion in '19, and $2.1 billion in '20. If we look at what we spend in '18, we spent $1.4 billion, about $540 million in expense and $800 million in capital. Now, on the expenses, we also had some depreciation but that wasn't on the chart that we shared with you. If you add the depreciation related to our investments in 2018, it was more like $700 million.", "As we look to '19, we are projecting in our guidance that we will spend $1.7 billion, $550 million in expense and about $1.1 billion in capital. That's roughly $200 million under what we shared with you in 2017. That spending is being pushed to '20. And it might push out a little past '20. The reason for this is because we're just getting smarter about how we're spending our dollars. In the past, you'd change the prioritization of some of our activity to deal with some of our legacy IT systems. As we look at it today, our estimate is we won't exceed our spend. In fact, we may be able to deliver this under the target. But we've got to space this the appropriate way so that we don't actually deliver an initiative that the foundation can't serve. So, hopefully that's helpful." ] }, { "name": "Craig Menear", "speech": [ "Yeah, Scott, this year was a learning year as it related to the investments. And we found that some things we could actually accelerate and other things are going to take us a little bit longer, as Carol mentioned, because of the legacy systems that we have to fix." ] }, { "name": "Scott Ciccarelli", "speech": [ "I understand. Okay. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey, thanks. Good morning. Carol, just on the macro again, just trying to connect the dots between your 5% guide and Lear's view for 2019, particularly its expectation that gains and renovation spending slows as the year progresses, which is kind of counter to what you're speaking to. And just also on a follow-up to the comp, with the shift coming from Weeks 1 to 52 to Weeks 2 to 53, I know some of the department stores, that tends to throw things off a lot. Is there anything that we should think about in terms of the quarterly cadence because of that?" ] }, { "name": "Carol Tom", "speech": [ "Yeah, so let me address the latter part of your question first and then we'll get back to the macro. So, the shift in the calendar wouldn't be such a big deal if we weren't such a seasonal business but we're a very seasonal business.", "So, this year, let's take the first quarter. We will be comparing Weeks 1 through 13 in '19 against Weeks 2 through 14 in '18. And that shift will have an impact. So, you would expect the comp in the first quarter to actually be lower than the actual sales growth that we report. That reverses in the second quarter. In the second quarter, we would expect the comps to be higher than the sales growth we report. In the third quarter, it'll be about the same and then, in the fourth quarter, the comp will be higher than the sales growth we report, principally because we're up against 14 weeks versus the 13 weeks that we will share.", "I will tell you that the first week difference is about $1.5 billion sales. So, we're dropping off the compare off of $1.5 billion and we're gaining a compare of over $2 billion. So, hopefully that helps you kind of model what that first quarter impact will be.", "Now, going back to the macro questions, we use a directionally correct but imperfect model and it's worked for us pretty well since we implemented it. And if you've been following us for a while, you'll recall that we set forth stages of housing recovery and the impact it would have on our comps. And we had three stages of housing recovery. There was sharp, there was moderate, and then there was stability. And if you look through that document -- I think it's on our website. If not, we can get it to you.", "You can see in the stability area, which is where we think we are trending, our models suggest it's GDP plus 1% to 2%. We conservatively said GDP plus 1%. So, if you use a 2.6% GDP and you add 100 basis points to that, you get to 3.6% and we rounded up a bit to 4%. And then as you heard from Craig, we added a point relative to our strategic investments. There are lots of forces and economic prognoses that you can use and one thing that we use to kind of support our point of view is what the Harvard Joint Center says for remodeling activity. And their forecast for remodeling activity in 2019 is 5% growth." ] }, { "name": "Chuck Grom", "speech": [ "Okay. Great. Thanks very much. And then one more for you, Carol. On the third quarter call, you gave some helpful color on tax refunds and the timing impact. Just curious if your views on that front have changed at all. And it looks like February refunds are down a lot, which is expected. Just wondering if that's impacted your business thus far in February." ] }, { "name": "Carol Tom", "speech": [ "Yeah, no. We wouldn't say that there's an impact to our business from tax in February. And as you pointed out, we wouldn't expect the benefits coming from tax reform to come in later as those filers who have an earned income credit or a child credit, they actually haven't filed. Those returns get filed and processed later." ] }, { "name": "Chuck Grom", "speech": [ "Okay. Great. Thanks, Carol." ] }, { "name": "Carol Tom", "speech": [ "Yeah." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, everybody. So, there's a lot of noise in '18. Hurricane, inflation in the first half of the year, a pinch in the fourth quarter of deflation. It would be helpful to think about 2018, if we backed out weather on an annual basis and we backed out the net benefit from inflation in the first three quarters, what is that underlying rate and how does that compare to the 5% guide that you're putting out for 2019 and does that guide include any benefit or headwind from inflation/deflation?" ] }, { "name": "Craig Menear", "speech": [ "We looked at that. We backed those noise levels out. It gets you somewhere in the area of a 5.5% to a 5.7% as a normalized run rate. You think about taking out the storms, you take out the weather, you take out the inflation, and that's what we round it to." ] }, { "name": "Carol Tom", "speech": [ "And, as you know, when we build our plans, we are commodity inflation neutral. We don't really know how to plan for that. Based on where commodity prices are, there may be a little bit of pressure in the first half of the year but we planned for that." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. So, just to summarize there, you're basically saying -- I mean, precise basis points -- but 70-80 basis points of moderation in the underlying comp from '18 to '19. Okay. Understood." ] }, { "name": "Carol Tom", "speech": [ "Which is exactly what you would expect. You would expect that where we are in the housing recovery. You would expect that." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And then, in terms of the shift from turnover net then pricing and now home equity and age, does that express itself in any way in terms of traffic versus ticket growth? Do you expect ticket to continue to lead? Does ticket growth actually become more of a factor versus the traffic growth? How are you thinking about that?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. It would impact -- continue to support ticket growth, for sure. And if you think about the formations, estimated to be increasing in 2019, while turnover is more flattish, to where it was in 2018, that would definitely project business." ] }, { "name": "Christopher Horvers", "speech": [ "Okay. And then one quick -- go ahead. Sorry, go ahead." ] }, { "name": "Ted Decker", "speech": [ "Sorry, Chris. I would just add on the ticket. The thing that's really encouraging about ticket, reasons we called out the innovative product in more premium roofing and a grill like the Traeger grill, we look at a number of signals very closely. One is the line structure, where sales are coming from OPP through good, better, best. We continue to see stronger productivity as you move up price points. And we break that out. The second data point we look at very closely is where is ticket growth coming from. And we include commodity, we include tariff, we include new items, etc. And, by far, our largest ticket growth is coming from the introduction of new, innovative items. It's actually much more significant than either inflation or tariff." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And then just to sneak one last one in, Carol, any particular cadence around gross margin in SG&A versus sales growth? Obviously, the fourth quarter, you lap the extra week but anything else to call out on a quarterly basis in margins?" ] }, { "name": "Carol Tom", "speech": [ "Yes. We have a seasonal business, as you know. And we try to predict when spring will break. And we use five-year historical averages and forecasts from Planalytics and we try to predict when it will break. We're usually wrong but we try. Now, based on the way that we built our plan, we think that spring is going to break -- it hasn't yet -- but we think that spring is going to break in the first quarter. So, because many of our seasonal categories are lower margin, you would expect the margin decline to be the greatest in the first quarter. So, that's an important thing to get out there as you're building your models. Chris, as you know, we're not really good at this but that's how we're planning.", "Then, from an expense growth factor, the real noise will be, I guess, in the fourth quarter but I think we've given you enough color there that you can model to that. So, there's really nothing too goofy on the expense side." ] }, { "name": "Christopher Horvers", "speech": [ "Have a great spring. Thanks very much." ] }, { "name": "Carol Tom", "speech": [ "Thanks so much." ] }, { "name": "Operator", "speech": [ "And our next question comes from the line of Steve Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steve Forbes", "speech": [ "Good morning." ] }, { "name": "Carol Tom", "speech": [ "Morning." ] }, { "name": "Steve Forbes", "speech": [ "I wanted to focus on the enhanced delivery and fulfillment option rollout that you mentioned for 2019. So, maybe you can just comment on the number and type of facilities slated to open in '19 and, I guess, how you're moving along relative to the original plan." ] }, { "name": "Craig Menear", "speech": [ "Yeah. Steve, we're excited about the pilots that we put in place in 2018 and the learning that we have. And Marc is here. I'll let him address that. But we also would say that we're excited about the options that we've provided for our customers during the year as well on same-day delivery for car and van service on products out of our stores." ] }, { "name": "Marc Brown", "speech": [ "Yeah. Just as a reminder, we have our five direct fulfillment centers already up, providing one- and two-day service to over 90% of the population. We've got our Interline Brands facilities, now Home Depot Pro, that give us near international coverage with next-day delivery via 700 private fleet trucks. We've opened three market delivery operations and we have openings planned and grand openings planned through the year on the various new platforms, market delivery operations, flatbed delivery centers, etc. So, we're looking forward to that. And, of course, we have our car delivery and van delivery, fast options there, with 40% coverage of the U.S. population for low-cost car delivery and 70% with van coverage." ] }, { "name": "Steve Forbes", "speech": [ "And then just a quick follow-up, maybe more of a modeling question as it relates to D&A specifically. Because I think if you walk back to the Analyst Day in '17, there was, I guess, an average three-year D&A run rate that was called out. Can you just update us on what we should be building in as we look out to 2020?" ] }, { "name": "Carol Tom", "speech": [ "So, I think in our guidance, we gave you a D&A number of -- what did we say? $2.3 billion. Some of that flows through cost of goods sold. So, on the expense line, you could plan about $2 billion of D&A on the expense line and the remaining $300 million would be up in the cost of goods sold." ] }, { "name": "Steve Forbes", "speech": [ "And any comment as we look out to 2020 relative to the three-year plan you laid out during the Analyst Day for D&A?" ] }, { "name": "Carol Tom", "speech": [ "Just keep it up at about that rate." ] }, { "name": "Steve Forbes", "speech": [ "Thank you very much." ] }, { "name": "Carol Tom", "speech": [ "Yeah." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zachary Fadem", "speech": [ "Hey, good morning. You talked about some of the dynamics around the transition to the spring selling season. With the later spring last year, is there anything that gives you confidence this year, from either a weather to-date or product perspective? And just given the calendar shift, you gave some helpful color, but curious whether you anticipate the Q1 comp to be above or below the full-year comp growth, just given the full shift." ] }, { "name": "Craig Menear", "speech": [ "I mean, I'd start with what Carol said earlier and that is we do use a multiyear average model in terms of planning. And when you look at that model, it suggests that we'll actually see spring break in Q1." ] }, { "name": "Carol Tom", "speech": [ "We don't provide quarterly guidance, as you know. So, I'd like to go back to the halves. It's the easiest way to think about our business. I would expect the first half comp to be lower than the full-year comp." ] }, { "name": "Zachary Fadem", "speech": [ "Okay. Fair enough. And could you comment on how some of the external factors in '19, like lower gas prices and mortgage rates for the consumer, are incorporated in the '19 outlook? And then, second, what are you assuming around the tariff environment?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. We have, for years, tried to correlate gas prices to our business. We've never been able to draw a correlation on that. And so there's nothing built in for that whatsoever. And then we've assumed nothing beyond what is in place today on tariffs. We don't try to plan for something that hasn't happened." ] }, { "name": "Ted Decker", "speech": [ "As we said with tariffs, that's been manageable. Good news, obviously, Sunday and it looks like negotiations are continuing. But all the tariffs that have been put in place to date, we have managed through that without any issue." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Our final question today will come from Seth Sigman with Credit Suisse. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Thanks. Hey, guys, thanks for taking the question. So, regarding the weather impact and the impact on exterior projects, you gave us the 85 basis point impact. I'm curious. During these types of periods, do you actually see an offsetting benefit on indoor projects? And then just narrowing in on the exterior projects, to what extent are you already starting to see those come back or expect to see those come back in that first half outlook? Thank you." ] }, { "name": "Craig Menear", "speech": [ "Yeah. I mean, generally, as Ted mentioned, we felt very positive about our paint business. And so customers have a tendency to focus inside when they can't do work outside. And that is something that happens in the business overall. So, we felt good about the interior side of the business." ] }, { "name": "Ted Decker", "speech": [ "Yeah. I would say every cycle we have had of bad weather -- Craig mentioned the huge swings in a market like Los Angeles -- we've seen that consistently across all our markets. Last spring, for example, we were delayed and as soon as the weather broke, our business just exploded. And we see that across markets now, weekend to weekend. So, full expectation that, when spring comes, we're ready for it. We've got great, innovative products. We're in stock and ready to go for our customers." ] }, { "name": "Seth Sigman", "speech": [ "Got you. Okay. And then just one follow-up on the pricing environment. You talked a lot about commodity prices. Can you just talk a little bit about price changes that you're seeing in non-commodity categories and if you're embedding anything in the guidance? Thanks." ] }, { "name": "Ted Decker", "speech": [ "There's nothing in the guidance, for sure. Across the board, not just for tariffs, but we've seen through '18 an increase cost expectation from our suppliers, just whether it's wages or transportation, supply chain, fuel, things that they experience, but we've digested all of that and run that across a portfolio basis and we don't see any increased pressure going into '19. If anything, as you mentioned, things like fuel, transportation capacity, and hopefully the tariff outlook, all those pressures should be fading a bit." ] }, { "name": "Isabel Janci", "speech": [ "So, thank you for joining us today. We look forward to speaking with you on our first quarter earnings call in May." ] }, { "name": "Operator", "speech": [ "This will conclude today's call. We thank you for your participation." ] }, { "name": "Seth Sigman", "speech": [ "More HD analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
HD	2023-02-21	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, President, and Chief Executive Officer", "name": "Ted Decker", "position": "Executive" }, { "description": " -- Executive Vice President, U.S. Stores and International Operations", "name": "Ann-Marie Campbell", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Jeff Kinnaird", "position": "Executive" }, { "description": "Chief Financial Officer & Executive Vice President", "name": "Richard McPhail", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings, and welcome to The Home Depot fourth quarter 2022 earnings conference call. A brief question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Isabel Janci.", "Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Welcome to Home Depot's fourth quarter and fiscal year 2022 earnings call. Joining us on our call today are Ted Decker, chair, president, and CEO; Jeff Kinnaird, executive vice president of merchandising; Ann-Marie Campbell, executive vice president of U.S. stores and international operations; and Richard McPhail, executive vice president and chief financial officer.", "Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our investor relations department at 770-384-2387.", "Before I turn the call over to Ted, let me remind you that today's press release and the presentations made by our executives include forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures.", "Reconciliation of these measures is provided on our website. Now, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Isabel, and good morning, everyone. Fiscal 2022 was another record year for our business as we achieved $157.4 billion in sales. We added over $6 billion in sales and increased diluted earnings per share 7.5% versus last year to $16.69. Over a three-year period, we have grown sales by over $47 billion and delivered diluted earnings-per-share growth of over 60%, while investing in the long-term health of our business.", "Throughout fiscal 2022, we continue to face reduced friction for our customers to improve the shopping experience. As Anne will discuss, we invested in an improved customer and associate experience in our stores by implementing a new store leadership structure. We also drove productivity within the four walls of our store through our Get Stores Right, or GSR space optimization initiative, and we've implemented new tools and technology in stores to reduce complexity for associates and improve customer service. We're also pleased with the traction we are seeing in our interconnected business.", "We've seen increased app engagement, downloads, conversion, as we've rolled out several enhancements, including an improved online experience for our pro loyalty program, seamless connectivity for our military program, and the launch of our new store mode feature, which makes store navigation and product interaction easier. We are very pleased with the continued progress on our supply chain buildout as we reached an important milestone earlier this year. All our appliance delivery volume is now managed through our market delivery operations, significantly improving the customer experience. In the near term, we continue to navigate a unique environment.", "Throughout most of fiscal 2022, we observed a resilient customer, who is less price-sensitive than we would have expected in the face of persistent inflation. In the third quarter, we noted some deceleration in certain products and categories, which was more pronounced in the fourth quarter. This, along with the negative impact from lumber deflation, led to fourth quarter comps that were slightly softer than anticipated. We are closely monitoring our elasticities and trends across the business and believe we have the tools team and experience to manage in any environment.", "This team has been effectively navigating the unprecedented growth in the last three years, and I have full confidence in their ability to execute as we go forward. The investments in our associates, stores, digital platforms, supply chain, technology and other strategic initiatives have strengthened our business and enabled us to grow share and deliver exceptional shareholder value over the long term. The most important investment we can make is in our people, which is why we are announcing that we are increasing annualized compensation by approximately $1 billion for our frontline hourly associates. We believe this investment will position us favorably in the market, allowing us not only to attract the most qualified talent, but also retain the exceptional associate base that is already in place.", "Today, our board approved a 10% increase in our quarterly dividend to $2.09 per share which equates to an annual dividend of $8.36 per share. Turning to 2023. We are targeting approximately flat comp sales and a mid single-digit percent decline in diluted earnings per share compared to last year. Richard will take you through the details in a moment.", "While we expect this to be a year of moderation in demand for home improvement, we believe that the long-term underpinnings of our market remains strong, and we are well positioned to leverage our distinct competitive advantages to capitalize on compelling growth opportunities in our space. I could not be more pleased with the resilience and strength that our associates have continued to demonstrate, and I want to thank them and our supplier partners for their hard work and dedication to serving our customers and communities. Now, I'm going to turn it over to Ann-Marie Campbell, executive vice president of U.S. stores and international operations, to share a little more on how we are taking care of our associates and continuing to enhance the customer experience." ] }, { "name": "Ann-Marie Campbell", "speech": [ "Thanks, Ted, and good morning, everyone. I'm very excited to have the opportunity to spend a few minutes talking about the best team in retail and the many ways we are investing in the associate experience at The Home Depot. We know that our associates are a key differentiator and they are essential in helping us sustain the customer experience we strive for. In order to provide the best customer experience in home improvement, we must focus on cultivating the best associate experience in retail.", "So, what does this mean to us? This means not only investing in competitive wages and benefits, but also providing tools, training, and development opportunities that make working at the Home Depot an enjoyable and rewarding experience. As Ted mentioned, we are making a significant investment of approximately $1 billion in compensation for frontline hourly associates. This is a meaningful investment that we believe will position us favorably in the marketplace. But this is just one component of the associate investment story.", "We know that the key to an engaged and committed workforce is investing in the person, taking an interest in them and in their development. To that end, we began the year with a new store leadership structure, the first time we have changed the structure since our company was founded. The driving forces of these changes were customer service and associate development. We created new management positions focused entirely on the customer service experience, increasing the number of managers on the floor at any given time.", "This frees up time for other store leaders to devote to associate training and development. The net result of all this is both an improved customer and associate experience, while also creating new career paths for our associates. Another important element of a best-in-class associate experience rests on simplification. How can we simplify processes and systems in our stores to enable associates to deliver a better customer experience? And how can we simplify and streamline paths, so that an associate can spend more time serving our customers? One example we have talked about before is the work we've done to simplify order management in our stores with the order up initiative.", "Historically, our associates have to navigate dozens of systems. But with Order Up, we have been able to streamline multiple systems into one that is simpler and more intuitive. We took simplification even further this year with the introduction of the new HD phone and associated applications such as Sidekick. The rollout of our HD phone was a direct result of associate feedback on the limitations of our first-generation in all devices known as first phones.", "For the first time ever, every associate on the floor will have an HD phone in their hand with enhanced communication features, tools, and training capabilities. This increased accessibility to real-time support is significant in helping our associates better serve our customers. In addition to enhancing the customer service experience, the home -- the new HD phone provides real-time access to tools and applications, such as Sidekick, that helps associates prioritize the highest value tasks more effectively. Powered by machine learning, Sidekick directs associates to key bays where on-shelf availability is low or out exist.", "The HD phone empowers our associates to provide a best-in-class customer experience, increase operational efficiency, and generally makes an associate job much easier. These are just a few examples of the many ways we're investing to enhance and improve the associate experience at The Home Depot. Our associates are trusted advisors for our customers and are the heartbeat of our company, and I want to thank them for all they do to take care of our customers. We will continue to invest in them with a focus on listening to their needs, maintaining competitive wages and benefits, and continuing to enhance our tools, training, and development opportunities.", "With that, let me turn the call over to Jeff." ] }, { "name": "Jeff Kinnaird", "speech": [ "Thank you, Ann, and good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their ongoing commitment to serving our customers and communities. During the fourth quarter, our comp average ticket increased 5.8%, and comp transactions decreased 6%. The growth in our comp average ticket was driven primarily by inflation across our product categories, as well as demand for new and innovative products.", "Inflation from core commodity categories positively impacted our average ticket growth by approximately 15 basis points during the fourth quarter. On lumber specifically, during the fourth quarter, we saw a significant decline in lumber prices relative to a year ago. On average, lumber prices were down over 50% year over year. Given this dynamic, comp sales were negatively impacted by approximately 70 basis points in the fourth quarter.", "Turning to our department comp performance for the fourth quarter, seven of our 14 merchandising departments posted positive comps. Building materials, plumbing, millwork, hardware, tools, outdoor garden, and paint had comps above the company average. Big ticket comp transactions, or those over $1,000, were up 3.8% compared to the fourth quarter of last year. While we saw big ticket strength across pro-heavy categories, like portable power, tight fitting, and gypsum, we did experience softness in other categories like laundry, soft flooring, and roofing.", "During the fourth quarter, pro sales growth outpaced DIY. Pro backlog still remain elevated compared to historical averages, and we saw positive comp performance in our build materials, plumbing, and millwork departments, as well as in certain bath-related categories. Turning to total company online sales. We are very pleased, with the performance of our digital assets.", "Sales leveraging our digital platforms increased over 4% compared to the fourth quarter of last year. This was driven by our continued investments, which are resonating with our customers. For those customers, that chose to transact with us online during the fourth quarter, approximately 45% of our online orders were fulfilled through our stores, a testament to the power of our interconnected retail strategy. During the fourth quarter, we held our decorative holiday, gift center, and Black Friday events.", "2022 was a record sales year for these events. We are the product authority in home improvement. And together with our supplier partners, we continue to offer the best product at the best value for our customers every day. A great example of this, is our recent partnership with Ecolab, a global leader in water, hygiene, and infection prevention solutions and services.", "The Ecolab scientific clean product line offers the cleaning solutions for commercial, industrial and residential use that Ecolab is known for to both our pro and DIY customers, giving them access to innovative cleaning technology. And this partnership is exclusive to The Home Depot. It marks the first of its kind in Ecolab's 100-year history. We're looking forward to the year ahead particularly, with the spring selling season, right around the corner.", "We have a great lineup of products from live goods to outdoor power equipment. We continue to see an industrywide shift from gas-powered to battery-powered tools. And as we've been discussing for some time, we have been leaning into this trend, offering a broad assortment of outdoor power equipment with cordless technology. We have the brands that matter across tools and outdoor power including RYOBI, Milwaukee, DEWALT, and Makita.", "In our spring gift center event, we are expanding our assortment to include cordless innovation in mowers, trimmers, blowers, and chainsaws. As an example, our Makita XGT platform will have over 125 professional-grade cordless tools. I'm particularly excited about our new 40-volt XGT mower that delivers gas-powered performance with high vacuum lift for premium cut quality. The XGT mower can cut over an acre in less than 60 minutes on two 40-volt XGT batteries.", "These Makita tools are exclusive to The Home Depot in the big-box retail channel. One of our key focuses in the spring is to provide great value and innovation for our customers within our live goods offerings. We continually work to strengthen our relationship with key vendors throughout the industry providing the best value, innovation, and guarded performance for our customers. We have expanded our offerings in national, regional, and proprietary brands, such as Vigoro, Rio, Southern Living, and Knock Out Rose, just to name a few.", "Our teams continue to look for better garden performance varieties that provide solutions for our customers, and we are excited about the upcoming spring season. With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Jeff, and good morning, everyone. In the fourth quarter, total sales were $35.8 billion, an increase of approximately $100 million, or 0.3% from last year. During the fourth quarter, our total company comps were essentially flat at negative 0.3% for the quarter. As Jeff mentioned, lumber prices in the quarter negatively impacted comp sales by approximately 70 basis points.", "We had comps of negative 1.3% in November, positive 0.8% in December, and negative 0.1% in January. Comps in the U.S. were negative 0.3% for the quarter, with negative comps of 0.4% and 1.4% in November, positive 0.7% in December, and negative 0.1% in January. For the year, our sales totaled a record $157.4 billion with sales growth of $6.2 billion, or 4.1% versus fiscal 2021.", "For the year, total company comp sales increased 3.1%, and U.S. comp sales increased 2.9%. In the fourth quarter, our gross margin was approximately 33.3%, an increase of seven basis points from last year. For the year, our gross margin was approximately 33.5%, a decrease of 10 basis points from last year.", "Gross margin was in line with our expectations, reflecting planned investments in our supply chain capabilities. Throughout the year, we continued to successfully offset significant transportation and product cost pressures, as well as increased pressure from shrink during the back half of the year and we did this while maintaining our position as the customer's advocate for value. During the fourth quarter, operating expenses were approximately 20% of sales, representing an increase of 32 basis points from last year. Our operating expense deleverage is driven largely by charges unique to the quarter related to litigation in California storm-related expenses and an unfortunate fire in one of our stores.", "For the year, operating expenses were approximately 18.3% of sales, representing a decrease of 13 basis points from fiscal 2021. Our operating margin for the fourth quarter was approximately 13.3% and for the year was approximately 15.3%. Interest and other expense for the fourth quarter increased by $85 million to $408 million due primarily to higher long-term debt levels than one year ago. In the fourth quarter, our effective tax rate was 22.6% and for fiscal 2022 was 23.9%.", "Our diluted earnings per share for the fourth quarter were $3.30, an increase of 2.8% compared to the fourth quarter of 2021. Diluted earnings per share for fiscal 2022 were $16.69, an increase of 7.5% compared to fiscal 2021. During the year, we opened six new stores and lost a store in California due to a fire, bringing our store count to 2,322 at the end of fiscal 2022. Retail selling square footage was approximately 241 million square feet at the end of fiscal 2022.", "Total sales per retail square foot were approximately $627 in fiscal 2022, the highest annual figure in our company's history. At the end of the quarter, merchandise inventories were $24.9 billion, an increase of $2.8 billion versus last year. And inventory turns were 4.2 times, down from 5.2 times from the same period last year. Moving to capital allocation.", "During the fourth quarter, we invested approximately $900 million back into our business in the form of capital expenditures. This brings total capital expenditures for fiscal 2022 to $3.1 billion. During the year, we paid approximately $7.8 billion of dividends to our shareholders. We look to grow our dividend every year as we grow earnings.", "And as Ted mentioned today, we announced our board of directors increased our quarterly dividend by 10% to $2.09 per share, which equates to an annual dividend of $8.36 per share. And finally, during fiscal 2022, we returned approximately $6.5 billion to our shareholders in the form of share repurchases including $1.5 billion in the fourth quarter. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was 44.6% compared to 44.7% at the end of the fourth quarter of fiscal 2021. Now, I'll comment on our outlook for 2023.", "As we think about how 2023 might unfold, we think it's helpful to look back on our performance since 2019. From 2019 through 2022, we grew sales by $47.2 billion, a compound annual rate of 12.6%. During the first five quarters of this period, from the first quarter of 2020 through the first quarter of 2021, our sales were driven by significant ticket and transaction growth. This growth reflects factors unique to home improvement, as homeowners spent more time in their homes and took on more projects as they saw their homes significantly increase in value over that period.", "The home improvement market also captured a greater share of the consumer's wallet, as spending on goods outpaced spending on services during the period. Beginning in the second quarter of 2021 and continuing through the fourth quarter of 2022, we reported strong sales and earnings growth driven by ticket while transactions steadily normalized back toward 2019 levels as the broader consumer economy shifted from goods and back into services. During this time, we continued to report positive sales growth in every quarter up to present. As we set targets for 2023, the context of the past three years led us to consider three factors that will likely influence our performance this year.", "First, the starting point for our target setting this year is our assumption regarding consumer spending. We've assumed like many economists that we will see flat real economic growth and consumer spending in 2023. Second, over the last seven quarters, we have seen our transactions gradually normalize as consumer spending has shifted from goods to services. We believe that if this shift continues at its current pace, the home improvement market would be down low single digits.", "And third, as an offset to this pressure, we plan to continue to capture market share. Our competitive advantages, the investments we have made over many years, and the unique advantage that our orange-blooded associates give us over our competition position us to take share in any environment. Taking these factors into account, we are targeting approximately flat sales and comp sales growth for 2023. Further, our operating margin target of 14.5% reflects approximately 60 basis points of impact from the compensation investment we announced today.", "Our effective tax rate is targeted at approximately 24.5%. Our diluted earnings per share, is targeted to decline by a mid single-digit percentage. Outside of this target setting, if lumber prices remain at current levels for the remainder of our fiscal year that would equate to approximately 100 basis points of pressure to comp sales and an insignificant impact to earnings. At today's current price, this would imply more pressure in the first half than in the rest of the year.", "We plan to continue investing in our business with capex of approximately 2% of sales on an annual basis. After investing in our business and paying our dividend, it's our intent to return excess cash to shareholders in the form of share repurchases. We believe that we have positioned ourselves to meet the needs of our customers in any environment. The investments we've made in our business have enabled agility in our operating model.", "As we look forward, we will continue to invest to strengthen our position with customers, leverage our scale and low-cost position to drive growth faster than the market and deliver shareholder value. Thank you for your participation in today's call. And, Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. Ted, in this environment, we're all just kind of guessing, but we assume that your guesses are a lot more educated than any of the rest of us. And in that case, what do you see as the downside risk for the home improvement market in turn, Home Depot this year, both in terms of the depth of a potential decline and the duration of a downturn? And in that case, how would Home Depot's earnings look in that scenario?" ] }, { "name": "Ted Decker", "speech": [ "Well, good morning, Michael. Thanks for the question. We'll certainly address that. But before we go into downside, I'd like to set the tone on what we see that's favorable in the business trends.", "And we feel very good about our business. As we've just referenced, we've grown the business $47 billion over the last three years and grown earnings 60% during that time. Our associates did an amazing job focusing on the customer in this challenging environment. And there's really no way we would have captured that much share, had we not been making the investments over the past few years.", "We also still see a healthy customer. I mean, we have good jobs, job growth, growing wages, still strong balance sheets. And most of our customers tend to own their home, which is seen as significant increase in value. But as we've said, we do see a unique environment with many cross currents right now.", "Obviously, there's heightened inflation and rising interest rates, a tight labor market and moderating equity and housing markets. So, given all that, we do expect moderation in home improvement demand. Pro backlogs are still healthy, Michael, although they are off their peak from last year. And customers are still spending time at home.", "Homes are aging and worth about 40% more than they were before the start of the pandemic. But people are also starting to shift spend more toward services. And as we've said, we see some more price sensitivity. So, given all that, we've set the stage for a moderating year in 2023, and Richard will take you through some of the downside cases that you alluded to." ] }, { "name": "Richard McPhail", "speech": [ "So, yeah. So, Michael, you know, just to recap quickly, the way that we set our target and our guidance for the year was to first start with the assumption of flat consumer spending. And then, with respect to the goods sector of the economy, as I said over the last seven quarters, we've seen that shift across the consumer economy from goods to services. So, we would anticipate this would put slight pressure on our market.", "And then, we look to overcome that by taking share in the manner that we've done consistently over the past several years. So, we're targeting flat. If you -- there are so many factors that influence our market right now, as Ted alluded to. But if you were to take a hypothetical situation, let's just think about that share shift that we call out.", "So, we look at the share that we currently capture as a share of consumption, PCE. And we've tracked that through the COVID period and over the last few years. As we said in our guidance, that share shift continued at the rates at which we have seen it behave. Currently, we would expect the market to face low single-digit negative pressure.", "But if you were to take, perhaps, a more extreme case and say, if that share of PCE that our market holds were to shift all the way back to 2019 levels by the end of the year, that would imply pressure of, call it, mid single-digit percentages. And so, that would sort of be one way to get your mind around a, you know, hypothetical case, where share shift happens more rapidly than it has been." ] }, { "name": "Michael Lasser", "speech": [ "So, in an environment, where the market down mid single digits presumably Home Depot is going to do better than that. It will take some market share. So, can you frame out what you think the decremental margins would be in a down three or four type scenario? And as part of that, where do you think you would see this first? You're already starting to experience some challenges in areas like soft flooring and others that you outlined. Is that a precursor to weakness that you might experience in other categories?" ] }, { "name": "Richard McPhail", "speech": [ "So, just to keep it simple because, you know, share shift is not a perfect science. In a hypothetical case, and again, we're not guiding this way. This is not a downside case. But in a hypothetical situation, that share shift, if our comps were to be mid single-digit negative, we would see operating margin around 14% as kind of a corollary to that hypothetical situation." ] }, { "name": "Ted Decker", "speech": [ "And, Michael, Jeff can give some further detail. But, you know, the price sensitivity is -- while it's a bit broader in Q4 than we saw in Q3, it's still primarily those larger, you know, single ticket more discretionary items that we've referenced before, appliances, you know, grills, patio, but still being a project-oriented business. And with the pro backlog, again, albeit down, still strong. We're still seeing, you know, strong project business.", "But there is a bit more overall sensitivity as we saw more one-for-one offset with ticket and transaction in Q4." ] }, { "name": "Jeff Kinnaird", "speech": [ "Yeah. Thank you, Ted. So, yeah, in general to your comments, you know, more broad than what we saw in the third quarter, but still very good project demand. If you look at the seven departments that outperformed, the plumbing business, building materials, millwork, hardware tools, and paint, above our company average and just reflected the strength of the project business, to your point, Michael, we're watching categories like flooring very closely.", "We're working assortments. We're working different opportunities in the market to look at what's happening in categories like flooring. But some broader-based sensitivity, but still good strength in the overall business." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much, and good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. So, can you please clarify your expectations for unit elasticity, if we were to start to see same, you know, inflation pressures ease? And then, secondly, any common denominators in categories or geographies where you're starting to see some of the incremental softness? Thanks." ] }, { "name": "Ted Decker", "speech": [ "Sure, Scot. I think, you know, the last two years, we've had the same guidance that we're having this year, and that is that whatever inflation is represented in our average unit retail in ticket would be offset by transactions. So, we started the year, you know, thinking about a balance of ticket and transaction, and that higher ticket driven by inflation would be offset with transactions. The outperformance of the prior two years was that we didn't see that much sensitivity.", "The consumer, our customer was much more resilient sort of purchase through that elasticity curve, if you will. What we are seeing now is some more sensitivity, and we had almost an exact one-for-one offset in Q4. That's what we're expecting for 2023, that there is still inflation. I mean, we are still in an inflationary environment, as we saw from CPI and PPI results last week.", "Although, it is abating and it's abating more, I would say, in our industry, our costs on the table are much lower than they had been. Our wraparounds and price moves going into 2023 will be much lower than they had been in the prior two years. And so, while we're still expecting an offset in transactions, because the ticket won't be as high, the negative transactions won't be as low, but still net to that flat guidance for 2023." ] }, { "name": "Scot Ciccarelli", "speech": [ "OK. Thank you. And then, any common denominator in terms of category or geographies where you're seeing some of the incremental softness? Is it just big ticket, or is there --" ] }, { "name": "Ted Decker", "speech": [ "Yeah, big ticket would be the ones, you know, that I called out before that have continued with softness. In the geographies, while we had a little more variability of our comp range, there's no particular geography that you call out other than, you know, weather-impacted ones that would show anything off the mean for us." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thanks a lot." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Hi. Good morning everyone. Maybe related to the last question, we've had -- home prices have decelerated for about six to eight months now, and we know existing home sales are in deep negative territory. If you align your business against those trends and in markets where they're more pronounced, is there a decoupling? In other words, the business is stable despite prices have fallen and existing home sales being, you know, down 20%, 30%." ] }, { "name": "Richard McPhail", "speech": [ "Thanks, Simeon. On home prices, we know, over the long-term, that our business does correlate to price appreciation. Obviously, we've had unprecedented growth and appreciation since 2019. Home prices peaked in June of 2022.", "In fact, at that point, they were 45% higher than they were at the end of 2019. They have regressed by about 3%, since that point. So, we've seen some modest correction. But I can tell you, we have not seen an impact on a market-by-market basis since that peak.", "There's no relationship with comp sales and the home price appreciation or correction that we've seen. On housing turnover, there's just that interesting dynamic of whether -- what is actually happening in housing turnover. They just aren't the willing sellers out there to the degree that they have been in, you know, past eras. We're in such a healthy -- our customer -- our homeowner customers in such a healthy position that, you know, you just think about their motive for selling.", "As you know, 90% -- over 90% of U.S. homeowners, either own their homes outright or have fixed rate mortgages under 5%. And so, that incentive to sell and move to a higher rate mortgage just isn't there. And in fact, the incentive is really there to improve in place.", "So, it's hard to say what the housing economy -- how the housing economy might impact us. But no, to answer your first question, to date, since 2022, we haven't seen a relationship." ] }, { "name": "Simeon Gutman", "speech": [ "And a follow-up to a point that was made earlier that if the share of PCE reverts back to the 2019 level, do you take a view on this? Or is there any confidence that it doesn't? And it's a view really on digestion. We've seen a couple of categories in real terms actually overcorrect the 2019. Only two right now, but not home improvement, obviously. But how confident are you that we don't need to go back that far, or that the digestion or so is done and we can hang out at the current share that we are?" ] }, { "name": "Richard McPhail", "speech": [ "You know, I think the only thing I look at really is the trajectory that we've observed. I think that's the best information we can use. We're not making an assumption about whether in your terms there's full digestion or not." ] }, { "name": "Simeon Gutman", "speech": [ "OK. Fair enough. Thanks. Good luck." ] }, { "name": "Ted Decker", "speech": [ "And, Simeon, I would say this -- as we said, this is a unique period and hard to gauge on the shortest horizon. But we are just so incredibly bullish on the longer horizon for this industry. Just all the dynamics that we know about starting with the fundamental shortage of housing, I mean we're still whether it's one million, two million, three million units short in with household formation and population growth and aging housing stock, all the things that we talk about. I mean that is all very much in place.", "And as the market works its way through PCE reversion or not or level of that and inflation mortgage rates, that will all settle. And what you're left with is still a market that is underserved in housing units built. And over half the homes are over 40 years old. And as Richard said, they remain in place with owning the home in low mortgage rates.", "People are going to want to make more significant improvements on those homes. So, we remain and just couldn't be more bullish on the longer-term view of this industry." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning. I had a couple of questions that are both maybe more philosophical question. But first off, and I guess, Ted, just some of the comments made, you know, here about increased price sensitivity, I think, on the part of your consumers, you know, maybe that turned a little more severe than we saw in the third quarter. One of the big -- I think I probably followed Home Depot for a long time, one of the big, you know [Technical Difficulty] the data --" ] }, { "name": "Isabel Janci", "speech": [ "Brian, we can't -- Brian, you're breaking up. Can you repeat that?" ] }, { "name": "Brian Nagel", "speech": [ "Oh, I'm sorry. I will move around here. So, the question, I'll make it short. The question I'm having is as you're looking at this, you know, the consumer behavior, you know, we're all seeking or searching right now for those signs of weakening consumer, given a tempered backdrop.", "But do you believe that we're still kind of in the one-off -- what you're seeing is more one-off in nature? Or is this really the beginning of a weaker trend coming that could persist over the next few quarters?" ] }, { "name": "Jeff Kinnaird", "speech": [ "Brian, it's Jeff. You know, as we talked about price sensitivity earlier, we are seeing some additional sensitivity or saw some additional sensitivity in Q4 versus Q3. But let me give you a real-time example of how we're looking at the business, and I'll go to the cleaning business as an example. As I spoke about in my prepared remarks, we launched in this quarter Ecolab, which is a premium cleaning brand in the market, which we're seeing exceptional performance.", "It is a trade-up category for many consumers, many pros, and we're just really, really excited about the partnership and the long-term opportunity in that category. At the same time, we're expanding our HDX cleaning lineup, and that's just a great everyday value brand for our customers. And we're seeing a great pickup in that brand as well. So, our merchants take the time by category to engineer what results they want to see, and cleaning is a great example there.", "At the same time, we're watching categories very closely, like appliances, like patio furniture, like grill that we spoke about in Q3 and earlier today, to ensure that we are positioned right for the current environment." ] }, { "name": "Brian Nagel", "speech": [ "Got it. I appreciate the time. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chris Horvers with JPMorgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, everybody. Can you talk about what you saw from a rate of change in DIY versus pro in 4Q relative to 3Q? Are you seeing one side change faster than the other? And how does that inform how you're thinking about the business in 2023?" ] }, { "name": "Ted Decker", "speech": [ "I don't know if we saw a rate of change, Chris. The highlight remains the high spend pro. I mean, that's still, you know, the strongest piece of the business. But I wouldn't say there was a rate of change much beyond that." ] }, { "name": "Chris Horvers", "speech": [ "Got it. And then, I guess can you share your -- the puts and takes on the cadence of '23 from a top-line perspective? You have DIY versus pro. You've got tough lumber laps in the near term, but you also have the easier spring lap. And so, how are you thinking about the cadence of the year? If you sort of had a did a zero in 4Q and you ran seasonal, you can get to a lot of different outcomes.", "So, how are you thinking about the cadence? And just to clarify, is the 100 basis points of lumber headwind in the top-line guide?" ] }, { "name": "Richard McPhail", "speech": [ "Right. So, Chris, our guidance assumes that we'll comp slightly lower in the first half than the second half. The lumber pressure we called out is sort of outside of guidance. There's so much volatility in that that we would not want to put that in guidance.", "There is 100 basis points of pressure to the year. If the number remains at current prices, that pressure exists predominantly in the first half." ] }, { "name": "Jeff Kinnaird", "speech": [ "And, Chris, as Richard mentioned, it's been a very turbulent couple of years in the lumber market. To give you an example of what we faced in the fourth quarter on the framing side, lumber was $420 per thousand on average compared to $886 on average in 2021. To put that in retail dollar sense for everyone, a 2x4 stud which is one of our top unit movers in the business, retail on average for $3.40 in the fourth quarter of this year. Last year, it was over $5.", "Now, we did make some ground back on units. So, you could say that, you know, when you see a lumber market depressed or normalized, you see good unit productivity and you see good overall project business. As you look forward into the front half, that same 2x4 stud is over $10. It's now $3.50.", "So, we'll see good unit productivity and certainly an opportunity to drive more project-related business." ] }, { "name": "Richard McPhail", "speech": [ "And, Chris, another reason we leave that sort of lumber hypothetical case outside of guidance, if that pressure does exist and come through we would not see any material impact to earnings." ] }, { "name": "Chris Horvers", "speech": [ "Right. So, you're not -- there could be a price headwind, but there could be some offsetting positive elasticity on that side. And so, net-net that, plus the fact that that doesn't hit bottom line, it's outside the guide?" ] }, { "name": "Richard McPhail", "speech": [ "That's correct. You got it." ] }, { "name": "Chris Horvers", "speech": [ "Thanks so much. Have a great spring." ] }, { "name": "Richard McPhail", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. I wanted to start, you know, really trying to expand on the $1 billion investment that was announced. So, curious, Ted or Richard or the team, can you comment on how the investment impacts planned compensation mix for the frontline associate in 2023 on average, inclusive of how we should think about the resetting of the success sharing program?" ] }, { "name": "Ted Decker", "speech": [ "Sure. Yes, Steven. And Ann will take you through, you know, some of the detail on the rates. But just to talk about, you know, this investment, we feel just great about doing this for our associates.", "Customer service at The Home Depot starts with our associates, and we believe this investment is consistent with our values, and it's going to position us favorably in the market. We've been operating successfully in a pressured labor market. We all know labor has been tighter and rates have been higher. But, you know, just last year, we were able to hire 200,000 associates.", "But we believe this move is going to protect our customer experience for the near medium and long term. We'll be able to track the most qualified candidates and retain the exceptional associate base that we already have. So, we, not only increased our starting wages again, Ann will go into some detail, but we increased wages for every single frontline associate. And there's a term in retail you get compression when you raise the starting rates with tenured associates.", "We addressed compression in a meaningful way in this $1 billion investment. So, our tenured associates saw real wage increases with this move. And we hope to improve retention through this. That's why we call it an investment, and it's going to improve the customer experience through a more effective associate who's just in the building longer, understands, you know, our procedures, and is much more effective engaging with the customer and selling.", "And, you know, we harken back to our values wheel of, you know, investing in our associates and what our founders said that if we take care of our associates, they take care of the customer, and everything takes care of itself. And that's what this investment is all about. But, Ann, you can give some more detail, please." ] }, { "name": "Ann-Marie Campbell", "speech": [ "Yeah. Thank you, Ted. First of all the investment is incremental. So, you asked about success sharing, and that is still a part of our total compensation package.", "One of the things I spoke about around how we think about investing in our associates. Wage is one component of it. We think about it not only with wage but benefits, but also the environment we create to promote or associate them within. And I think the piece that I will say, we've spoken about this before, that, you know, close to 90% of our leaders started on the floor of the store.", "And why is that important? This $1 billion investment puts us favorably in the marketplace so we can recruit, retain, and attract the best leaders because they are the future leaders for the company. So, this is an incremental investment. Every single hourly associate will receive an increase. And to Ted's point, you know, our more tenured associates, who are even key, when we think about going into the spring season, also got an incremental investment, a pep in their step to continue to take market share in 2023." ] }, { "name": "Ted Decker", "speech": [ "And, Steven, while we don't, you know, disclose average wages, and we've always and will continue to be competitive on a market-by-market level, and we've been competitive, it's why we're able to hire the 200,000 people last year, but after this change, our starting rate in any one market -- you know, there'll be no market under $15 for a starting rate. And starting rates go much higher than that, depending on the market. And then, the average wage, again, particularly with the investment in every associate, including, you know, tenured with addressing compression, we have an average wage that is well, well above the $15." ] }, { "name": "Steven Forbes", "speech": [ "I appreciate the color. And then, maybe just a quick follow-up for Richard. I think we're sort of targeting recapturing a 60% accounts payable to inventory ratio. But maybe just clarify if that's still the goal and when we should expect to achieve that this year." ] }, { "name": "Richard McPhail", "speech": [ "Well, you know, we're still -- while we know that global supply chains are improving, at least relative to where we were last year at this time, we're still pulling forward inventory. We still see extended lead times. And we think that 2023 is going to be a year of continued improvement in supply chains. So, we are encouraged by the inventory movements in our business.", "The year-over-year inventory increase was the smallest quarterly increase of the entire year. And so, we feel good about our inventory productivity. And, you know, again, we've been managing in kind of exceptional circumstances. But yes, I think over the long run, you will see us heading back to convention with respect to working capital." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Ted Decker", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Credit Suisse. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. Good to talk to you. The first question I just want to ask is, looking at the relationship on sales growth versus EBIT growth, and I'm actually talking about this excluding the billion-dollar investment, obviously, EBIT growth on a one-year basis is decently below sales growth.", "So, wondering just how to think about that relationship, including or excluding, but going forward. And then, wondering if you could just talk a little bit about what you're seeing on 1Q to date in terms of comp performance?" ] }, { "name": "Richard McPhail", "speech": [ "Sure. So, it may be more helpful to talk about the construction of operating margin year to year just to kind of tick that out. That gives you a better sense. So, in a flat comp environment, we would expect to see deleverage on a fixed cost base and obviously in an inflationary environment as it exists today.", "That deleverage is somewhere between 30 to 40 basis points. In addition, our wage investment represents about 60 basis points of movement in year-to-year wage. And then, offsetting that are productivity initiatives that we expect will generate between 10 and 20 basis points of recapture of margin. And so, that's how we walk from the 15.3 to the 14.5.", "Over the long run, we always expect to grow operating income faster than sales. We've been managing in a unique environment. And certainly, our guidance implies the wage investment that we've made today. And the second part of your question, I'm sorry I forgot." ] }, { "name": "Karen Short", "speech": [ "Oh, it was just -- could you -- any color you could provide on 1Q performance in terms of comps?" ] }, { "name": "Richard McPhail", "speech": [ "Well, as I shared just a few questions ago, we do anticipate that comps in the first half will be slightly lower than the second half, and our performance to date reflects that guidance." ] }, { "name": "Karen Short", "speech": [ "OK. Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. Richard it sounds like most of the margin pressure in 2023 is expected to land at the operating expense line. And I'm curious if you could talk to the puts and takes to gross margin specifically. And is it fair to assume the inflection we saw in Q4 to slightly positive is a fair year-over-year run rate from here, just given the bulk of your supply chain investments are running their course and then freighted commodities could be a tailwind?" ] }, { "name": "Richard McPhail", "speech": [ "You know, there are a lot of ins and outs. There are a lot of ins and outs in 2022. You know, we basically delivered gross margin precisely where we anticipated to at the beginning of the year. And underlying that was a lot of product costs and transportation costs offset by actions and, within that, continued supply chain investment in our downstream or delivery operations.", "For 2023, we're targeting gross margin that's roughly flat year over year. Again, it will be a year of several ins and outs. Product cost inflation has decreased but does persist above historical levels. Transportation costs should actually be a tailwind.", "But we still have investment in our supply chain. And look we did see some increased pressure from shrink in the back half, right? So, we've got a lot of ins and outs. But roughly speaking, we're targeting essentially flat gross margin for the year." ] }, { "name": "Zach Fadem", "speech": [ "Got it. That's helpful. And then, following up on the billion dollars in wage investment. Can you talk about where this puts you competitively versus your peers? And then, if for whatever reason if your comp appears to be falling short of that flattish expectation range, would you still make the planned investments in 2023? Or could you spread them out over a couple of years?" ] }, { "name": "Richard McPhail", "speech": [ "We're committed to our investment. That's done. With respect to how we manage our P&L, we always operate with a degree of financial flexibility. And so, in any environment, we're going to assess, what that environment means for us and how we should manage the P&L." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Thanks for the time." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question will come from the line of Steven Zaccone with Citi. Please proceed with your question." ] }, { "name": "Steven Zaccone", "speech": [ "Good morning, all. Thanks for fitting me in here. I wanted to circle back to the duration part of Michael's first question. You know, Ted, when you think about home improvement demand seeing a moderation this year, when you take a little bit of, you know, a more medium-term outlook over the next couple of years, just since you've seen strength in the business for the last three, you know, what are you focused on with the health of the homeowner that may be this moderation could last couple of years in nature?" ] }, { "name": "Ted Decker", "speech": [ "Well, you know, as we've said, we're thrilled with the share we captured, the sales we drove. And while we don't love the moderation, you know, you can't fight the tide, if you will, with PCE spend going back to services, people traveling, and whatnot. But the two main things that we're going to stay focused on to take share, you know, one, you know, I say the consumer. The consumer writes the check for all projects, even if the pro is doing the work.", "But, you know, for the consumer, we are laser-focused on delivering the best interconnected, frictionless shopping experience. I mean, retail as we know, is all about interconnection, physical world and the digital world. And we are laser-focused. Matt Carey and his team is focused on taking out all friction in that.", "And as we continue to delight customers with that frictionless experience, we'll look to gain more share. And then, we haven't talked much about the pro in this call, but, you know, we are still 100% focused on building out all the capabilities of that pro ecosystem. It is going to allow us to capture more share of wallet with the pro and move up to larger plan purchases. And extremely pleased with the results we're seeing as we continue to put those capabilities in the marketplace.", "So, that's what we're going to do to keep taking share regardless of the environment or the duration of the environment." ] }, { "name": "Steven Zaccone", "speech": [ "OK. Thanks. And then, the brief follow-up I had was just a question on the promotional environment. You know, it really hasn't been that much of an issue in home improvement the last couple of years.", "Would you expect it to be more of a factor this year, just given an overall moderation in demand?" ] }, { "name": "Jeff Kinnaird", "speech": [ "Steven, it's Jeff. No nothing specific to call out on the promotional environment as we head into the first quarter further into the first quarter. We're excited about the value we're ready -- we're offering our customers. And our spring sets have gone exceptionally well.", "And we're looking forward to the spring season. But no change that we can predict in the promotional environment." ] }, { "name": "Steven Zaccone", "speech": [ "Thanks" ] }, { "name": "Operator", "speech": [ "Thank you. Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and thank you for joining us today. We look forward to speaking with you on our first quarter earnings call in May." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2021-08-17	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Craig Menear", "position": "Executive" }, { "description": "President and Chief Operating Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice president and Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Barclays Investment Bank -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Oppenheimer & Co. Inc. -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": "Wolfe Research -- Analyst", "name": "David Bellinger", "position": "Analyst" }, { "description": "Loop Capital Markets -- Analyst", "name": "Laura Champine", "position": "Analyst" }, { "description": "Cleveland Research -- Analyst", "name": "Eric Bosshard", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to The Home Depot second-quarter 2021 earnings call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "[Audio gap] quarter 2021 earnings call. Joining us on our call today are Craig Menear, chairman and CEO; Ted Decker, president and chief operating officer; and Richard McPhail, executive vice president and chief financial officer. Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors, and as a reminder, please limit yourself to one question with one follow-up.", "If we are unable to get to your question during the call, please call investor relations at 770-384-2387. Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission.", "Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and good morning, everyone. We appreciate you joining us on our call this morning. We were pleased with our performance in the second quarter as we achieved over $40 billion in quarterly sales for the first time in our history. Sales for the second quarter were $41.1 billion, up 8.1% from last year.", "Comp sales were up 4.5% from last year with U.S. comps of a positive 3.4%. Diluted earnings per share were $4.53 in the second quarter, up from $4.02 in the second quarter last year. The strong underlying demand across the business continues.", "During the second quarter, we did observe some changing consumer patterns in the U.S. as the U.S. economy opened up. This has manifested itself in several ways.", "We have seen a shift in pattern of sales within the week as our weekday sales performance has actually strengthened relative to the weekend. We attributed this to consumers returning to travel and other recreational activities. And while the consumers return to pre-pandemic activities, we continue to see them engage in home improvement projects. We also see customers more comfortable taking on larger projects as evidenced by the continued strength with our pro customer, which outpaced the DIY customer for the second quarter in a row.", "We remained agile and flexible, and we're pleased with our ability to respond to strong home improvement demand and comp to comp in the second quarter. We had positive comps every week despite unprecedented compares last year and grew sales by $3.1 billion in the second quarter and more than $12 billion year to date. Over the last six quarters, we have grown the business by more than $34 billion, a level unmatched in our market. From a geographic perspective, 15 of our 19 U.S.", "regions posted positive comps versus last year. On a two-year stack basis, all 19 regions saw strong double-digit comp growth. However, unlike the past four quarters, in the second quarter, we did experience some variability in performance from a geographic perspective. The variability in our regional performance is driven by our northern division, where we saw a more pronounced shift in sales with stronger sales in outdoor seasonal categories during the first quarter.", "Mexico posted double-digit positive comps. And despite significant customer restrictions during the quarter due to COVID-19, Canada posted comps that were essentially flat in local currency. We continue to effectively manage the strong demand for home improvement products despite significant industry disruptions in supply chains. We are leveraging the scale of our supply chain and partnership with our vendors to prioritize key SKUs in high-demand categories.", "And while our in-stocks are not where we want them to be, they have improved from where they were a year ago, and our network continues to flow goods remarkably well, thanks to the investments we have made in our supply chain over a number of years. The team continues to make progress on building out our one Home Depot supply chain vision. We remain largely on track with our plans with the critical mass of buildings scheduled to come online this year and next. We believe that the network we are building is unique to the market.", "It will not only enhance the customer experience from a delivery standpoint, but also expand the breadth and depth of our current opportunity set, drive efficiency end to end and leverage our scale to further extend our low-cost position in home improvement. In the near term, we remain focused on being flexible and agile as we navigate this dynamic environment. But we also continue to leverage the momentum of our strategic investments to further enhance interconnected shopping experience in support of our goals, to drive growth faster than the market in any environment, further strengthen our position as a low-cost provider in home improvement with a relentless focus on productivity and efficiency and deliver exceptional shareholder value. Throughout all the events of the past 18 months, our cultures remain our north star.", "In fact, I recently spent time with a number of new associates that we have hired in the past year and was struck by how engaged and connected these associates were to The Home Depot culture. They were onboarded during a time when our stores and teams were busier than ever. But our associates took the time to get to know these new folks and share what it means to be part of the orange-blooded family. Our ability to invest for the future while also managing the most fluid environment in our company history is a direct result of our associates and their extraordinary efforts.", "I want to close by thanking them for the many ways they continue to live our values by serving our customers, communities and each other. And with that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their commitment to serving our customers and communities. As you heard from Craig, during the second quarter, we continue to see strong performance in our business, particularly as we lap the significant growth from the same period last year. We were able to meet strong customer demand despite ongoing pressures throughout the supply chain.", "Raw material shortages, production constraints and pressures across modes of transportation are creating a difficult supply chain environment. That being said, our performance would not be possible without the cross-functional efforts by our supply chain, merchandising, store and MET teams as we continue to flow record volumes of goods week after week. Over the course of the pandemic, you've heard us talk about a number of initiatives we've implemented, many in concert with our suppliers to improve our in-stock positions and get product to our customers. And our teams continue to use our culture and values to guide our decisions.", "One of our values is entrepreneurial spirit, which is alive and well at The Home Depot. Our supply chain teams recently leveraged our scale and flexibility to arrange for several container vessels for exclusive use, yet another way our teams found a creative solution to better serve our customers in this dynamic environment. While our in-stock levels are still not where we want them to be, we are maintaining the improvements we made over the last few quarters in building depth in key categories as evidenced by inventory growing faster than sales compared to the same period last year. Turning to our comp performance.", "During the second quarter, 10 of our 14 merchandising departments posted positive comps, led by kitchen and bath and lumber. During the second quarter of this year, we saw single-digit negative comps in paint, hardware and indoor and outdoor garden. It is important to note that these were some of our strongest performing departments during the second quarter of last year. On a two-year stack basis, each of our departments posted healthy double-digit comps.", "Our comp average ticket increased 11.3% and comp transactions decreased 6%. The growth in our comp average ticket was driven in part by inflation in certain categories, notably lumber. On a two-year stack basis, both comp average ticket and comp transactions were healthy and positive. This was another historic quarter for lumber price volatility.", "During the first few weeks of the second quarter, prices for both framing and panel lumber reached all-time highs before quickly falling from their peaks. As an example, during the second quarter, framing lumber peaked at approximately $1,500 per thousand board feet before falling over $1,000 to approximately $500. While pricing for both framing and panel has come down from the peaks, the average price during the second quarter was still significantly higher than the same period last year. Inflation from core commodity categories positively impacted our average ticket growth by approximately 420 basis points during the second quarter.", "Big ticket comp transactions or those over $1,000 were up approximately 24% compared to the second quarter of last year. We saw big ticket strength across many pro heavy categories like lumber, vinyl plank flooring, gypsum and pipe and fittings. During the second quarter, pro sales growth outpaced DIY growth for the second quarter in a row. On a two-year stack basis, growth with our pro and DIY customers was consistent and strong.", "We're encouraged by the momentum we are seeing with our pros. Growth with our larger pros continues to outpace that of our smaller pros, and they tell us that their backlogs are long and growing. In fact, the National Association of Home Builders remodeling index hit all-time highs during the second quarter. And during the quarter, we saw many of our customers turn to pros to help them with larger renovation projects.", "This can be seen in the strength of several of our kitchen and bath categories, like in-stock kitchens, tubs and showers and vanities, all of which posted one- and two-year comps above the company average. Sales leveraging our digital platforms were essentially flat during the second quarter as we lap digital sales growth of approximately 100% in the second quarter of last year. On a two-year stack basis, sales from our digital platforms increased approximately 100%. We're thrilled with the customer engagement across our interconnected platforms.", "We know the vast majority of our customers engage with us in an interconnected manner, whether it be through project inspiration and research, transacting, fulfillment or support, our customers blend the physical and digital worlds. And while customers have gotten more comfortable buying online, we've never been more confident in the importance of our physical stores as they remain the center of our customer experience due to the project nature of our business. For those customers that chose to transact with us online during the second quarter, more than 55% of our online orders were fulfilled through our stores, a testament to the power of our interconnected retail strategy. As we look forward to the back half of the year, we know our pros are busy and we are working hard to secure the best products to help our pros get their jobs done.", "Last quarter, we highlighted several exclusive products for our pro customers. This quarter, we're excited to announce a new big-box home improvement exclusive relationship with LP Building Solutions, a top provider of OSB panel boards. In addition, we are pleased with the momentum we are seeing with our pro extra loyalty program. Several quarters ago, we relaunched pro extra, and we've been thrilled with the membership take-up and engagement we are seeing.", "Pro extra offers more frequent touch points with our pros and convenient services like purchase tracking and volume pricing along with other benefits. In addition, all pro extra members are now able to access our B2B pro online experience, offering pros more personalization on homedepot.com. During the third quarter, we are also thrilled to announce the rollout of what we believe is the most innovative paint offering in years through our exclusive relationship with Behr. BEHR DYNASTY is a brand-new four-in-one interior paint that offers DIY-ers, Pro painters and design professionals a unique product exclusively from The Home Depot.", "It is our most stain-repellent, scuff-resistant, fast-growing one-coat coverage paint, all in one can. With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ted, and good morning, everyone. In the second quarter, total sales were $41.1 billion, an increase of $3.1 billion or 8.1% from last year. Foreign exchange rates positively impacted total sales growth by approximately $385 million. During the second quarter, our total company comps were positive 4.5%, with positive comps in all three months.", "During the quarter, we saw total company comps of 4.7% in May, 3.9% in June and 4.9% in July. Comps in the U.S. were positive 3.4% for the quarter with comps of 3.1% in May, 2.7% in June and 4.3% in July. In the second quarter, our gross margin was 33.2%, a decrease of approximately 80 basis points from the same period last year.", "While there are many factors that impact gross margin, the year-over-year change during the second quarter was primarily driven by lumber, which accounted for approximately 60 basis points of pressure. In addition, several other factors negatively impacted our gross margin, including rising transportation costs, one supply chain investments and lapping a benefit from canceled events in the second quarter of last year. During the second quarter, operating expense as a percent of sales decreased approximately 100 basis points to 17.1%. Our operating leverage during the second quarter reflects significant COVID-related expenses that we incurred in the second quarter of 2020 to support our associates.", "These expenses were partially offset by underspend in other expense items in the second quarter of last year, most notably payroll, as we staffed up to meet strong demand. Our operating expenses during the second quarter of this year also include wage investments that we made at the end of 2020. Our operating margin for the second quarter was 16.1%, an increase of approximately 20 basis points from the second quarter of 2020. Interest and other expense for the second quarter decreased by $16 million to $321 million.", "In the second quarter, our effective tax rate was 23.9%, down from 24.4% in the second quarter of fiscal 2020. Our diluted earnings per share for the second quarter were $4.53, an increase of 12.7% compared to the second quarter of 2020. At the end of the quarter, inventories were $18.9 billion, up $5.4 billion from last year, and inventory turns were 5.7 times compared with 6.1 times this time last year. Turning to capital allocation.", "After investing in our business, it is our intent to return excess cash to shareholders in the form of dividends and share repurchases. During the second quarter, we invested approximately $520 million back into our business in the form of capital expenditures. And during the quarter, we paid approximately $1.75 billion in dividends to our shareholders, and we returned approximately $3 billion to shareholders in the form of share repurchases. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 44.7%, up from 41.1% in the second quarter of fiscal 2020.", "As you heard from Craig, we are very pleased with the strong performance we saw during the second quarter, particularly as we lap the unprecedented growth we saw this time last year. And while these challenging compares continue through the back half of the year, we are encouraged by what we are seeing. During the first two weeks of August, we've seen comps in the U.S. consistent with the second quarter.", "Customer engagement and demand for home improvement is healthy. Housing remains strong, and we see a supportive environment for home improvement spending as we look out over the next several years. That said, there is still a significant amount of uncertainty in the broader environment as it relates to the evolution of the COVID-19 pandemic and the new and spreading variants. As we've previously shared, we do not believe we can accurately predict how the external environment will evolve and how it will ultimately impact consumer spending.", "We will continue to execute with flexibility and focus on what has driven our successful performance. Longer term, we remain committed to what we believe is the winning formula for our customers, our associates and our shareholders. We intend to provide the best customer experience in home improvement. We intend to extend our position as the low-cost provider, and we intend to be the most efficient investor of capital in home improvement.", "If we do these things, we believe we will continue to grow faster than our market and we will deliver exceptional value to our shareholders. Thank you for your participation in today's call. And Christine, we will now open the call for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, everyone. Good morning." ] }, { "name": "Craig Menear", "speech": [ "Good morning" ] }, { "name": "Simeon Gutman", "speech": [ "Hi, Craig and Richard. I wanted to ask -- maybe I'll ask this every quarter for now. I wanted to ask about home improvement demand, whether it has to digest the next couple of years or we can keep compounding. And I think Richard just mentioned in his comments, like expecting several years of healthy demand ahead.", "So curious if your thoughts have evolved on the next couple of years given the massive growth we've had over the past two." ] }, { "name": "Craig Menear", "speech": [ "Simeon, when we look at the overall backdrop for support in home improvement from a housing perspective, from the remodeling index, we feel pretty good about the long-term outlook for home improvement. Hard to predict the short term, but the longer-term outlook looks solid. Richard, I don't know if you want to add to that." ] }, { "name": "Richard McPhail", "speech": [ "If you just -- if you look at the -- we believe that home price appreciation is a fundamental support of home improvement activity and demand. As your home becomes more valuable, you are more likely to spend more on it. We are at a point now where the housing stock of the United States is over 20% more valuable than it was two years ago. And so, as we look forward, not only have we seen that home price appreciation, but the homeowner balance sheet is incredibly healthy.", "The state of mortgage finance is incredibly healthy. And so, that's why -- some of the reasons why we're optimistic." ] }, { "name": "Simeon Gutman", "speech": [ "That's helpful. And then, one near-term question. The second half outlook for gross margin, does the dynamic that occurred in the second quarter, does it ease allowing the gross margin to improve in the back half -- or not improve, but at least the rate of change improved from what happened in the second quarter?" ] }, { "name": "Richard McPhail", "speech": [ "I'd say we're focused on executing week-to-week here. There are certainly cost pressures in the environment, and I think we're all dealing with that. But we've dealt with that throughout our history, and we're comfortable with our ability to manage through the cost environment effectively." ] }, { "name": "Craig Menear", "speech": [ "Simeon, I think there are some very unique scenarios, obviously, in the quarter. Lumber being the one, as Richard called out, unprecedented level of drop and unprecedented speed with which it drops. Normally, the only impact you have is from mix. But with the rapid decline and the extent of the decline, we always have a philosophy that we want to lead the market down and lag going up to remain as competitive as possible for our customers.", "And that actually created an impact which in this quarter was unique that we normally don't see." ] }, { "name": "Richard McPhail", "speech": [ "And I'd make another comment, which is the shape of the business given the volume that is coming through our system is not predictable. But we know, we're confident that we are taking share, and we're there to meet the demand that we see from our customer. That mix may have an impact, but when we look at the operating profit dollar growth we're generating as a company, we feel great about it. So we're looking more at driving market share capture and driving that operating profit dollar growth." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Michael Lasser", "speech": [ "How should the trends that you outlined with diverging performance on the weekdays versus the weekends inform how we think about the DIY business moving forward? Do you attribute that to more of a temporary condition, where consumers had pent-up demand to go on vacation this summer and they return to the projects in the fall? Or alternatively, as families return to traditional activities like your sports, watching college and pro sports, and gradually returning to the office, it's going to put accelerating pressure on the DIY business. And do you think there's enough strength in pent-up demand for the pro segment that it can offset that?" ] }, { "name": "Craig Menear", "speech": [ "Michael, it's a great question. It's something we're watching carefully as the consumer gets back to more normal environment. What we did see is -- the consumers in our research would suggest this as well -- consumers are taking on more projects. They are larger projects and have a tendency to hire a pro to do them.", "And as a result, we've seen our pro business strengthen for several quarters in a row, with the last two quarters where the pro outperformed the DIY customers for the first time since the pandemic started. And so, we're very optimistic about where the pro business goes and the strength of that pro business, and we're focused on making sure that we can take care of those pros along with our DIY customers but feel like there's solid opportunity to continue to grow. Pros tell us their backlogs are bigger than ever. Consumers continue to tell us the home is more important than ever and that they have a longer list of projects." ] }, { "name": "Michael Lasser", "speech": [ "That's all helpful, Craig. And you're going to have this funky dynamic where maybe the pro business is good, maybe the DIY business decelerates from here. And how is that going to impact your labor model, which is activity-based? So if comps do turn negative in the back half, how quickly can you flex that? And how well is it fine-tuned for this dynamic, where you might have a decline in DIY transactions, you may actually not need as much labor, so you can save some SG&A dollars on that." ] }, { "name": "Craig Menear", "speech": [ "Yeah. Michael, you hit it on the head in terms of our labor model is an activity-based model, which has a component in there of transaction. So we can adjust relatively quickly. It's a short-cycle model, and we'll make the appropriate adjustments as we go.", "We plan out a few weeks in advance." ] }, { "name": "Michael Lasser", "speech": [ "OK. Thank you very much and good luck." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey, good morning. I was just wondering if you guys could elaborate a little bit more on some of the benefits you expect to see once the one HD supply chain gets built out sometime in 2022." ] }, { "name": "Ted Decker", "speech": [ "Sure. The whole purpose of the supply chain is really our ability to deliver all of our products, parcel and big and bulky, to 90% of the U.S. population, same and next day. And we're three-plus years into this build out.", "We have multiple facilities up of each type that we're building. They're all performing well and fulfilling that expectation of being able to deliver and satisfy the customer. Speed and reliability is what's required, particularly with our pro customers. In addition, it's allowing us to expand our assortments from what we carry in our stores.", "So not only can we get the product in a quicker, more reliable fashion to our customers, we can get a broader assortment to our customers. And lastly, we're up to $660 a square foot of sales this past quarter in our stores. And it's just a tremendous amount of activity in cube in that building. So to be able to get deliveries, particularly the big and bulky deliveries out of the store, that helps our customer flow and our associate activities in the store.", "And we're just thrilled with that in particular as our FDCs have opened up, we're relieving tremendous amount of delivery activity in cube flow out of our stores and delivering directly out of the new facilities, exactly the way the supply chain team had planned it." ] }, { "name": "Chuck Grom", "speech": [ "That's great. And then, just on lumber. I'm curious what you're seeing from a unit volume perspective as prices dropped throughout the quarter." ] }, { "name": "Ted Decker", "speech": [ "Well, clearly, when we hit $1,500 plus a thousand board feet, people backed out of the market for sure, and waited. And it wasn't that we got a tremendous amount of new supply in the marketplace. I think once you hit that tipping point where people backed off on the margin and prices started to fall -- and as Craig said, it was falling so quickly, 100, 150, even $200 a thousand board feet per week. People just stepped back even further.", "That's now settled at about $430 for framing lumber. And for sure, at those high levels, we saw an impact to units. Our units had turned negative. And as prices have come down, units are still negative, but on a sequential basis, improving in responding to that lower price.", "So we're very pleased. Supply and demand dynamics worked as expected." ] }, { "name": "Chuck Grom", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. Just wondering with respect to inventory, obviously, you're up against your comparisons from last year. But looking at overall areas of inventory, is there any area where you think you're still lacking product? And then how to think about inventory growth in the second half of the year?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. First of all, Karen, I'd say we're super pleased that we've been able to continue to build depth but yet, at the same time, have incredible inventory productivity at 5.7 turns. So we're very, very pleased with that. There's still -- we're in a situation still where we're not exactly where we want to be from an in-stock perspective.", "Our suppliers are working hard, but our merchants have worked with our suppliers to kind of narrow the focus on key SKUs. And so, there's opportunities still to continue to bring more product in across the breadth of the assortment. But right now, we're trying to stay focused on the things that really, really matter." ] }, { "name": "Ted Decker", "speech": [ "And I'd say it's been a category-by-category story. And as Craig said, we're trying to build depth in our highest-velocity SKUs. We're trying to build depth in job lot quantities for our pro customers, and that tends to be heavy on the building materials side of the business, so lumber and building materials and electrical and plumbing fixtures. And we've recovered nicely in all of those departments.", "But again, it can be category by category. There's a COVID outbreak in a factory. There's a shipping constraint. There's a domestic transportation capacity constraint.", "So it's been a story of two steps forward, one step back. But we are making progress, and that's why we're happy to lean into inventory. We're blessed with the financial strength and liquidity. Our goods tend to be nonperishable, not a lot of obsolescence, particularly in our core product.", "So if -- a lot of this is who has the product, who's going to sell the product. And I think our supply chain and merchants responding, as well as they have is one of the reasons we've taken so much market share in this environment." ] }, { "name": "Karen Short", "speech": [ "OK. That's helpful. And I just was wondering, on the pro extra loyalty, I was wondering if you'd be willing to give a little update on the number of members in the program. And then, any color, if you can provide, on average spend of members versus the nonmember pro or just any metrics that you could provide?" ] }, { "name": "Ted Decker", "speech": [ "Yeah. I won't get into details, but you know our rough dynamic, about 4%, 5% of our customer base being the pro makes up 45% of our sales. So this is a number in the mid-millions of our core pros. Very strong number of those, percentage of those, are in the pro extra program.", "And now, as I mentioned in my prepared remarks, we are building a B2B website, and all of our pro extra members now have been transferred over to that B2B experience. So with the combination of the benefits that you're getting with pro extra -- we've stood up a separate pro extra app that those pros are using -- and the ability to engage on the B2B website, which has all sorts of functionality built out specifically for the pro, so think of bills of material for jobs, tracking jobs, quotes, building quotes, reorder capability, tracking all receipts, preferred pricing in certain instances, all of that is coming together, as well as personalization and building relevance on that pro B2B website. So think of something like search results, if you or I would put in pliers, we have thousand suppliers that could be returned in that search result. We're getting to the point now that we know an electrician is performing that search.", "So we're going to provide relevance and we're going to provide our electrical pliers as the first results in that search query. So this is just another great add to our pro ecosystem and just been tremendous engagement with the pro loyalty app, the pro extra program and now the B2B website." ] }, { "name": "Karen Short", "speech": [ "Great. Thanks very much for all the color." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hey, good morning. Thank you for taking my question. A couple of questions with regard to sales and pretty quick ones. First off, just with respect to lumber, I know you talked about it in your prepared comments and in response to the questions.", "But could you say just to what extent lumber was a benefit to comps this quarter?" ] }, { "name": "Richard McPhail", "speech": [ "About 1.3 billion." ] }, { "name": "Brian Nagel", "speech": [ "OK. And that was weighted more toward the first -- the way you've laid it out, I'd assume that was weighted much more toward the first half of the quarter -- early in the quarter, I guess you'd better say that better?" ] }, { "name": "Richard McPhail", "speech": [ "Yeah, Brian, for sure. It was an unbelievable fast fall. But yes, it was -- that was heavily geared toward the first part of the quarter." ] }, { "name": "Brian Nagel", "speech": [ "OK. And then, the second question I have, and I know this is awful nuance. But as you talk about the strength in the pro business, in your conversations, your connections with your pro customers, do you think that the jobs are being taken on now? Were those jobs that were started during the pandemic and are only now being able to be fulfilled because the pros have -- pros are available to work? Or these projects are actually seriously starting right now?" ] }, { "name": "Craig Menear", "speech": [ "I think you probably have a combination would be my best guess. Don't know that for sure. But we know, for example, when we talk to pros that they've had a backlog for some time. And so, I think, clearly, there's probably some that have been in the works where they've been waiting to -- customers have been waiting for pro to start a job.", "And then, I think there's probably scenarios where it's a quicker cycle. But we don't really have a way of knowing that." ] }, { "name": "Richard McPhail", "speech": [ "The National Association of Home Builders index has a lot of interesting survey data within it. One of the survey components is consumer optimism and intent around projects. And we have actually seen intent tick up for small projects, medium-sized projects and large projects really surge sequentially through the year. So I think if you kind of take the question off of the backlog and you say, what's the intent, it does seem like that homeowners are leaning into projects.", "And whether it's a pro or consumer customer, it all eventually is the same customer demand. So it looks like the trend is strengthening in project demand." ] }, { "name": "Ted Decker", "speech": [ "And I think if you look at our services business as a proxy, we're certainly seeing that as well. As our service business, think of -- these are large projects, carpet installation, cabinet installation, refacing, bath, HVAC, those all are strong and accelerating." ] }, { "name": "Brian Nagel", "speech": [ "Appreciate all the color. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. So you're lapping a period of very low promotional activity, as you know. And given the three major holiday events in Q2 with Memorial Day, Father's Day, July 4th, could you talk about to what extent these events were a material top line driver in the quarter? And then with respect to gross margin, to what extent did this have an impact in Q2? And how should we think about the promotional impact as that mixes into the gross margin line in the second half?" ] }, { "name": "Ted Decker", "speech": [ "I would say our promotions were up from last year, but only because we canceled so many last year. We were on the margin less promotional, say, than going back to '19. So while we're very happy with our events and our sell-through, we had record sell-through in virtually all of our programs, the events were not a huge driver of our comp, and it wasn't -- the things Richard called out on our margin impact, it wasn't particularly meaningful." ] }, { "name": "Richard McPhail", "speech": [ "It wasn't meaningful." ] }, { "name": "Zach Fadem", "speech": [ "Got it. That's helpful. And then, Richard, could you talk about how your pro versus DIY trends performed through the quarter and if there was any variability in trend from one versus the other? And then for Q3, does the commentary that trends are in line during the first two weeks of August, does that also hold for both pro versus DIY?" ] }, { "name": "Richard McPhail", "speech": [ "Well, so we're not going to break out intra-quarter. It was the second quarter where we saw our pro customer grow faster than our DIY customer. I'd say, in the first two weeks of the quarter, not much has changed with respect to the direction of our business." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Appreciate the time." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Liz Suzuki with Bank of America. Please proceed with your question." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you. Could you just give an update on the MRO market and the trends you're seeing there? I mean you mentioned that your big pros were outpacing small pros. So was MRO growth even above that of those big pros given relatively easier comparisons against last year?" ] }, { "name": "Craig Menear", "speech": [ "Liz, we're very pleased actually with our MRO business and the acquisition of HD Supply. The business there is very, very solid. What we're excited about, candidly, with that business is the opportunity to much better serve 50 million households in the multifamily space. Not only can we serve them with MRO products, but obviously, as we have relationships and build that through our MRO business, the opportunity to then participate in capital refreshes for those property owners, on those 50 million households that are in the multifamily is a huge opportunity for Home Depot going forward.", "So we're super pleased with the business and the progress that we're making there." ] }, { "name": "Liz Suzuki", "speech": [ "Great. And I'm just tacking on to Zach's question a little bit. I mean, it may be early to be thinking about this, but how are you approaching the holiday season this year from a procurement standpoint and a promotional standpoint? Should we expect it to look more like last year, where marketing started early and extended longer, but the promotions were a bit shallower than a normal year? Or do you think it will go back to kind of the shorter and deeper promotional cadence like pre-pandemic season?" ] }, { "name": "Ted Decker", "speech": [ "Well, Liz, as you can imagine, the -- with the international supply chain involved in those type of events, the merchants and supply chain teams made the bulk of those buy decisions some time ago. So it's a fixed buy. We're not expecting huge growth in those programs. But to your point, it's deeper buys, stronger values, fewer items, and we think we have great programs.", "In terms of marketing early, I think we're going to follow all our normal trends. We had a sneak peak with opening up Halloween online and just sold out our sort of pre-released Halloween product almost immediately. So that's a very strong indication that people are still going to engage in decorating, and we look forward to setting our decorative holiday later in October." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, everybody. It's been a long time since the weather was a potential question. But during the second quarter, do you think it was in that headwind? The major DIY holidays had record rain in some of the northern geographies, and so was it beyond just the bathtub effect of 1Q versus 2Q?" ] }, { "name": "Richard McPhail", "speech": [ "I wouldn't say it was beyond it, but we certainly saw it. So we think that it may have accounted for low single-digit comp impact, call it 100 to 200 basis points of comp pull-forward from Q1 -- sorry, from Q2 into Q1, particularly in the Northern division. So as Craig called out, while we did see a difference in divisional performance, that really was the primary driver in our view." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And then, on the lumber side, as prices stand now, would lumber be a modest headwind comp for the balance of the year? And is that reflected in the quarter-to-date commentary?" ] }, { "name": "Ted Decker", "speech": [ "So yeah, lumber, just the market pricing of lumber, Chris, right now, framing is approaching 40% under LY, and panel is 10% under LY. So with neutral units, there would be a negative comp impact. As I said, unit progression is going in the right direction with these lower prices, and that all speaks to the project nature. But from a price perspective, not expecting any tailwind in lumber." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And then, the last question, Richard, as you think about how transportation costs, I assume some of that gets hung up in inventory. So do you think the transportation cost pressure actually gets worse as you look in the back half? So as much as the rate pressure from lumber doesn't repeat itself, you could have higher transportation cost pressures on gross margin." ] }, { "name": "Richard McPhail", "speech": [ "The back half is a long period of time. I'm not going to speculate on what transportation costs might look like. I'll just tell you that I would bet on our team every single day to be able to manage through that dynamic. Our supply chain team is exceptional and creative and I think that they have reinforced our position as a low-cost provider in the market.", "So regardless of where the market goes, I think we'll be in an advantaged position." ] }, { "name": "Christopher Horvers", "speech": [ "I'm sorry, one last quick one. In July, how would you characterize sort of the competitive promotional environment? There are some questions out there that maybe some of your competitors got more promotional, although it was for you just more of a comparison to a low level last year." ] }, { "name": "Craig Menear", "speech": [ "Didn't see anything majorly different." ] }, { "name": "Ted Decker", "speech": [ "Didn't notice that much, Chris." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Thanks so much. Best of luck." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Kate McShane with Goldman Sachs. Please proceed with your question." ] }, { "name": "Kate McShane", "speech": [ "Hi. Good morning. Thanks for taking my question. Just a couple of housekeeping type questions.", "I wondered if you could address at all the trend of trading up by the customer, if that was something you continue to see during the quarter. And any commentary you can give specifically around appliances and what you saw in Q2?" ] }, { "name": "Ted Decker", "speech": [ "I would say, yes, we continue to see the trading up. It's not as clear as I used to report on it just because of the inventory situation, and we're seeing lots of substitution of goods, depending on what's in stock on the shelf that particular day. But if you look at power tools, for example, outdoor power equipment, the appliance category, grill category, riding lawnmower and zero-turn category, just as a few examples, Kate, people are trading up to innovation in all those categories. So just more powerful, longer run time on batteries, that's moving over to outdoor power equipment.", "The design aesthetic and the features of modern appliances, people are happily trading up to quite strong price points in appliances. LED lighting that's going through, not just light bulbs but integrated in ceiling fans and fixtures, that trade-up is innovation and newness-driven, and we are seeing that as strong as ever." ] }, { "name": "Isabel Janci", "speech": [ "Does that complete your question?" ] }, { "name": "Kate McShane", "speech": [ "Yes. Sorry. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Greg Melich with Evercore. Please proceed with your question." ] }, { "name": "Greg Melich", "speech": [ "Thanks. I had a follow-up on comps, and then SG&A. I guess I'd start with SG&A. So you had 100 bps of leverage in the first half, and you guys have talked about getting back to leveraging the way that Home Depot did in the past.", "Should we expect the second half to have similar-type leverage? Or is there something unique about what happened last year that means it would be less?" ] }, { "name": "Richard McPhail", "speech": [ "Well, Greg, 2020 was such a unique year, and comparisons from 2021 to 2020 are difficult for a number of factors. You think about the amount of COVID expense that we put in place in support of our associates last year, you think about expense underspend as we worked to bring staffing up to levels to meet demand, and then you think about the wage investment that we made toward the end of 2020, all these make comparisons difficult. We are committed to generating operating expense leverage over the long term. We feel great about the operating expense leverage that we've delivered in Q2 and in the first half.", "You're always going to see fluctuations quarter to quarter. Leverage is a function of top line sales, it can be a function of seasonality and other factors. So in any given quarter, you may see volatility. But over a period of quarters, you're going to see from us operating expense leverage.", "And again, we're very happy with how the quarter and the half played out." ] }, { "name": "Greg Melich", "speech": [ "Got it. And my follow-up, maybe linked to that, is on comps. So if the trend -- I just want to make sure I got it right. If the trend is similar to the second quarter, but there's no inflation in lumber, is it fair to say that that two-year comp is stable in the mid-20s without inflation? Am I interpreting that correct?" ] }, { "name": "Richard McPhail", "speech": [ "Well, two-year comp is sort of similar in its consistency to one-year comp in the first couple of weeks of the month." ] }, { "name": "Greg Melich", "speech": [ "Got it. All right. Appreciate it. Thanks a lot, and good luck." ] }, { "name": "Richard McPhail", "speech": [ "Thanks, Greg." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of David Bellinger with Wolfe Research. Please proceed with your question." ] }, { "name": "David Bellinger", "speech": [ "Hey. Good morning and thanks for taking the question. I wanted to ask in regard to supply chain. So you alluded in the prepared comments working through a difficult environment.", "So are you seeing incremental pressures now versus just a few months ago? Is there some level of sales that you missed out on in the Q2 period? And maybe a bigger-picture question. Through all the recent supply chain issues across the industry, is there anything now that you're reevaluating or making some type of change within the one Home Depot buildout?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. I'd say the first comment that I'd have is as it relates to the potential sales impact really, really hard to tell. And the reason it's so hard to get a gauge on that is the fact that there is a high level of willingness of substitution on the customer's part since this pandemic began, much more so than pre-pandemic. Is there some level of impact? The logic tells you there probably was, but it's really hard to gauge.", "And we think we captured most as a result of substitution." ] }, { "name": "David Bellinger", "speech": [ "And any change in regard to your larger build-out plans at one Home Depot?" ] }, { "name": "Craig Menear", "speech": [ "No. Not at all. No. We're -- that buildout -- I'm sorry, that buildout is focused on where the customer has taken us and how they want to engage with The Home Depot.", "So it has no impact at all." ] }, { "name": "David Bellinger", "speech": [ "Got it. And just my follow-up here. You mentioned a new exclusive relationship with LP Building Solutions. Can you expand upon that any further? Does that reflect some type of shift in the business, where maybe you lean more into Pros tied to more new home construction as the next level of Pro sales growth and just give the company more exposure on the new home construction side.", "Can you just expand upon that any further?" ] }, { "name": "Ted Decker", "speech": [ "No. I mean, the intent was not to be any different position in regards to new home construction. It's not a market we play in or consciously go after. LP is similar to what we did last quarter with Carlon electrical boxes.", "As Carlon is the largest provider, particularly for the pro in PVC electrical boxes, LP is one of the top couple OSB providers, very strong brand. And this is a matter of The Home Depot making arrangements with top suppliers so that they can focus their supply chain into serving us, and we can focus on having that depth of inventory in these critical pro categories on our shelves. So the likes of exclusives with Carlon and LP is all about taking care of our pro customer." ] }, { "name": "David Bellinger", "speech": [ "Got it. Appreciate the color." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Laura Champine with Loop Capital. Please proceed with your question." ] }, { "name": "Laura Champine", "speech": [ "Thanks for taking my question. I just wanted to get some context around the commentary that you should be able to lap the difficult comparisons given the strong macro drivers and home prices and comparing that to the outcome in Q2 of transactions that were down. Is the thought there that the transactions were down largely because of lumber inflation and other sort of onetime issues and that transaction should tick back up as we move through the rest of this year and next?" ] }, { "name": "Craig Menear", "speech": [ "Laura, first comment would be we didn't really provide any outlook going forward. We don't believe we can take past performance and project that forward due to the uncertainty in the environment that exists today. As it relates to the transactions, I mean, huge transactions last year as a result of PPE. Ted, I don't know if you want to comment." ] }, { "name": "Ted Decker", "speech": [ "Yeah. I mean, that was one of our single biggest drivers of the falloff is people coming in for masks and hand sanitizers. The four departments that we did see negative sales, hardware, outdoor and indoor garden and paint, those are -- can tend to be more consumer-oriented, lots of units in mulch, in soil and things and paint is -- that DIY-er was home, not doing other activities on the weekend. So we're not alarmed by that falloff at all.", "We'll get through that. I'd say that -- take a category like paint. I mean, paint had been a one- or two-unit grower for several years up until the pandemic. And painting is one of the initial home improvement projects that a customer engages in and starts to build confidence in home improvement.", "And while we saw a dip in Q2, the levels in unit volume that we're seeing in paint is well above 2019. And I've talked about the millennials before, and the millennials are engaged in housing. They're engaging in home improvement. They've done that first project, which is painting and some gardening work generally.", "So we're just thrilled that they're engaged in the category and moving on to bigger projects." ] }, { "name": "Laura Champine", "speech": [ "Got it. And then, as a follow-on, do we have a better sense now on where digital should be in terms of a longer-term sustainable growth rate and/or as a percentage of sales, hopefully, things are settling out there?" ] }, { "name": "Craig Menear", "speech": [ "I mean, we really look at this as an interconnected experience. Our customers are clearly blending the physical and digital worlds together. Because of the project nature of our business, certainly, from pre-pandemic levels, we've seen an accelerated rate of engagement in terms of sales through our digital channels. But that's not how we focus on it or look at it.", "We view it as a capability for our customer to engage with The Home Depot." ] }, { "name": "Laura Champine", "speech": [ "Got it. Thank you." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Eric Bosshard with Cleveland Research. Please proceed with your question." ] }, { "name": "Eric Bosshard", "speech": [ "Thanks. Two things. First of all, perhaps for Richard, some clarity on lumber. You talked about leading on the way down with price to do what's best for the customer.", "Does that necessitate more gross margin pressure from lumber in 3Q? Or am I thinking about that wrong?" ] }, { "name": "Richard McPhail", "speech": [ "By and large, the pressure from lumber, at least what the prices we've seen in the market, have been recognized to date, so no. And now it depends on future lumber price, right? But at the moment, the precipitous decline had its impact in Q2 for the most part." ] }, { "name": "Craig Menear", "speech": [ "Yeah. Eric, the key for that -- normally, you don't see any pressure from gross margin as a result of lumber. It's all because of mix. The reason that we saw it this time was the steep decline that happened in price in a very compressed time frame.", "And again, we weren't going to change our approach to the market. We want to be incredibly focused on driving the best value for our customers. So we always try to lag the market when it's going up and lead it when it's coming down." ] }, { "name": "Eric Bosshard", "speech": [ "Perfect. That makes sense. And then, secondly, the sales growth over the last couple of years now is exceptional, as you pointed out. You've obviously invested to take care of your associates and take care of your customers.", "The margin leverage has been less than what we would have expected with nearly a $50 billion, 50% increase in sales in the last three years. Is there some embedded operating margin improvement that can get released over the next couple of years if things return to normal? Or is the cost of doing business and other investments you've made taken some of that away? Trying to figure out if the operating margin of the enterprise can lift incrementally in the next couple of years or if more of the focus is on sales growth and a little bit less on releasing operating margin." ] }, { "name": "Richard McPhail", "speech": [ "I think so. I think that we have to go back to the central focus that we have from a financial performance perspective, which is growing operating profit dollars as fast as possible and generating an exceptional return on investment on those dollars. And so, we feel very pleased with the market share that we've captured over the last three to four years. And we feel exceptionally pleased with the shareholder value that we've created as well.", "We think that the formula of having the best experience in home improvement retail, being the lowest-cost provider and being the best investor of capital in the market is a formula that can't be beat, and that's what we're going to continue to do." ] }, { "name": "Eric Bosshard", "speech": [ "Great. Thank you very much." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I'd now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thanks, Christine. And thank you, everyone, for joining us today. We look forward to speaking with you on our third-quarter earnings call in November." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2018-08-14	[ { "description": "Vice President of Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, CEO, & President", "name": "Craig Menear", "position": "Executive" }, { "description": "Executive Vice President of Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "Chief Financial Officer & Executive Vice President of Corporate Services", "name": "Carol Tom", "position": "Executive" }, { "description": "Senior Vice President of Supply Chain & Product Development", "name": "Mark Holifield", "position": "Executive" }, { "description": "Executive Vice President of Outside Sales & Service", "name": "William Lennie", "position": "Executive" }, { "description": "President of Online & Chief Marketing Officer", "name": "Kevin Hofmann", "position": "Executive" }, { "description": "Morgan Stanley & Co. LLC -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS Securities LLC -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Wells Fargo Securities, LLC -- Analyst", "name": "Zachary Fadem", "position": "Analyst" }, { "description": "JPMorgan Securities LLC -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Credit Suisse Securities (USA) LLC -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Oppenheimer & Co., Inc. -- -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Barclays Capital, Inc. -- Analyst", "name": "Matthew J. McClintock", "position": "Analyst" }, { "description": "Citigroup Global Markets, Inc. -- Analyst", "name": "Jeffrey Small", "position": "Analyst" }, { "description": "Goldman Sachs & Co. LLC -- Analyst", "name": "Matthew J. Fassler", "position": "Analyst" }, { "description": "Jonathan -- Jefferies Financial Group -- Analyst", "name": "Jonathan", "position": "Analyst" }, { "description": "Budd Bugatch -- -- Raymond James Financial, Inc. -- Analyst", "name": "Budd Bugatch", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good day, ladies and gentlemen. Welcome to The Home Depot Second Quarter 2018 Earnings Conference Call. Today's call is being recorded. [Operator Instructions]", "At this time, I'd like to turn the conference over to Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, and good morning, everyone. Joining us on our call today are Craig Menear, Chairman, CEO, and President; Ted Decker, Executive Vice President of Merchandising; and Carol Tomé, Chief Financial Officer and Executive Vice President, Corporate Services.", "Following our prepared remarks, the call will be opened for questions. Questions will be limited to analysts and investors, and as a reminder, we would appreciate it if participants would limit themselves to one question with one follow-up. If we are unable to get to your question during the call, please call our Investor Relations Department at 770-384-2387.", "Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.", "These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and good morning, everyone. We're very pleased with our performance in the second quarter, achieving a milestone of the highest quarterly sales and net earnings results in our company history. Sales for the second quarter were up (sic) $30.5 billion, up 8.4% from last year. Comp sales were up 8% from last year with US comps of positive 8.1%. Diluted earnings per share were $3.05 in the second quarter.", "Our results in the second quarter reflected what we call the bathtub effect. As expected, a majority of seasonal sales we missed in the first quarter were recovered in the second quarter. We also continue to see broad-based strength across the store and all geographies. In the US, all three of our divisions hosted positive comps in the second quarter, as did our 19 regions and top 40 markets. Internationally, Canada and Mexico posted mid to high single-digit positive comps in local currency during the quarter.", "Our solid performance was driven by the outstanding execution of our store associates, merchants, suppliers, and supply chain teams. Navigating a sudden spike in demand like the one we witnessed in May isn't easy. For example, in the Northern Division, the variability in sales over a two-week period of time was as high as 2,770 basis points as the weather turned more favorable.", "As Ted will detail, both ticket and transactions grew in the quarter. We saw a healthy balance of growth from both our Pro and DIY categories, with Pro sales once again outpacing DIY sales in the quarter. The alignment of our Interline and legacy outside sales forces around four targeted end markets continues to gain traction. These sales professionals are experts in their respective fields, providing valuable insight and partnership to the Pro customers that they serve. This, in turn, drives greater engagement in incremental spend.", "Our digital business continued to be a source of growth. Online traffic growth was healthy and second-quarter online sales grew approximately 26% from the second quarter of 2017. Customer continue to respond to ongoing investments and enhancements we're making in support of the customer experience.", "Delivering a best in class interconnected shopping experience encompasses much more than our digital properties and physical store assets. Our supply chain and the investments that we're making to enhance the delivery and fulfillment options available for customers is also an important area of focus. We have continued to develop and rule out new delivery capabilities. We've now ruled our small parcel express delivery from store, via car and van, in nearly all our major markets in the US with plans for further expansion.", "Additionally, we told you that 2018 would be the year of the pilot as we test and learn with new fulfillment centers. I'm pleased to report that we are on track with our plan and opened our first MDO, or market delivery operation, during the quarter. In the second half of this year, we plan to open additional facilities. The opening of these facilities is a cross functional endeavor. From a real estate team that locates the appropriate sites, to our IT teams that develop the proprietary software that runs them, and our supply chain team that owns execution throughout, the buildout of the One Home Depot supply chain is truly a collaborative team effort. I want to commend everyone for their work thus far in getting our five-year journey off to a strong start.", "Let me touch briefly on the progress we're making with some of our store investments. We have implemented our wayfinding sign and store refresh package in over 500 stores year-to-date, ahead of our initial plan. We also continue to make progress on the rollout of our redesigned front-end areas and BOPIS lockers, among other investments. We are only seven months into a three-year investing journey. We remain energized and excited about the work and the opportunities ahead. We're focused on improving the customer experience by investing in our business and in our associates.", "Turning to the macro environment, the US economy and drivers for home improvement spending are strong. As Carol will detail, because of our outperformance in the first half versus our plan, we are increasing our sales and earnings per share guidance for the year. We now expect Fiscal 2018 sales growth of approximately 7%, and diluted earnings per share of $9.42.", "I want to close by thanking our associates for their hard work and continued dedication to our customers as they once again successfully navigated our busiest selling season. Based on the first half results, 100% of our stores qualified for Success Sharing, our profit-sharing program for our hourly associates. We are very proud of their efforts.", "And with that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. We had a strong quarter with results that exceeded our expectations. The team did a great job of maintaining excellent service levels while preserving high end stocks over a period of elevated demand. Our core business continues to perform well and, as expected, we saw record sales in our garden business as spring broke across the country.", "Looking at our departments, lumber, indoor garden, outdoor garden, and electrical had double-digit comps in the quarter. Tools and appliance were above the company average. All other departments but lighting posted mid to high single-digit comps. Lighting had a low single-digit negative comp, driven primarily by LED price deflation.", "In the second quarter, comp average ticket increased 4.9% and comp transactions increased 2.9%. Commodity price inflation in lumber, building materials, and copper positively impacted average ticket growth by approximately 119 basis points. In addition to core commodity inflation, we are now experiencing inflation in other areas. These inflationary pressures come in many forms, including rising raw material costs and transportation costs along with recently enacted tariffs. However, as the customer's advocate for value, it is our job to work with our partners throughout the value chain to manage these pressures.", "Turning to big-ticket sales in the second quarter, we previously defined big-ticket sales as transactions over $900.00. Today, we are redefining big-ticket sales as transactions over $1,000, as they now represent approximately 20% of US sales. In the second quarter, transactions over $1,000 were up 10.6% compared to the second quarter Fiscal 2017. A few drivers behind the increase in big-ticket purchases were vinyl plank flooring, appliances, and strength with our Pro customers.", "In the second quarter, sales to our Pro customers grew double digits. Pro heavy categories like lumbar, in-stock kitchens, power tools, windows, and concrete all recorded double-digit comps. As you heard from Craig, our professional salesforce is driving stronger relationships and a deeper level of engagement with our Pro customers, which in turn lead to higher sales. This partnership is particularly important with our MRO customers, where we saw strong mid single-digit growth in the quarter.", "Sales to our DIY customers also showed solid results as they completed a variety of spring projects. Categories like lawnmowers, watering, patio, ceiling fans, and interior and exterior paint all had strong comps. In fact, our interior paint business had its best half performance in more than five years. While the favorable weather drove outdoor project activity, we also saw good performance for maintenance and repair categories during the quarter, with great results in water heaters, HVAC, safety and security, and air circulation.", "During the quarter, we held our annual Memorial Day, Father's Day, and Red/White/Blue events. Our merchants' merchandising execution team in stores did a fantastic job bringing great value to our customers, which helped drive transactions, both in store and online.", "As part of our focus on balancing the art and science of retail, we have created approximately 50 cross functional squads focused on agile development to improve the flexibility and ease of our online customer experience. As Craig called out, we saw strong growth in our online business, driven in part by an increase in our conversion rates. And our interconnected retail offering is resonating with our customers as 47% of all of our online orders are picked up in the store.", "Now, let's turn our attention to the third quarter. We are thrilled to announce our new appliance partnership with Bosch. Bosch is one of the largest home appliance manufacturers in the world and brings over a century of product innovation and engineering to The Home Depot. We are excited to offer a broad selection of their appliances, both in store and online. Most notably, Bosch is recognized as having the quietest and most reliable dishwasher on the market today, and they own the number one brand position in the category.", "Building on the success and momentum of our LifeProof carpet and vinyl plank, we are excited to introduce LifeProof slip resistant tile. LifeProof tile is 50% more slip resistant than ordinary tiles and is particularly good for wet areas like bathrooms, kitchens, and even outdoor patios. The innovative coating eliminates the need for gritty texture and does not freeze, fade, or crack. It is low maintenance and easy to clean. LifeProof tile is exclusive to The Home Depot.", "We're also excited to be introducing some great new innovation across our Husky tool portfolio. The growing Husky brand is owned and backed by The Home Depot and offers incredible value to our customers who need tough, quality tools and storage at affordable prices. In mechanics tools, we're introducing new impact sockets that offer easier access in tight spaces. In plumbing tools, we're introducing a ratcheting PVC pipe cutter that requires less force to cut and allows for easy single hand operation. All of our Husky hand tools are backed by lifetime warranty and can be replaced at any of our stores.", "In addition to great new products, we are excited about our upcoming events. As summer winds down and cooler temperatures arrive, we will have an incredible lineup of great values and", "With that, I'd like to turn the call over to Carol." ] }, { "name": "Carol Tom", "speech": [ "Thank you, Ted, and good morning, everyone. In the second quarter, total sales were $30.5 billion, an increase of 8.4% from last year. Recall that at the beginning of Fiscal 2018 we adopted a new accounting standard pertaining to revenue recognition. The new standard changes the geography of certain items on our income statement, but has no impact on operating profits.", "In the second quarter, the change in accounting positively impacted sales growth by $33 million. Our total company comps were positive 8% for the quarter, with positive comps of 11% in May, 7.5% in June, and 5.7% in July. Comps in the US were positive 8.1% for the quarter with positive comps of 10.6% in May, 7.6% in June, and 6.3% in July.", "As you heard from Craig, our second quarter performance exemplified what we call the bathtub effect of a seasonal business. In other words, the majority of the seasonal sales missed in the first quarter due to inclement weather were recovered in the second quarter. And, as you've heard, we didn't just recover seasonal sales. Our total sales growth exceeded our expectations. On last comment on sales for the quarter -- foreign currency exchange rates had a negligible impact on sales growth.", "In the second quarter, our gross margin was 34%, an increase of 36 basis points from last year. There were a number of factors that impacted our gross margin performance year-over-year, two of which can be isolated, and the third is just the net results of a number of factors. Specifically, we had $152 million of gross profit, or 46 basis points of gross margin expansion, due to the new accounting standard. We reported 16 basis points of gross margin contraction due to higher transportation and fuel costs in our supply chain. And, finally, we had 6 basis points of gross margin expansion due to the net result of a number of factors, including sales mix and the impact of recently acquired companies.", "For the year, we expect our gross margin rate to expand by approximately 41 basis points. This expansion is down slightly from our previous guidance due to higher than anticipated transportation costs in our supply chain. In the second quarter, operating expense as percent of sales increased by 16 basis points to 17.9%, reflecting 90 basis points of expense leverage in BAU, or business as usual, offset by the impact of the new accounting standard and expenses associated with the strategic investment plan we laid out at our December investor conference.", "Expanding on this, the new accounting standard resulted in a $152 million increase in our operating expenses and caused 48 basis points of operating expense deleverage. And expenses related to our strategic investment plan of roughly $174 million resulted in approximately 58 basis points of operating expense deleverage. Given our strong first half performance, we now expect our Fiscal 2018 operating expenses to grow at approximately 137% of our sales growth rate.", "Our operating margin for the second quarter was 16.1%, an increase of 21 basis points from last year. For the quarter, interest and other expense decreased by $3 million to $246 million, and our effective tax rate was 24.7% compared to 36.6% in the second quarter of Fiscal 2017. The decrease in our effective tax rate reflects, for the most part, the benefit of tax reform. For the year, we continue to believe our effective tax rate will be approximately 26%. Our diluted earnings per share for the second quarter were $3.05, an increase of 35.6% from last year.", "Moving on to some additional highlights, during the quarter, we opened one new store in Mexico for an ending store count of 2,286. Selling square footage at the end of the quarter was 238 million square feet. Total sales per square foot for the second quarter were $504.00, up 8.6% from last year. At the end of the quarter, merchandise inventories were $14 billion, up 9.1% from last year. Inventory turns were 5.4 times, up one-tenth from last year.", "In the second quarter, we repurchased $2 billion, or approximately 9.3 million shares, of outstanding stock. This included approximately 2.1 million shares on the open market and approximately 7.1 million shares repurchased through an accelerated share repurchase, or ASR, program. We also received approximately 874,000 shares related to an ASR program we initiated in the first quarter.", "Note that for the shares repurchased under the second quarter ASR, it is an initial calculation. The final number of shares repurchased in the second quarter will be determined in the third quarter, when the second quarter ASR terminates. Year-to-date, we have repurchased approximately $3 billion of our outstanding shares and now we expect to repurchase approximately $6 billion of our outstanding shares for the year.", "Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 37.9%, 590 basis points higher than the second quarter of Fiscal 2017. As we look to the back half of the year, we continue to expect strong economic growth with a backdrop of a healthy home improvement environment. Homeowners continue to enjoy home price appreciation, and rising wages and low unemployment have driven consumer confidence to record high levels. These trends are all supportive of our business, but we also know that in the second half of Fiscal 2017, we experienced over $600 million of hurricane related sales that we must comp.", "So, today, we are lifting our Fiscal 2018 guidance primarily for our first half outperformance. Now, if there's a bias in our forecast, based on the economic environment and our August performance-to-date, the bias is to the up.", "Remember that we guide off GAAP. Recall that Fiscal 2018 will include a 53rdweek, so the fourth quarter of Fiscal 2018 will consist of 14 weeks. For Fiscal 2018, we now expect sales to increase by approximately 7% with positive comps as calculated on a 52-week basis of approximately 5.3%. For earnings per share, we expect Fiscal 2018 diluted earnings per share to grow approximately 29.2% to $9.42. Our earnings per share guidance includes our intent to repurchase approximately $3 billion of outstanding shares in the back half of Fiscal 2018.", "...", "So, with that, I'd like to thank you for your participation in today's call. And Kat, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator Instructions] Our first question will come from Simeon Gutman with Morgan Stanley." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning, everyone. Nice quarter. I wanted to first ask about the macro. It probably will be a busy topic on it this morning. There is a lot of noise out there. There are a lot of healthy metrics, but there are also some cautionary ones. Home improvement demand and how it aggregates from declining existing home sales -- your guidance clearly doesn't imply that there's any reason to be worried. But, how do you look at the world now?" ] }, { "name": "Craig Menear", "speech": [ "Simeon, we feel very positive about the strength of the home improvement sector and the customer's willingness to spend. I'll let Carol walk you through some of the details of how we actually think about it." ] }, { "name": "Carol Tom", "speech": [ "We've expanded our thinking in this regard. We look at all housing metrics -- housing turnover, home price appreciation, new household formation, the age of the housing stock, and housing starts -- although that isn't as directly impacted to our business as the others. We've learned that you can't look at any housing or home improvement driver in isolation. They all play off each other. Let's taking housing turnover as an example. Housing turnover now stands at about 4% of units. That is in part because we have a housing shortage in our country. We only have 4.1 months of supply against a normal month-of-supply of more like 6 months.", "With the housing shortage, home prices have appreciated. With home price appreciation, homeowners have more equity in their homes. In fact, home equity values have increased over 120% since 2011, about $73,000 per homeowner in terms of equity. So, as homeowners view their home as an investment and not an expense, they spend more. If we look at correlating our comp sales against housing turnover, going back to that number, to your point, we've disconnected. We think that has to do with this housing shortage. In a normal housing environment, where there is adequate supply, you see a pretty tight correlation between our comp sales and housing turnover. But now, we because we have this housing shortage, it's disconnected.", "I could go on and on about the macro because I know there are a number of other things we could talk about. Craig, I don't know if you want me to continue on or pause." ] }, { "name": "Craig Menear", "speech": [ "I think probably the biggest question we get is around affordability as it relates to the housing environment. With the increase in interest rates, when do we get worried about affordability? Carol can walk through how we think about affordability, but the affordability factor with interest rates doesn't impact the majority of folks." ] }, { "name": "Carol Tom", "speech": [ "It's so very important, when you think about the affordability index -- right now, the affordability index for the country is 144. If you look at the historical average, it's 127. In the past, we said, \"Well, if it gets to 127, that could be a watch out for us.\" But, as we thought about it, we thought that you really need to think about it on the margin. If only 4% of housing units are turning in a year, that means 96% of homeowners are staying in their home. They don't care about rising interest rates. In fact, they love rising home prices because their equity is worth more. So, when you think about affordability, it's the 96% of the housing units that are in place that are driving the home improvement spend and not so much the marginal turnover that the media tends to pay attention to." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks for all of that. On affordability, you have this visibility and we don't. There are some markets in which the affordability index has dropped a little more severely than the average. This quarter was really about seasonal and bathtub effect, but can disaggregate those markets in which the affordability has deteriorate the most and what the topline trend -- anything in those markets of note?" ] }, { "name": "Carol Tom", "speech": [ "Yeah. Let's just take Seattle. The home prices have been on fire, and on fire for a while. Our comp in the Seattle market in the second quarter was 7.7%." ] }, { "name": "Simeon Gutman", "speech": [ "Great. Got it. Okay. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Chuck Grom with Gordon Haskett." ] }, { "name": "Chuck Grom", "speech": [ "Hi. Thanks. On the expense front, Carol, your growth factor saw a little bit of a stepdown here versus the pace in the first quarter, despite the better comp. I was just wondering if you could frame out some of the components for us -- the BAU. Also, looking ahead into the third and fourth quarter, how do you see it framing out?" ] }, { "name": "Carol Tom", "speech": [ "Sure. So, in the second quarter, we had 90 basis points of expense leverage in BAU. If you look at the drivers of those 90 basis points, roughly 50 of the basis points came from payroll and payroll related items. You've heard Ann-Marie Campbell talk about a new labor model that she's introduced into the stores. We're driving productivity in our stores while, at the same time, increasing our customer reports. Our customers are very happy with the service they're getting in our stores. The rest of the leverage came from leveraging fixed costs as well as everything else. Productivity is a virtuous cycle here at The Home Depot. When you put up a comp of 8%, you expect to get pretty good expense leverage, and indeed we did.", "As we think about the balance of the year, our expense growth factor for the first half of the year was 139%. We would expect it to be around 135% for the back half of the year, giving us the guidance that we gave you of 137%. And just to comment on the quarters, we would think the expense growth factor would be slightly higher in the third quarter than the fourth quarter because, remember, the fourth quarter has that extra weight." ] }, { "name": "Chuck Grom", "speech": [ "Great. That's very helpful. Craig, on the MDOs. You said you opened up one so far. Any early learning so far? Can you quantify how many you think you're going to do on the back half of the year? Bigger picture, how do you frame out the opportunity across the board?" ] }, { "name": "Craig Menear", "speech": [ "First of all, it's very, very early to gather any learnings. We just got the facility open, but we're up and running and learning as we go. We won't disclose how many we will open in the back half, but if you think about the approach to this, it is using the advantage that we've built in our upstream network to feed the downstream opportunity that we have to continue to drive the way the customer wants to engage with us. Mark, do you have any additional comments?" ] }, { "name": "Mark Holifield", "speech": [ "Right. The market delivery operation that we've opened is just part of our overall plan to drive the fastest, most efficient delivery in home improvement. Just getting started there, so it's very early days in terms of that. But, this is one of those stockless locations that's a delivery hub in a local area. We deliver primarily appliances out of there at this point, but we'll be adding more products to that as we go. Expect more and we'll keep you posted as we go in the second half and beyond." ] }, { "name": "Operator", "speech": [ "Thank you. We'll continue on to Michael Lasser with UBS." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks for taking my question. If we average out your comp transactions between the first and second quarter, to account for the seasonality and seasonal shift between those two periods, it looks like it was up around 0.7%. That represents the slowest traffic growth in the past few years. Do you think that's a sign that maybe the cycle is entering the later stages? What would cause that to reaccelerate from here?" ] }, { "name": "Carol Tom", "speech": [ "We probably need to look at your math, but when we look at our transactions for the second quarter and back out garden, or our seasonal business, our comp transaction was up 1.6%." ] }, { "name": "Michael Lasser", "speech": [ "Okay. That's helpful. Given all the discussion about tariffs and inflation, maybe you can tell us about your performance in the appliance category -- particularly, washing machines -- because that has been an area where there has been significant pricing passed through. Based on that experience, how to do you see the next few quarters unfolding in terms of elasticity of demand as you try and navigate through what's probably going to be a hotter inflationary environment?" ] }, { "name": "Craig Menear", "speech": [ "Michael, at this point, the tariff environment is manageable. Given our sales, size, and scale, it's even that much more manageable. Overall, on the lumber tariffs with Canada and the laundry tariffs in washing machines, and the Section 301s that have come through, this is all low single-digit percent of our COGS and just 25-odd basis points of cost pressure. We are seeing increased cost requests from suppliers, particularly the ones that have been impacted by the tariffs. But, as you can see, the overall size is very manageable at this point.", "Now, there are some categories -- laundry being the most specific -- where you had up to 25% and 50% tariff if you get over certain volumes of imports. For sure, that elasticity showed up -- you had mid-teen increase in the industry with laundry prices. And you did see some unit falloff there. But, as the Korean manufacturers get their facilities up and running in Tennessee and South Carolina respectively, that tariff pressure will mitigate because they'll be producing all their machines here domestically." ] }, { "name": "Michael Lasser", "speech": [ "Just to follow up on that, is there anything you can learn from the experience with washing machines that you might be able to apply to other categories, especially those ones that will be affected by the next round of tariffs?" ] }, { "name": "Craig Menear", "speech": [ "Sure. We take a portfolio approach to this. These tariffs are very specific. They're calling out products with specific dimensions. So, it's not always even a category of goods. It's a specific unit or number of units within a category of goods. So, yes, we apply learnings and elasticity and we're not necessarily taking a one-for-one retail with a cost increase. We manage it at the portfolio level. With this gross, less than low single-digit percent of COGS, it's well within our scope to manage this at the portfolio level." ] }, { "name": "Michael Lasser", "speech": [ "Thank you so much and good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from Kate McShane with Citi." ] }, { "name": "Jeffrey Small", "speech": [ "Hello. This is Jeff Small on for Kate McShane. Thank you for taking our questions. We want to first dig into the second quarter sales result. You mentioned that the majority of lost sales from the first quarter were recovered in the second quarter. I just wondered if you could quantify that amount and provide color? Will there be any ongoing benefit in the third quarter? Just curious if you saw any ongoing benefit from the hurricane recovery in your second quarter results as well?" ] }, { "name": "Carol Tom", "speech": [ "Yeah, we can unpack that 8% comp for you this way. I'm going to round to make it easy. About 2 points of growth came from our seasonal business, about 1 point of growth came from the index-based commodity categories that Ted called out, another 1% came from hurricane related sales, and then the remaining 4 came from everything else." ] }, { "name": "Jeffrey Small", "speech": [ "Understood. That's helpful. I also want to dig into the comp performance of your newly remodeled and refreshed stores. I think 250 were completed in the first quarter and you're now through 500 of those stores. Can you provide any detail on the comp performance of those refreshed stores? We're also curious how many refreshes, or remodels, you expect to complete over the course of this year." ] }, { "name": "Craig Menear", "speech": [ "For competitive reasons, we're not going to call out performance of those stores, but we're continuing to roll that through the back half of the year." ] }, { "name": "Carol Tom", "speech": [ "Yeah, we're really excited about the execution of this initiative. In fact, if you look at the capital that we spent for the first six months of the year, 50% of that went into the stores. Our team's just doing a great job of putting in everything we said we were going to do." ] }, { "name": "Craig Menear", "speech": [ "Yeah, we're super excited. The greatest penetration of stores will get our new wayfinding and sign package, which really brightens up the store and makes navigation of the store much easier. We also do what we call a general environmental cleanup of the store -- spiff the floors, add lighting, paint, remodel restrooms and breakrooms for the associates, etc. We're very pleased with the look and feel and our customer sat scores are trending up as we roll that out. As Craig mentioned, we're rolling lockers out, revamping some frontends of the store, putting buy online pickup in store storage lockers into the stores.", "Also, very excited to be rolling out electronic shelf labels. We've not done this in the past and we're starting with our appliance department and we'll do over half the stores this year with sort of iPad sized electronic price signs and information on the appliance in our appliance departments." ] }, { "name": "Carol Tom", "speech": [ "So, this is not for the faint of heart. There's a lot going on inside the stores. But, we piloted this for over a year before we even started to roll. And perhaps that's one reason why we're rolling faster than we thought we might." ] }, { "name": "Craig Menear", "speech": [ "Right." ] }, { "name": "Jeffrey Small", "speech": [ "That's very helpful. Thank you very much and best of luck in the third quarter." ] }, { "name": "Operator", "speech": [ "We'll now hear from Steve Forbes with Guggenheim Securities." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. Regarding gross margin, were there any surprises this quarter? You called out transportation headwind 16 basis points, which I think is up about 8 basis points sequentially. But shrink wasn't called out. Is shrink improving and how do you expect that transportation headwind to trend as we move into the back half of the year?" ] }, { "name": "Carol Tom", "speech": [ "We, like the rest of the nation, are facing higher transportation and fuel costs. We reflected that in the guidance that we gave for our gross margin for the year now. We expect an expansion of 41 basis points for the year. Last quarter, we expected 44 basis points. So, we're doing our best to manage through it, but there's a real issue in the transportation markets in our country.", "On the shrink side, shrink was one of those other factors. When I called out the drivers of gross margin performance, the change in accounting, transportation, and then all other -- shrink was in that all other bucket of 6 basis points of expansion. It was actually a hurt in the quarter, but we were able to offset with the benefits coming off of the newly acquired companies. We have a cross functional team that's working on shrink and, just yesterday, we had a really great report out and have hired a new loss prevention officer into our company. We're excited about that." ] }, { "name": "Steven Forbes", "speech": [ "Just a quick follow-up. You called out that 100% of the stores qualify for profit sharing this quarter. How did that compare to last year as we conceptualize the year-over-year impact from the stronger performance of the business broadly? How do we think about that impact for the full year?" ] }, { "name": "Craig Menear", "speech": [ "For the first half -- and, if I recall correctly, for the first half of the last year we were 100% for our stores as well." ] }, { "name": "Carol Tom", "speech": [ "[Crosstalk] Yeah, we might have been --" ] }, { "name": "Craig Menear", "speech": [ "Might have been two stores that missed last year." ] }, { "name": "Carol Tom", "speech": [ "Yes." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Seth Sigman with Credit Suisse." ] }, { "name": "Seth Sigman", "speech": [ "Thanks for taking the question. Nice quarter, guys. A couple of follow-up questions here. First, in terms of the inflation impact on comps that you talked about, to clarify, it sounds like the bulk of the impact is just on commodity items at this point. Are you expecting to see more increases in some of the non-commodity items as you move through the year? And, from a competitive perspective, are you seeing any of your competitors handle the inflation differently, meaning maybe not pass as much through, get more aggressive, etc.? Thanks." ] }, { "name": "Craig Menear", "speech": [ "Yes. At this point, by far, the largest impact is the 119 basis points that we called out from core commodities. There are puts and takes in that, but for the most part, lumber, for example, is priced weekly. You might have some differential on a SKU or market here or there, but those tend to be priced competitively by everyone across the marketplace. We don't see large impacts in the second half from the non-commodity. In fact, commodity has come down meaningfully. Lumber and copper each, which are behind the 119 basis points, have moved down over the last 8 weeks. If you look at lumber prices, we are now, on framing, only 4% ahead of last year. And the peak there was about 40%. So, we're not going to see the same lumber inflation in the back half.", "Panel prices, again, were 35-40% above LY, and that's now at about 1% over last year. The good news is, we spoke about elasticity earlier -- at 40% increase, and we saw such a sharp and quick run-up in lumber prices, we were starting to see an impact in units. But, over the last 6-8 weeks, as these prices have come down, units have responded nicely. We'll take the volume any day over price in commodities." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Thanks for that color. On the digital business of 26%, a nice acceleration. I think it contributed 170 basis points to the comps, which is one of the strongest we've seen. Is this driven by the seasonal shift? Was there a benefit from that, or something else you can maybe point to that you think is driving that strength? I think a lot of it is still coming from the store, or picked up in the store. What are you seeing that's helping drive that acceleration? Thanks." ] }, { "name": "Craig Menear", "speech": [ "Overall strength in our online business, but certainly supported as well with the seasonal categories. It's interesting that seasonal businesses pick up in the online space just like they do in the physical space." ] }, { "name": "Kevin Hofmann", "speech": [ "Yeah, certainly, we saw balanced growth in both traffic and conversion, as we continue to manage the shift to mobile as well. We had really solid progress with our mobile properties. While we had strength across the stores, real strength in the seasonal businesses really helped." ] }, { "name": "Carol Tom", "speech": [ "And 47% of our online orders are picked up inside of the store. So, we're really driving this interconnected experience." ] }, { "name": "Seth Sigman", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from Matt McClintock with Barclays." ] }, { "name": "Matthew J. McClintock", "speech": [ "Good morning, everyone. Craig, you talked about rolling out small parcel across all major markets now. Could you talk a little bit about the experience of what you're seeing in the business, in those markets, when that capability is rolled out?" ] }, { "name": "Craig Menear", "speech": [ "Sure. We're actually very pleased with what we're seeing here, and it give us the ability to offer different value propositions to our customers. So, a customer who needs a smaller delivery, we can do that much more effectively and much faster for them. Then, it's providing leverage into our overall delivery capability. Right, Mark?" ] }, { "name": "Mark Holifield", "speech": [ "That's right. Again, on the theme of the fastest most efficient delivery in home improvement, certainly we're fast when we have car and van same day delivery available from our stores in all of our major markets. We're almost there with all of our major markets. It's great, because that's incredibly fast, but it also has great coverage. We'd match our coverage of same day delivery up against anyone in the marketplace, and we'd say that our home improvement capability is unmatched in the marketplace. Kevin mentioned the drivers of digital growth. One of those is increased conversion due to faster delivery." ] }, { "name": "Matthew J. McClintock", "speech": [ "Thanks for that. And, Carol, on the macro, I understand you have to look at everything holistically. But, is there any independent impact on certain product categories with housing turnover being as low as it is. I'm just trying to parse through with the 96% of the people that are staying in their house, 4% that are moving -- does that have an outsize impact on specific product categories or not?" ] }, { "name": "Carol Tom", "speech": [ "Let's just look at the math of housing turnover. With 4% of units turning, that's about 5 million households turning. And I'm looking at occupied households today. That's 5 million units turning. The average spend is $3,500 per unit. That means the market opportunity for housing turnover is $17.5 billion. If you use our NYEX market share of 28%, that gets you $5 billion-ish of sales. So, $5 billion-ish of sales on our base of $100 billion suggests that turnover just isn't that important. Just for fun, I modeled what could happen, using that simple math, if turnover were to decline 15%. No one's projecting that. But model it just for fun. The impact on comps -- again, it's not very big -- was less than 1%.", "So, to your specific question about category specific, we have no insight there. But, I'd bring it up to 40,000 feet and say it's just not that important." ] }, { "name": "Craig Menear", "speech": [ "On categories, if you think about the number one project, it would be painting. You would think that if there was going to be an impact, it would be there. We just had our best paint quarter in five years." ] }, { "name": "Carol Tom", "speech": [ "Right. Exactly. Good point." ] }, { "name": "Matthew J. McClintock", "speech": [ "Thanks for the color." ] }, { "name": "Operator", "speech": [ "Our next question comes from Jonathan Matuszewski with Jefferies." ] }, { "name": "Jonathan", "speech": [ "Thanks for taking my question. Could you talk a little bit to the traction you're having in home furnishings? It's a category, I believe, you're leaning into more with SKU count additions. Any color there would be helpful." ] }, { "name": "Ted Decker", "speech": [ "Sure. Very early days. We're adding a number of SKUs in things like tabletop, décor, rugs, etc. Very early days, but pleased with our traction. Significant growth, but on a low base. We've completed the integration of The Company Store, and one of our first integration moves was to list a lot of their better sellers on The Home Depot website. That just went live some weeks ago, and starting to see an uptick there. This is all a journey for our customers to find this product on our website and engage with The Home Depot in these adjacent, but we think very relevant, categories." ] }, { "name": "Craig Menear", "speech": [ "If you think about the data that shows that average number of retailers that customers shopped in roughly the last four years has declined from 13 to nine. Our consumer research said that the customer trusts us to bring value and questions why we don't help them fulfill the balance of their needs in their home. This is an opportunity for us as we go forward, largely as this business continues to shift to the digital world. So, you should think about this as a digital strategy." ] }, { "name": "Jonathan", "speech": [ "Great. Any updates on the B2B site that you're developing for the Pros? Is that currently being piloted in select markets? Any update there would be great. Thanks." ] }, { "name": "Craig Menear", "speech": [ "Sure. I'll let Bill address that." ] }, { "name": "William Lennie", "speech": [ "When we talked about this last December, we said this was a two- to three-year journey, and it will be to build out all the tools and applications that our professional business customers needs. We're still in the customer intercept interview phase and we're in testing mode. So, we'll probably get a couple of customers over on a small test as we go through Q3, but we'll see more activity around this space in Q4." ] }, { "name": "Carol Tom", "speech": [ "We saw a demo of it yesterday, though, and the demo looked good. We've got to get it now out of beta into the customer's hands. But, it looked pretty good." ] }, { "name": "William Lennie", "speech": [ "Good progress as we lean into the initiative." ] }, { "name": "Jonathan", "speech": [ "Great. Thank you, guys." ] }, { "name": "Operator", "speech": [ "We'll now go to Matt Fassler with Goldman Sachs." ] }, { "name": "Matthew J. Fassler", "speech": [ "Thanks so much, and good morning, everyone. My first question relates to inventory. It was a very healthy quarter and inventory was up around the case of sales, but a bit more so than in Q1, and a bit above the rate of sales growth that you seem to anticipate for the second half of the year. So, any color on what drove the increase would be terrific." ] }, { "name": "Craig Menear", "speech": [ "So, Matt, the main thing there is we're investing at an accelerated rate in merchandising resets. The inventory from a seasonal perspective is in great shape. We're at record high levels of in stock, which we felt was critically important to be able to capture the sales that we did in the second quarter. But, the main reason for the increase is the add on of new businesses and the investment in accelerated merchandising resets." ] }, { "name": "Carol Tom", "speech": [ "Right. And just the capital associated with our merchandising resets alone this year is $275 million. So, we're investing into this for the long-term customer experience." ] }, { "name": "Matthew J. Fassler", "speech": [ "Gotcha. On the sales for the second half, you don't typically guide precisely to the quarter. Can you give us a sense of whether that second half sales guidance is, as you presented it today -- what was implied in the business plan at the end of Q1? And also, any comments given the storm impact on Q3 versus Q4 and the anticipated pace of business?" ] }, { "name": "Carol Tom", "speech": [ "Right. So, based on the guidance we gave today, the comp in the second half of the year would be lower than the first half of the year. That meant the two-year stacks will be identical. Our two-year stack in the first half was over 12. That gives you a sense. There's no deceleration happening in the business.", "On the storm side, I called out about a point of growth from hurricane related sales in the second quarter. We recovered 500 million of the 600 million we had last year, so we think we'll get another 100 million in Q3-Q4-ish. But remember, then we have to comp all this stuff, so it's a relative comparison. Does that make sense?" ] }, { "name": "Matthew J. Fassler", "speech": [ "It does. You spoke about inflation earlier in the call. You started to see inflation last year, but it's been quite persistent. Any sense for the inflation backdrop imbedded in that second half guide?" ] }, { "name": "Carol Tom", "speech": [ "There isn't any." ] }, { "name": "Craig Menear", "speech": [ "We really didn't. Like Ted said, we're seeing the commodity side of the inflation mitigate. It's really going away." ] }, { "name": "Matthew J. Fassler", "speech": [ "Okay. Thank you so much, guys." ] }, { "name": "Operator", "speech": [ "We'll now go to Budd Bugatch with Raymond James." ] }, { "name": "Budd Bugatch", "speech": [ "Thank you very much for taking my question. Congratulations on the quarter. Pro penetration -- you've had some really great growth in Pro. I think penetration, last we knew, was like 40% of sales. Has that moved off at all with the continuing outpacing of Pro?" ] }, { "name": "Craig Menear", "speech": [ "Yeah, actually we are seeing movement on that as we've consistently had our Pro business growth accelerate against out growth in DIY. So, we are seeing that." ] }, { "name": "William Lennie", "speech": [ "We would take the Pro penetration closer to 45% today. We've seen several years of growth where Pro outpaced consumer. Consumer strength has been there, but it's the activity and the home investment that Carol spoke to. The Pro growth has exceeded that and we'd peg it at about 45%." ] }, { "name": "Budd Bugatch", "speech": [ "And to your particular area, the integration of the outside sales force and the inside sales force -- can you give us a little bit of flavor of where that is in the Interline integration today? You've made a lot of progress, but where is that and what have you been pleased by?" ] }, { "name": "William Lennie", "speech": [ "Craig spoke about integrating our outside sales force and that's been completed. We're seeing great collaboration across the organizations, which is allowing us to cross sell between Interline's inventories and Home Depot's inventories. And then, our sales professionals really provide a service beyond just product for our customers. They are experts in their field. With that, it does drive engagement. We've seen great strength, both in store and outside of the store, particularly with our accounts. So, that integration continues to progress nicely." ] }, { "name": "Budd Bugatch", "speech": [ "Thank you very much. Good luck on the second half." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from Zach Fadem with Wells Fargo." ] }, { "name": "Zachary Fadem", "speech": [ "Hey, good morning. With respect to your online business, would you say there are any particular categories where you tend to over index relative to your overall mix? Conversely, what are the categories that maybe haven't resonated with the consumers, haven't seen that response yet? Could you talk about the dynamics there?" ] }, { "name": "Craig Menear", "speech": [ "We've seen the opposite effect. There were categories that we anticipated the customer may not engage in the digital world, but that shopping experience actually starts in the digital world, even if it finishes in the physical world. So, if you think about things like flooring for doors, which you would traditionally think of as a category that would be purchased in store, in most cases, the shopping experience actually starts in the digital world. We've seen really nice engagement with the customer, really across categories." ] }, { "name": "Zachary Fadem", "speech": [ "That's interesting. On the Pro, could you talk about any impact you're seeing from your data initiatives, and any evidence today that you're gaining share of the Pro wallet? With respect to the categories, where do you see the biggest opportunities to gain Pro share? Thanks." ] }, { "name": "William Lennie", "speech": [ "On the Pro data, through my view and our tools at the Pro desk, we've been able to provide better insights for our instore Pro sales associates. We've seen growth across all of our managed accounts and our portfolios. But, the fastest growing segment of our Pro business is the Pros that are in our stores and covered by our policies. So, it just shows that as we provide insights we can give them some guided selling tools, they engage more with the customers, and can provide better insights for us, what services and what products we can provide. That just leads to engagement and Pro growth. Strength has really been outpaced in store versus our outside sales, which is all about execution and in stocks and great relationships." ] }, { "name": "Zachary Fadem", "speech": [ "Got it. Thanks for the color. Appreciate the time." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from Chris Horvers with J.P. Morgan." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning. There has been a lot of management changes at your largest competitor and I know it's early, but are you seeing any difference in terms of how they approach the market, whether from a customer service perspective or from a promotional perspective, or any other changes?" ] }, { "name": "Craig Menear", "speech": [ "Chris, our job is to focus on our customer. That's really what we're focused on doing." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. Besides appliances, you don't bank market share gains into your guide. Can you talk about how you assess your performance relative to the market in 2Q overall? Did you gain share in any sense on the breakdown in share between share capture in DIY versus Pro?" ] }, { "name": "Carol Tom", "speech": [ "If only we had that insight into share capture of DIY versus Pro. As you know, market share is a bit elusive for us. The best we can do is look at the NYEX 4441. If we look at the NYEX 4441, it would suggest that we gained share in the second quarter." ] }, { "name": "Christopher Horvers", "speech": [ "And then, as you think about your outlook for market growth in the back half of the year, have there been any changes since you put out the initial guidance in 4Q, or since the 1Q update?" ] }, { "name": "Carol Tom", "speech": [ "No. Home price appreciation is doing exactly what we thought it would do. Household formation is trending the way that we thought it would. The age of the houses -- well, they're getting older. The housing turnover is the only one that slowed down a little bit. But again, it's not that important. It's a driver of spend, not a driver of growth." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks very much. Best of luck." ] }, { "name": "Isabel Janci", "speech": [ "Kat, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from Brian Nagel with Oppenheimer." ] }, { "name": "Brian Nagel", "speech": [ "Good morning. Congrats on a very nice quarter. There has been a lot of discussion about lapping the hurricanes in the second half of this year. As we look at what's happening now on the West Coast of the United States, with fires out there, how does Home Depot typically react with that? Is there an initial wave of demand that comes? Is there a long-term demand that comes as a result of that activity? Thanks." ] }, { "name": "Craig Menear", "speech": [ "First, our thoughts and prayers go to all the folks that are being impacted here. It's a horrible situation for sure. For us, the good news is that we don't have any structures that have been impacted, but we certainly have associates and customers who have been impacted. It's a tough situation. Fires are a tough thing. Fires destroy everything. Essentially, you're in a new rebuild from that point forward. That's obviously not the focus of our business. That's not where our strength or focus is. So, no. It's a tough deal for those affected. We feel for everybody that's going through this. You certainly hope for the safety of all the folks battling the blazes, our first responders." ] }, { "name": "Brian Nagel", "speech": [ "Got it. Congrats again on the quarter. Thanks." ] }, { "name": "Isabel Janci", "speech": [ "Thank you for joining us today. We look forward to speaking with you on our third quarter earnings call in November.", "..." ] }, { "name": "Operator", "speech": [ "Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you all again for your participation. You may now disconnect." ] }, { "name": "Budd Bugatch", "speech": [ "More HD analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
HD	2022-05-17	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chief Operating Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Jeff Kinnaird", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Executive Vice President, Outside Sales and Service", "name": "Hector Padilla", "position": "Executive" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings, and welcome to The Home Depot first quarter 2022 earnings call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Welcome to Home Depot's first quarter 2022 earnings call. Joining us on our call today are Ted Decker, CEO and president; Jeff Kinnaird, executive vice president of merchandising; and Richard McPhail, executive vice president and chief financial officer. Following our prepared remarks, the call will be open for questions.", "Questions will be limited to analysts and investors. [Operator instructions] If we are unable to get to your question during the call, please call our Investor Relations department at (770) 384-2387. Before I turn the call over to Ted, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.", "These risks and uncertainties include, but are not limited to, the factors identified in the press release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thank you, Isabel, and good morning, everyone. We appreciate you joining us on the call this morning. Fiscal 2022 is off to a strong start. Sales for the first quarter were $38.9 billion, up 3.8% from the same period last year.", "Comp sales were up 2.2% from the same period last year, and our U.S. stores had positive comps of 1.7%. Diluted earnings per share were $4.09 in the first quarter, up 6% from $3.86 in the first quarter last year. The strong performance in the quarter is even more impressive given the robust performance we were comparing against last year.", "A year ago, we delivered the highest first-quarter sales in company history as we benefited from outsized demand for home improvement goods, favorable weather, and government stimulus. This year, we achieved a new high watermark for first-quarter sales as strong demand for home improvement goods continued despite a slower start to spring in many parts of the country. Delivering such strong results on top of last year's historical growth is a testament to our orange-blooded associates. They are maintaining their relentless focus on our customers while continuing to navigate the ongoing pandemic, global supply chain disruptions, inflation, and a tight labor market.", "We are also thankful for the strength of our relationships with our supplier and transportation partners. Our respective teams are working tirelessly to flow product to source and distribution centers as quickly and efficiently as possible. I would like to thank them for their ongoing support as we continue to navigate a challenging and dynamic environment. The demand seen in the first quarter exceeded our expectations.", "The home improvement consumer remains engaged. Customers continue to tell us that their homes have never been more important, and project backlogs are very healthy. We believe that the medium- to longer-term underpinnings of demand for home improvement have never been stronger. We are thrilled with our Pro performance in the quarter, driven by underlying strength in project demand.", "We continue to invest in an ecosystem of capabilities, including enhanced fulfillment options, a more personalized online experience as well as other business management tools to drive deeper engagement with our Pro customers. And we believe our efforts are resonating. We are navigating a unique environment, but we believe we have the tools, the team, and the experience to effectively manage through. While we don't know how inflation might impact consumer behavior going forward, we are closely monitoring elasticities and customer trends across our respective categories and geographies and remain encouraged by the underlying strength we see in the business.", "Jeff will provide a bit more color about what we've observed from a category and big-ticket standpoint in a moment. And while inflation impacted our average ticket increase this quarter, it wasn't the only impact. As we've seen over the past several years, our customers continue to trade up for premium innovative products. In March, we held an in-person store manager meeting for the first time in three years.", "One of the many highlights of that week is our Product Walk, where vendors showcased the latest in product innovation. And what I can share with you is that the level of innovation across the business is robust. In fact, almost 90% of the products on display this year are entirely new SKUs to The Home Depot. So the pipeline for innovative products remains very strong.", "Beyond product and innovation, my biggest takeaway from the store managers' meeting is how energized the team is. The exceptional execution our associates delivered over the last few years hasn't been easy, but our teams have consistently risen to the challenge. We frequently survey our associate base and are pleased that engagement and morale remain high. Last quarter, we talked about our customer-backed approach to remove friction at every touchpoint of the shopping experience.", "To that end, we recently announced that Matt Carey has been named executive vice president of customer experience. In this newly formed role, Matt will partner across the business to help design and develop new and innovative solutions to drive a seamless experience for our customers. As Matt transitions to this new role, we also announced that Fahim Siddiqui has been promoted to executive vice president and chief information officer, where he is responsible for all aspects of our technology development and strategy. These moves will help drive further alignment around our interconnected retail strategy, which will allow us to enhance what we believe is the best experience in home improvement.", "Richard will talk to you in a few minutes about our guidance for the remainder of the year, but the first quarter certainly got us off to a great start. We're also encouraged by the continued strength we see in the business through the first two weeks of the second quarter as spring is breaking more broadly across the U.S. Our team continues to focus on what is most important: our associates and customers. Our merchants, store and met teams, supplier partners, and supply chain teams did an outstanding job delivering value and service to our customers throughout the quarter.", "I'd like to close by thanking them for their dedication and hard work. With that, let me turn the call over to Jeff." ] }, { "name": "Jeff Kinnaird", "speech": [ "Thank you, Ted, and good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their ongoing commitment to serving our customers and communities. As you heard from Ted, during the first quarter, we continued to see outsized demand for home improvement projects and strong execution from our teams and supplier partners. Turning to our comp performance during the first quarter.", "11 of our 14 merchandising departments posted positive comps, led by plumbing, building materials, millwork, and paint. During the first quarter of this year, we saw double-digit negative comps in our seasonal departments due to the late arrival of spring. Appliances posted slightly negative comps. Adjusting for a shift in event timing, appliance comps would have been positive for the quarter.", "Excluding seasonal categories, we are thrilled with the broad-based strength across the business and healthy project demand. During the first quarter, our comp average ticket increased 11.2% and comp transactions decreased 8.4%. The growth in our comp average ticket was driven primarily by inflation across several product categories as well as demand for new and innovative products. Comp transactions reflect the late start to spring and anniversarying of stimulus.", "And on a two- and three-year basis, both comp average ticket and comp transactions were healthy and positive. Inflation from core commodity categories positively impacted our average ticket growth by approximately 240 basis points during the first quarter, driven by inflation in lumber, copper, and billing materials. Lumber prices remained volatile during the quarter. As an example, framing lumber peaked at approximately $1,300 per 1,000 board feet during the first quarter before falling over $400 to approximately $900.", "Big-ticket comp transactions or those over $1,000 were up 12.4% compared to the first quarter of last year. We saw big-ticket strength across many Pro-heavy categories like pipe and fittings, gypsum, and fasteners. During the first quarter, Pro sales growth outpaced DIY. On a three-year comp basis, both growth with our -- growth with both our Pro and DIY customers was consistent and strong.", "We're encouraged by the momentum we are seeing with our Pros, and they tell us that their backlogs are strong. And during the quarter, we saw many of our customers turn to Pros to help them with larger renovation projects. This can be seen in the double-digit comp performance of our building materials and flowing departments as well as in certain kitchen and bath categories like in-stock kitchens, tubs and showers, and countertops. We also saw double-digit growth in our kitchen and bath installation business.", "This underscores the strength of project demand we are seeing across the business. Sales leveraging our digital platforms increased 3.7% during the first quarter. We are very pleased with the performance of our digital assets as we delivered the highest sales dollar volume in our company history. For those customers that chose to transact with us online during the first quarter, more than 50% of our online orders were fulfilled through our stores, a testament to the power of our interconnected retail strategy.", "As you heard from Ted, we are very excited about the innovation we are introducing across the business. We continue to lean into products that simplify the project, saving our customers time and helping them take on more jobs. One example is our Viega ProPress line of plumbing. Your plumbers can create a water-tight copper connection in 60% less time than a traditional copper solder job.", "Viega ProPress fittings require no flame and work in wet applications. Viega is the market leader in this space and is exclusive to The Home Depot in the big-box channel. In paint, working with Masco and PPG, we have put together a formidable Pro paint lineup that is resonating with our Pro painters. Masco's bare-formulated, Pro-specific offering continues to perform well in our stores.", "And in the first quarter, we added PPG Speed High series. This Pro-specific paint that is specced in the vast majority of multihousing and large commercial jobs, giving us an entry point with our Pro painter for larger-scale projects. And this is now exclusive to The Home Depot in the big-box channel. In spray paint, we launched PPG's GlitonMaxFlex spray paint.", "PPG's proprietary industrial-based technology is uniquely flexible, covering and preserving their original look and feel of a wide range of services, including leather and fabric. And with Masco, we've expanded their exclusive offerings to spray paint, caulks, and sealants as well as interior stains. Now let's turn our attention to spring and the exciting lineup of products we have for our customers. We are thrilled to showcase our new product offerings across our seasonal categories.", "We are seeing an industrywide shift from gas-powered to battery-powered mowers. Demand for cordless mowers have never been stronger. And our lineup of battery-powered mowers, including RYOBI's 80-volt zero-turn riding mower, Milwaukee's new MAT fuel walk mower, DEWALT's FlexVolt walk mower and Makita's LXT walk mower is unmatched. This lineup offers something for everyone, building on an ecosystem of innovative tools powered by the same battery platforms.", "In patio, we have continued to add optionality. And today, customers can create their perfect patio set to transform their outdoor living space through an enhanced online experience. And we expanded our assortment of grills. We're particularly excited about our new Traeger Timberline XL, which provides a larger cooking surface, easier maintenance, and a side burner to enhance your cooking needs.", "Our new Nivo Next Grill is the first propane-powered grill controlled via an app or your mobile device. The app displays timers, grill temperatures and internal food temperatures, providing a consistent cooking experience for hours. We're also excited about our Life Bus program. Each year, our merchant provider customers with new and improved varieties to enhance the overall garden experience.", "We've expanded our disease- and drought-resistant products offering superior performance. For example, Beacon in patients are disease-resistant, and our easy way petunias now require less sunlight and lasts up to six weeks longer. Adding these new hardier plants allows our customers to have a vibrant and healthier garden for longer. Our Live Good Cabo looks incredible.", "We are ready for spring from everything from shrubs to a variety of flower and edibles for every type of gardener. And with that, I'll turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Jeff, and good morning, everyone. In the first quarter, total sales were $38.9 billion, an increase of $1.4 billion or 3.8% from last year. During the first quarter, our total company comps were positive 2.2% with positive comps of 12.9% in February, essentially flat in March and negative 2% in April. Comps in the U.S.", "were positive 1.7% for the quarter with positive comps of 12.5% in February, negative 0.3% in March and negative 2.9% in April. Recall that March reflects the anniversarying of stimulus and April was impacted by a delayed spring this year. Our results this quarter were once again driven by continued strength across the business. Spring temperatures broke late in all our geographies, but in particular, impacted some of our northern regions.", "In local currency, both Mexico and Canada posted comps above the company average. In the first quarter, our gross margin was 33.8%, a decrease of approximately 20 basis points from last year, primarily driven by supply chain investments and pressure from lumber. We continue to successfully offset significant transportation and product cost pressures while maintaining our position as the customers' advocate for value. During the first quarter, operating expense as a percent of sales remained essentially flat to last year at approximately 18.6%.", "We were pleased with our operating expense performance during the first quarter, which reflected planned increases in wage and planned rollout of investments designed to drive efficiency in our store environment. Our operating margin for the first quarter was 15.2%, compared to 15.4% in the first quarter of 2021. Interest and other expense for the first quarter increased by $36 million to $369 million due primarily to higher long-term debt levels than one year ago. Our effective tax rate was 23.9% in the first quarter of both fiscal 2022 and 2021.", "Our diluted earnings per share for the first quarter were $4.09, an increase of 6% compared to the first quarter of 2021. Our total store count at the end of the quarter was 2,316, and selling square footage was 240 million square feet. Unfortunately, during the quarter, we lost a store in San Jose, California due to a fire. Thankfully, no one was injured, and all of our associates have been reassigned to other nearby stores.", "And the team has done a fantastic job continuing to serve our customers in the area. At the end of the quarter, inventories were $25.3 billion, up $6.1 billion compared to the first quarter of 2021. And inventory turns were 4.4 times, down from 5.5 times last year. This level of inventory reflects outsized demand for home improvement projects, actions taken to improve in-stocks, and the impact of the delayed start to spring.", "While our in-stock position is not back to pre-pandemic levels, it is the healthiest it has been since the pandemic began. Turning to capital allocation. After investing in our business and paying our dividend, it is our intent to return excess cash to shareholders in the form of share repurchases. As we have mentioned on previous calls, we plan to continue investing in our business with capex of approximately 2% of sales on an annual basis.", "We also plan to maintain flexibility to move faster or slower depending on the environment. During the first quarter, we invested approximately $700 million back into our business in the form of capital expenditures. And during the quarter, we paid approximately $2 billion in dividends to our shareholders, and we returned approximately $2.25 billion to shareholders in the form of share repurchases. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 45.3%, up from 45.1% in the first quarter of fiscal 2021.", "Now I will comment on our updated guidance for fiscal 2022. As you heard from Ted, we are very pleased with the strong performance we saw during the first quarter, which surpassed our expectations. Today, we are raising guidance for 2022. We now expect sales growth and comp sales growth of approximately 3% for fiscal 2022.", "We expect comps to be stronger in the first half of the year than the second half of the year. We expect our fiscal 2022 operating margin to be approximately 15.4% for the year, and we expect mid-single-digit percentage growth in diluted earnings per share compared to fiscal 2021. While a number of uncertainties remain, we feel confident that we will be able to continue to manage through a dynamic environment while growing faster than our market and delivering exceptional shareholder value. Thank you for your participation in today's call.", "And, Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] Our first question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. Understanding that your overall results were very strong, are you seeing any signs that either inflationary pressure, rising interest rates, or simply home improvement fatigue are starting to have a negative impact on the business? And does it give you pause that comp transactions were down high single digits in the quarter as maybe a leading indicator that the business could soften from here?" ] }, { "name": "Ted Decker", "speech": [ "Thanks, Michael. So a lot in that question. As we've said, we had a great in comp to comp from last year. As you recall, Q1 last year was our highest first-quarter sales and our highest comp at 31% in the very, very long time.", "So as we went into this year, we were understandably conservative as to how we thought Q1 would pan out. But in fact, we saw that the consumer is very engaged. The Pro is very strong, and we posted those results with very much delayed spring. In Q2, it's early, but we're off to a strong start.", "We also think that the fundamentals -- I mean these are all very short term in nature comments, but the fundamentals for home improvement remain incredibly supportive. So when you look at inflation and interest rates in any fatigue, if I take those in order, inflation is definitely higher than we thought. If you recall, last year, we thought we'd have about 5% growth in ticket. We're seeing obviously much higher than that with 11% in ticket.", "A lot of that is inflation-driven. But our customers are resilient. We are not seeing the sensitivity to that level of inflation that we would have initially expected. On interest rates, and Richard can talk a little bit more about interest rates and housing, but we have not seen that impacting our business.", "And the nature of housing, again, Richard will cover in greater detail. And then the fatigue, we're not seeing at all. We'd look at PCE and ships in PCE, and while we are seeing some shift to services in general, we're not seeing a big shift out of home improvement, and we're not seeing fatigue with our customers given repair/remodeler, intent and activity still tracking at the highest levels that we've recorded. And then lastly, on transactions, we do always look for a balance of ticket and transactions.", "But again, with these inflation rates, it's a very unique year in inflation, and ticket is higher the norm for sure. But again, the consumer is hanging in there. And, Richard, why don't you touch on the interest rates?" ] }, { "name": "Richard McPhail", "speech": [ "Sure. So just first to start with who our customer is, you need to keep in mind our customers are homeowners. Virtually all sales to our Pro customers are on behalf of a homeowner, and over 90% of our DIY customers are homeowners as well. So let's talk about home improvement demand and what drives it.", "Over our history, we've seen that home price appreciation is the primary driver of home improvement demand. When your home appreciates in value, you view it as a smart investment and you spend more on it. So let's look at what's happened at home prices. We've seen appreciation of over 30% over the last two years.", "In fact, home equity values over the last two years have increased by 40% or over $7 billion just in the last two years. So the homeowner has never had a balance sheet that looks like this. They've seen the price appreciation, and they have the means to spend. And in surveys, our customers tell us that their homes have never been more important, and their intent to do projects of all sizes has never been higher.", "And our Pros say the same thing about their backlogs. So let's talk about interest rates. I think it's important to remember that our addressable market is the 130 million housing units occupied in the U.S. plus probably, call it, 40 million to 50 million more in Canada and Mexico.", "Of those 130 million housing units, on any given year, only about 4% or 5% are sold. That means that over 95% of our customers are staying in place. They're not shopping for a mortgage. Nearly 40% of those homes are owned outright.", "Of those who have mortgages, about 93% of those mortgages are fixed rates. So when you think about our addressable market, the vast majority aren't really paying attention to mortgage rates. And what we've -- what's interesting about that is what we've heard, when they do look at moving, they're actually more and more tempted to stay in their low fixed rate mortgage and remodel their home instead. So these low locked-in mortgages are probably a benefit to an improvement." ] }, { "name": "Michael Lasser", "speech": [ "That's all very helpful information. And in light of that, I hate to follow up with such a negative question, but out of an abundance of conservatism, I'll ask that. Historically, Home Depot has talked about a 20 basis point margin change for every 1% increase or potentially decrease in its same-store sales. Recognizing that the environment hasn't necessarily been business as usual for quite some time, if we do want to take a conservative expectation on the overall macro, would it be reasonable to think that if comps were to decline 1% that that would translate to a 20 basis point decline in operating margin? Or has the business just advanced so much over the last few years through the deployment of technology, a greater sophistication of supply chain, and other factors that perhaps the deleverage wouldn't be as significant moving forward as it might have been in past?" ] }, { "name": "Richard McPhail", "speech": [ "So, Michael, first, we operate an activity-based model with respect to payroll, which is our largest operating cost. And so that naturally decreases as volume decreases. More importantly, we operate with a degree of financial flexibility in our P&L, and that financial flexibility allows us to manage as we think is appropriate in any given environment. So we have room to manage, and we're confident that we can take share in any environment and manage this P&L wisely per the environment.", "With respect to any old benchmarks we may have given, we're beyond that. We have financial flexibility in our model. And again, we would flex to sort of meet the circumstances we would see them." ] }, { "name": "Michael Lasser", "speech": [ "That's helpful. Thank you so much, and good luck." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Hey, everyone. My first question is if we could talk a little more detail around the intent and the backlog that was just mentioned. Curious if you're seeing demand come through because supply was constrained, there's some pent-up projects versus what the backlog or pipeline continues to build." ] }, { "name": "Richard McPhail", "speech": [ "Well, I think you can just start with some survey results. These are public and these are published by the National Association of Homebuilders. This is a survey that goes back to 2001. And the survey, if you bear with me, just sort of says, are conditions -- are you optimistic or pessimistic, 50 being kind of the medium mark here.", "So for the 20 years up to 2020, that optimism index never got above a 58. Today, it stands at an 86. So that is the sentiment of the remodeler. With respect to backlog that is also surveyed, that number over the past 20 years never got above a 64.", "Today, it stands at an 84. Both of those sentiment numbers are all-time highs." ] }, { "name": "Simeon Gutman", "speech": [ "Fair enough. And maybe a follow-up. You mentioned home price appreciation being the most important lever. It looks like the home prices in Canada are starting to turn a bit, and the business seems to be holding up well.", "Can you talk about if that relationship holds or if the same dynamic, the macro conditions for the customer exists and that's why the business is sort of breaking away from that trend?" ] }, { "name": "Ted Decker", "speech": [ "Well, yes, our Canadian business. I'm not as up to speed, Simeon, on the Canadian stats that Richard just went through for the U.S. But our Canadian business is in terrific shape. I mean, remember, they had much more significant lockdowns last year.", "Ontario, in particular, our stores were closed in the first quarter, and we had curbside pickup only. So the business is very, very strong. I don't have as much detail on the relationship with home prices." ] }, { "name": "Richard McPhail", "speech": [ "Well -- but let's just sort of reflect on something. So last Q1, as a company, we reported a 31% comp. Canada was higher than that. So we had a tougher comp in Canada.", "And this quarter, our comp in Canada was higher than company average." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "OK. Two. One, simply, can you just quantify, if there's any way to quantify, the weather impact the late spring? How much of that hurt April? And what should we expect that to contribute into May? And then I'll have a follow-up question." ] }, { "name": "Ted Decker", "speech": [ "So for the quarter, Michael, we think it was about 1%, the negative impact to comp sales in Q1." ] }, { "name": "Michael Baker", "speech": [ "And presumably, most of that occurs in April. Is that fair to say?" ] }, { "name": "Ted Decker", "speech": [ "Yes. Because February, it's not spring anywhere and it's our lowest-volume month. So yes, that's April-driven. As Richard said in his notes, March was more of a stimulus impact as well as a weaker spring in the south.", "And then as you started to move toward northern markets, particularly cold weather in April and for the quarter, 1%." ] }, { "name": "Michael Baker", "speech": [ "Yes. We've all felt that cold weather up here in the Northeast, although it's getting better now. I also wanted to follow up on the home price appreciation question. We've all looked at this for many years, and I think most people get that home price appreciation is that important.", "How concerned are you that higher interest rates eventually slow down existing home sales? And we've seen that decline three or four months in a row, such that the record home price appreciation that we're seeing eventually has to slow down, particularly as the Fed keeps raising rates. And so how big of a concern is that as you think about the rest of the year?" ] }, { "name": "Richard McPhail", "speech": [ "Well, I think we're in a unique position now in recent housing history where we have built a chronic shortage of housing units in the U.S. consistently and steadily for the last 10 years. Some economists assume that that shortage is a little less than 2 million. You hear numbers as high as 4 million.", "If you take other estimates of what will likely be built, we're looking at least five years, if not seven or eight years, before we could actually get back to a point of equilibrium. So we believe that supply and demand are going to be the main drivers of support for home price appreciation, and we know that that chronic undersupply is going to be a condition for quite some time." ] }, { "name": "Michael Baker", "speech": [ "OK. Yeah. Thanks. Appreciate your comment on that." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chris Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning. So on the seasonality sort of lens as you think about the year, you mentioned shifting of the bathtub effect in the second quarter. It looks like the guide doesn't assume that this above-average seasonality that you saw in the first quarter despite a late spring holds.", "You're actually sort of degrading the seasonality going forward. So I guess my first -- the two questions: are you expecting a full bathtub effect into the second quarter? And then why -- is there any reason why you wouldn't think normal seasonality could hold through the back half?" ] }, { "name": "Ted Decker", "speech": [ "Chris, yes, I would -- we certainly don't think it's going to degrade. I would say posting the results that we posted with a very cold and wet spring certainly exceeded our expectations. And as commented earlier, we haven't generally raised guidance after the spring because we say bathtub effect. And too early into Q2 at the time of this call to make a determination.", "But the first quarter beat our expectation by such an extent, even with the poor weather, we felt necessary to raise to the 3% for the year. We haven't taken a specific of a view of Q2. I mean we know at least the 1% is going to flow into Q2. We generally get back all of our spring sales in Q2, even tracking back to the two or three worst early spring since I've been at Home Depot.", "But it is still just so early, and our largest weeks are ahead of us. So we don't want to get too far over our skis, but we're certainly not anticipating the degradation of that normal bathtub effect." ] }, { "name": "Chris Horvers", "speech": [ "Got it. And then my follow-up question is a number of vendors have indicated more price increases are coming. Can you talk about how much of the ticket increase was inflation? How are you expecting inflation to play out over the year? Like we just sort of flatten out as we lap through more price as -- over the next year? And do you expect units to turn positive as the year progresses?" ] }, { "name": "Ted Decker", "speech": [ "Right. So I'll start and then Jeff will give a little bit more detail. Yes, as I mentioned earlier, inflation is higher than we had expected to the extent about two times. The 11-odd percent ticket was the vast majority of that was inflation-driven.", "It is impacting transactions, but as we said, not to the extent that we would have thought. So that's all good. We have taken costs this year, and there is more on the table. Transportation, we've just finished up our ocean contracts.", "That's a global contract cycle that goes into effect in May. So those are in place for the next 12 months. Those are certainly higher on a contract basis from 2021. So we think inflation doesn't go up necessarily from where we are but that it would hold steady at this, call it, double-digit, low 10-ish percent in our product categories through the balance of the year.", "In terms of the impact on transactions, we're going to have better transaction results in Q2 just given spring. When you think of the number of transactions in our garden business in the springtime, that's just a tremendous amount of transactions, and we feel very good that we'll get those in Q2. And then lumber was -- it's been on a bit of a seesaw and was high on average to last year in Q1, and we saw that in negative transactions in lumber. But now we're down quite a bit, and we're down about 35% in lumber prices year over year.", "So we expect to pick up in Q2, in particular, in lumber activity. In terms of the balance of the year and how we think about managing through this, I'll let Jeff provide some more color." ] }, { "name": "Jeff Kinnaird", "speech": [ "Yes. Thank you, Ted. Look, we are -- to Ted's comments, we are managing through an inflationary environment, about two times what we expected in the first quarter. And we see some continuation of that.", "We are working with our supplier partners on managing through this inflationary environment. We've had long-standing relationships with many of our suppliers, and it's a partnership to understand the ongoing complexities of the inflation we're seeing. What we are doing is we are still the customers' advocate for value in our business. And if you look at the value that we're offering across the spring categories, across the entire business, it is exceptional.", "If you look at the project business, we are pleased with what we're seeing in project-related demand, inclusive of some of the inflation that we have experienced across the organization. And again, as the customers advocate for value, we have the tools and the capabilities to manage our broader portfolio strategy and manage the inflationary environment. So very pleased with the partnership across the business to manage this inflationary environment." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, everyone. So with the One Home Depot supply chain strategy, you guys are effectively moving into some new markets or certainly expanding your presence in certain verticals and expanding your TAM. Is there any way to potentially size the impact that some of these new markets are having on your results, be it -- whether it's MRO, large Pros, etc., maybe places where you weren't as competitive just a couple of years ago?" ] }, { "name": "Richard McPhail", "speech": [ "Generally speaking, we are excited about what we're building out in terms of capability and our ability to go after the repair and remodeler planned purchase occasions that we haven't necessarily been able to in the past. But when you start thinking about contribution to results, we're building an ecosystem here for the Pro. It's not just about fulfillment and delivery. It's about an online experience that we think is second to none that's seen incredible traction over the very short term.", "We have a relationship with our Pros in the store that we think is second to none. And, Hector, I'll turn it to you for a second with some detail. But again, with respect to results, we're quite pleased that we grew by $40 billion over the last two years. We were really pleased that we were able to comp the comp and enter into a second quarter so far with two strong weeks.", "And I think over the coming years, you're going to see every element of our model add up to our ability to take market share in any environment. But, Hector, maybe you'll talk a little bit about the Pro." ] }, { "name": "Hector Padilla", "speech": [ "Yes. Richard and Scot, we are building capabilities to attract more of the Pro planned purchase. Every one of those Pro planned purchase help us pull a lot of the other occasions out of our stores. So when Richard talks about the ecosystem, it is about enabling capabilities across all channels to remove friction from the transactions and experiences from our Pros in every instance.", "We are super encouraged from the early signs that we're seeing on the commercialization of the supply chain investments that we're making. And the team is super encouraged and involved and engaged." ] }, { "name": "Ted Decker", "speech": [ "And, Scot, I would add on the MRO piece in the TAM, we couldn't be happier with the combination of our legacy Interline HD Pro business with Home Depot Supply. So not only did we combine the No. 1 and 2 players in that industry, but the Home Depot Supply had additional verticals that our business didn't participate in. So we think the TAM in that MRO market essentially doubled to about $100 billion, and we still sit with less than 10% share.", "The capabilities that we're building, combining those two businesses, we're well on our way of combining sales forces, getting customers oriented to one legacy customer sales force or the other. We're beginning to integrate the supply chains. What we're able to do now in for multifamily housing is incredibly robust and then new verticals, hospitality in particular, as travel has come back. In the hospitality, occupancy rates are going up.", "That business is just booming. So we love our position in MRO in the verticals we're in. And Shane O'Kelly and his team are just doing a great job of that business." ] }, { "name": "Richard McPhail", "speech": [ "I think, just to the TAM point, we talk about the 130 million households in the U.S., about 30 million of those households actually occupy multifamily dwellings. And so that HD Supply acquisition opened up that TAM for us and is a unique attribute of The Home Depot." ] }, { "name": "Scot Ciccarelli", "speech": [ "Excellent. Thanks a lot." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. Wondering if you could just give a little bit more color on puts and takes for 2Q to 4Q with respect to gross margin and SG&A, I guess, in the context of assuming inflation remains at the current level. And then also a bit more context on how you think traffic and ticket will shake out for the full year.", "And then I have one other question." ] }, { "name": "Richard McPhail", "speech": [ "Sure. So for the year, we believe that gross margin, if you just sort of stay mix-neutral, gross margin will see slight pressure from the investments we're making in One Supply Chain. Those have been planned all year, and we've expected that for a while. With respect to operating expense leverage, as we have taken our sales guidance up, we've also raised our operating margin guidance.", "That reflects the operating expense leverage we expect to generate on those incremental sales. With respect to ticket and transaction, we assume that comps in the back half are positive. If inflation persists for the year, persist at current levels, we expect ticket could be in the range of 10% to 12% for the year, offset by transactions to net out to a three comp for the year." ] }, { "name": "Karen Short", "speech": [ "So I guess the question on that, my follow-up would be -- I mean investors are focused on your two -- one-year, two-year, three-year traffic trends. And I appreciate there's a labor efficiency component with negative traffic to some extent. But at what point does the traffic on a multiyear basis maybe start to concern you?" ] }, { "name": "Ted Decker", "speech": [ "Well, this is definitely a unique year for sure in our ticket and transaction dynamic. As I stated earlier, we do look for a balance between ticket and transaction. And we usually plan that growth will come from more or less an equal mix of ticket and transaction. With the -- two fundamental things going on, Karen.", "One we're -- to your point on two- and three-year stacks, we're comping off the $40 billion of sales growth that Richard commented on; and in Q1, at a 31% comp, the highest comp in the longest time at Home Depot. And to comp that, we didn't plan on, to comp that is a huge positive. Now the balance isn't the norm for sure, again, a unique year with this level of inflation, 10, 10-odd percent. But the customer's engagement is much more resilient than we would have thought.", "That's why we hit -- we knew the inflation going into the year, and we knew the potential impact to transactions. The level of activity in our space, and I've talked about the backlog and the intents, is really helping offset that in the consumers staying more engaged. Now as we lap through these extraordinary comps from the $40 billion of growth and certainly hopefully lap through the inflation, we would get back to the balance that we would certainly prefer." ] }, { "name": "Karen Short", "speech": [ "OK. That's helpful. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey. Good morning. Ted, following up on your comment that Q1 beat your expectations, could you talk about the extent that was Pro-driven versus DIY or other pockets of your business? And then as you think about the second half of this year, to what extent do you incorporate stable Pro trends? And could they offset a more variable DIY if the macro or inflationary environment softens from here?" ] }, { "name": "Ted Decker", "speech": [ "Sure. I would start by saying in even our Pro traffic is consumer-driven, right? I mean all projects fundamentally on the home -- we certainly have trades in our business, buying product for servicing other spaces than the home, but the vast majority of our activity is supportive of the home. And whether it's a consumer buying themselves or a Pro, the Pro is buying ultimately for a consumer's home. So with that being said, though, yes, Pro is stronger than we would have thought.", "I mean that's where the beat came from. Our Pro is incredibly strong. And we're so optimistic of, as Hector outlined, ecosystem we're building. We just continue to gain momentum with that Pro customer and certainly offset more of an as-expected consumer.", "When you think of spring as a consumer business in terms of garden, we don't have large penetrations in Pro in our garden business, so that is consumer-driven. And then the stimulus is really impacting the consumer. I mean we all have heard plenty of anecdotes about consumers getting their check last March truly going to buy a new power tool or a new lawnmower. So that was what was unique about the consumer.", "In terms of the trend over time, not just the intent that Richard talked about in the ecosystem, that Hector talked about, but what we love with our Pro customer and the confidence we continue to build in what's happening is when we look at our comps with our Pro customers, we get a stronger progression of comps with the Pro from what we call an unplanned purchase in store, which is still a strong comp, but sequentially going up to higher and higher comps as we get to a planned delivered purchase. So think of that Pro who's just coming to the store to do cash-and-carry in an unplanned purchase versus one who we know is staging out a project and getting that project delivered. The sequence of comps of that engagement gets higher and higher and higher with the highest being planned delivered. Also, when you think about the engagement with our loyalty models in our engagement with our sales forces, again, while still positive, our Pros who are not in our loyalty program, buying a cash-and-carry unplanned purchase while positive, that is the lowest comp going all the way through to a Pro who's in the loyalty program, who's purchasing with us on an interconnected basis and is managed by an outside sales contact, those, by far, have the highest comp within the Pro.", "So we just love this ecosystem that we're building the engagement that we're starting to see, the sequential strength of comps as these Pros get more engaged with us. And yes, we think those Pro trends are going to keep powering the business." ] }, { "name": "Zach Fadem", "speech": [ "That's helpful. And then for Richard, with your inventory growth outpacing sales growth for the past four quarters by a pretty wide margin, how do you think about your position here in terms of having enough inventory or too much inventory? And with the slower start to spring that you called out, how should we think about the potential impact of higher promo on the gross margin line?" ] }, { "name": "Richard McPhail", "speech": [ "So first of all, we're -- we took steps, as Ted had said earlier in the call, to invest in improving our in-stock position. And while we're not -- we're quite where we were pre-pandemic, we are the healthiest we've been in the last few years. So if you think about sort of that pull-forward of inventory, making sure that we landed inventory early because in this business, customer service starts with being in-stock. And you also consider the impact of a late spring.", "That really makes up about half of the increase in inventory, and the other half is simply the impact of inflation. So as we think about this through the year, obviously, we're -- as spring kicks in, we'll see that inventory begin to reflect the seasonality. And we work hard. Our merchants and our supply chain team and our vendor partners work hard to make sure that we have an advantaged position." ] }, { "name": "Ted Decker", "speech": [ "Just a comment on the promotional activity. We did shift an appliance event into May, driven by the Easter following mid-April. As I commented, thrilled with the performance of our appliance business as we finish the event in May. We -- at this point, we don't focus on promotions at all.", "Our focus is providing everyday value for our customers. That has been multiple years of progression, and we're thrilled with the value we're providing every single day in terms of being priced right every day, driving great innovation, and driving a great experience for our customers.Thanks for the time." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Zaccone with Citi. Please proceed with your question." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Good morning, everyone. Thanks for taking my question. Maybe a follow-up about consumer spending toward the home since it's been discussed in detail here.", "Clearly, you're seeing strong demand from ongoing projects. I think investors are trying to grapple with the fact that home spending may slow at some point because of the macro, but the home also has increased importance post pandemic. What's your take on that debate? Do you think that makes home improvement spending more recession-resistant than it's been in the past?" ] }, { "name": "Richard McPhail", "speech": [ "Well, we really just have to look at the health of our customer today, which is strong. And we also have to listen to our customers, those same surveys where the Pro survey, there's also one with respect to consumer intent to do projects. Homeowner intent to do projects of small, medium, and large sizes has never been higher than right now." ] }, { "name": "Steven Zaccone", "speech": [ "Got it. Very helpful. Then just shifting, could you talk about capital allocation priorities if the macro environment were to get a bit choppier? How do you balance capital investment, share buyback, and the potential for M&A? And I guess, specific to M&A, it's been 18 months since you did the HD Supply acquisition. Would you be open to additional M&A in the next few years to reach your higher TAM? How best to think about the criteria?" ] }, { "name": "Richard McPhail", "speech": [ "Well, with respect to capital allocation, we generate strong free cash flow and so have returned significant capital to shareholders over the last decade-plus. With respect to capex and investment in the business, we take a long-term view. We are always going to invest ahead of the customer. We are always looking years ahead to make sure that we build the best customer experience in home improvement.", "And so that would likely be our stance. But we always have to take circumstances into consideration, and we do that in any event." ] }, { "name": "Ted Decker", "speech": [ "And on M&A, we've always maintained an active strategic business development group, and they're always looking in the marketplace for companies really regardless of size, generally on the smaller size, that can add capabilities. So you've heard us talk about some various data shops we've acquired. Certainly, the larger acquisition of supply helped us into a market space, and that is an ongoing review that we're active looking at capabilities and market spaces that an acquisition can help accelerate our development in that space." ] }, { "name": "Steven Zaccone", "speech": [ "All right. Thank you very much." ] }, { "name": "Operator", "speech": [ "Our final question will come from Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey. Good morning. Great results, and congrats. On the inflation front, curious if you're seeing any unit demand destruction as you've been taking retails higher.", "Or is there any signs of trade-down in the basket? Walmart called that out this morning, and I know your basket is obviously very different than theirs. Just wondering if you're seeing anything on that front." ] }, { "name": "Ted Decker", "speech": [ "Chuck, we're seeing no trade-down in the environment, and we're thrilled with the innovation that we're offering to our customers. Ted commented -- as I commented earlier, we're seeing trade-up for innovation. We're seeing a lot of activity around our consumers looking to improve their homes, to adopt new innovations. I talked about the electrified lawnmower business and the opportunity there.", "That's just one example of many examples of trade-up. And then on the project business, we're seeing great demand, as we commented earlier on the project business, both for the Pro and for the consumer." ] }, { "name": "Chuck Grom", "speech": [ "OK. That's great to hear. And then one for Richard. Can you flesh out the expectation for comps in the front half to be better than the second half? If I look at your compares on a three-year geo stack, they're pretty consistent.", "Just wondering if you're being conservative there or I guess the expectation for the trend to slow a little bit in the last six months of the year." ] }, { "name": "Richard McPhail", "speech": [ "It's early. What I would say is we do expect Q2 to be the highest-comp quarter of the year. And expect the first half to be higher than the second half, but we do expect positive comps through the year." ] }, { "name": "Chuck Grom", "speech": [ "In the back half. OK. Great. Thank you." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and thank you, everybody, for joining us today. We look forward to speaking with you on our second-quarter earnings call in August." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2022-11-15	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chair, President, and Chief Executive Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Jeff Kinnard", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Executive Vice President, Outside Sales and Service", "name": "Hector Padilla", "position": "Executive" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Mike Baker", "position": "Analyst" }, { "description": "MKM Partners -- Analyst", "name": "David Bellinger", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steven Forbes", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to the Home Depot third-quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded.", "It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Welcome to Home Depot's third-quarter 2022 earnings call. Joining us on our call today are Ted Decker, chair, president, and CEO; Jeff Kinnard, our executive vice president of merchandizing; and Richard McPhail, executive vice president and chief financial officer. Following our prepared remarks, the call will be open for questions.", "Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question and one follow-up. If we are unable to get to your question during the call, please call our investor relations department at 770-384-2387. Before I turn the call over to Ted, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.", "These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thank you, Isabel, and good morning, everyone. We appreciate you joining us on our call this morning. Sales for the third quarter were $38.9 billion, up 5.6% from the same period last year. Comp sales are up 4.3% from the same period last year.", "And our U.S. stores had positive comps of 4.5%. Diluted earnings per share with $4.24 in the third quarter compared to $3.92 in the third quarter of last year. From a geographical perspective, each of our 19 U.S.", "regions delivered positive comps versus last year, while Mexico posted comps above the company average, and Canada, below the company average, both in local currency. The team has done a fantastic job serving our customers while continued to navigate global supply chain disruptions, inflation in a tight labor market. This quarter also marked another active hurricane season. As they always do, our associates and suppliers did an incredible job supporting those in the path of both hurricanes Fiona and Ian.", "My thoughts continue to be with those impacted by these storms. Our results in the quarter reflect continued solid demand for home improvement projects. While we did see some deceleration in certain products and categories, as Jeff will detail, the project business remains strong across most of our departments. We also saw year-over-year growth with both our pro and DIY customers in the quarter.", "While the business performed very well and our consumer remains resilient, we are navigating a unique environment. We can't predict how the evolving macroeconomic backdrop will impact our customer going forward. However, we continue to closely monitor elasticities and trends across our business and believe we have the tools, team, and the experience to effectively manage in any environment. Despite near-term uncertainties, we believe the long-term underpinnings of demand for home improvement remain strong.", "We are well positioned to leverage our distinct competitive advantages to capitalize on compelling growth opportunities in our space. We are pleased with the traction we are seeing in our interconnected business as we continue to build on our momentum with both our pro and DIY customers. For example, as we add better functionality and capabilities in our Home Depot app, we see greater engagement. In fact, throughout the year, we have seen strong double-digit growth in monthly active users versus last year.", "The growth is attributable to several enhancements we have made, including an improved online experience for our Pro loyalty program, the seamless connectivity we've provided for our military program, and the launch of our new store mode feature, which makes navigating the store and interacting with products much easier. These enhancements translate to less friction of our customers as they navigate the digital world and connect to the physical world. We also remain focused on driving continuous improvement in productivity within the four walls of our store to enhance both the associates' and customer experience. We are currently launching a new application on our in-store mobile devices called Sidekick, which is an in-aisle tasking tool designed to direct associates to the highest-value tasks in real time.", "The tool direct associates to key bays where on-shelf availability is low or outs exist. By simplifying our operations, we can generate productivity, enhance both the customer and associate experience. For the pro customer, we remain focused on investing in an ecosystem of capabilities, including enhanced fulfillment and more personalized online experience, as well as other business management tools to drive deeper engagement with these customers. While we are focused on removing friction from the shopping experience, we are also onboarding capabilities to help our pros run their businesses more efficiently.", "Our pros tell us that finding qualified, skilled labor is a pain point in their business. To that end, we recently announced a Path to Pro platform, connecting skilled tradespeople with hiring trades professionals. This unique and proprietary platform is available at no cost to all Pro Xtra members. It already contains thousands of candidates, and pros have begun posting their open jobs.", "Our team remains focused on what is most important: our associates and customers. Our merchants, store and net teams, supplier partners, and supply chain teams did an outstanding job delivering value and service to our customers throughout the quarter. I'd like to close by thanking them for their dedication and hard work. With that, let me turn the call over to Jeff." ] }, { "name": "Jeff Kinnard", "speech": [ "Thank you, Ted. And good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their ongoing commitment to serving our customers and communities. As you heard from Ted during the third quarter, we continue to see solid demand for home improvement projects and strong execution from our teams and supplier partners.", "Turning to our comp performance during the third quarter, 11 of our 14 merchandising departments posted positive comps. Build materials, plumbing, lumber, millwork, paint, and hardware had comps above the company average. All other departments, with the exception of appliances, flooring, and indoor garden, were positive but below the company average. During the third quarter, our comp average ticket increased 8.8%, and comp transactions decreased 4.4%.", "The growth in our comp average ticket was driven primarily by inflation across our product categories, as well as demand for new and innovative products. Inflation from core commodity categories positively impacted our average ticket growth by approximately 200 basis points during the third quarter, driven by inflation in build materials, lumber, and copper. Big-ticket comp transactions or those over $1,000 were up 10.1% compared to the third quarter of last year. We saw big-ticket strength across many pro-heavy categories like fasteners, pipe and fittings, and gypsum.", "During the third quarter, both pro and DIY sales growth were positive with pro outpacing DIY. We're encouraged by the continued momentum we were seeing with both our pro and DIY customers. In addition, our pros tell us their backlogs remain strong. During the quarter, our project business remained healthy.", "This can be seen in the double-digit comp performance of our building materials, plumbing, lumber, and millwork departments, as well as in other categories like fencing, siding, conduit boxes and fittings, tubs and showers, and cabinets. We're also encouraged by the momentum we continue to see with our larger pro customers. The medium to large repair or model pros continue to post strong double-digit comps. We believe we are building a unique, interconnected pro ecosystem that will increase our ability to grow share in a $450 billion addressable pro space.", "To serve the pro, it's about removing friction through a multitude of enhanced product offerings and capabilities. We feel confident that the investments across our pro ecosystem are resonating and that we continue to gain share with this important customer. As you know, we've been on a journey to remove friction from our interconnected shopping experience. The great example of this was our announcement in December of 2017 to own more of the appliance delivery end to end.", "And in the third quarter, we achieved an important milestone. We now have 100% of our appliance delivery volume managed through our market delivery operations. This has significantly improved the customer experience. On-time and complete deliveries have increased meaningfully.", "And customer satisfaction metrics have increased by approximately six percentage points compared to the third quarter of last year. Turning to total company online sales. We were very pleased with the performance of our digital assets. Sales leveraging our digital platforms increased nearly 10% compared to the third quarter of last year.", "This was driven by our continued investments which are resonating with our customers. For example, during the quarter, lead times improved across different fulfillment capabilities, which drove greater conversion. For those customers that chose to transact with us online during the third quarter, approximately 50% of our online orders were fulfilled through our stores, a testament to the power of our interconnected retail strategy. We're excited about the holiday season.", "During the third quarter, we hosted our Halloween event and could not be happier with the result. 2022 was a record sales year for Halloween programs, both in-store and online as our customers continue to add to their collection with our unique and exclusive assortment. As we turn our attention to the fourth quarter, we intend to continue this momentum with our annual holiday Black Friday and Gift Center events. Our teams have sourced the most compelling artificial tree assortment we have ever had, which makes it easier for our customers to find the perfect tree for their holiday.", "In terms of our decorative holiday program, we couldn't be happier with our industry-leading assortment with extraordinary features and functionality that looks great and also reflects exceptional value. In our Gift Center, we continue to lean into brands that matter most for our customers. With our assortment of Milwaukee, Ryobi, Makita, Dewalt, Rigid, Husky, and more. Earlier this fall, we launched the next generation of the Milwaukee Drill and Drive M18 Fuel lineup, offering more power, run time, and increased safety for our customers.", "In our Gift Center, we are featuring this innovation [Inaudible] with four-tool and two-tool. And we have our exclusive Rigid four-tool, 80-volt brushless combination kit with two free tool, all backed by our lifetime service agreement. And in appliances, we have exciting offers on LG, Samsung, Bosch, Whirlpool, GE, and Frigidaire. We have multiple exclusive offers, including the LG side-by-side refrigerator with Craft Ice, a great innovation in ice making.", "As with prior years, we've extended these events over several weeks, and we believe we are well positioned with the right brands, the right inventory, and a great customer experience. With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Jeff. And good morning, everyone. In the third quarter, total sales were $38.9 billion, an increase of $2.1 billion, or 5.6%, from last year. During the third quarter, our total company costs were positive 4.3% with positive comps of 7.1% in August, 4.4% in September, and 2.1% in October.", "Comps in the U.S. were positive 4.5% for the quarter with positive comps of 7.2% in August, 4.2% in September, and 2.5% in October. On a three-year basis, monthly costs were consistent across the quarter. In the third quarter, our gross margin was approximately 34%, a decrease of approximately 10 basis points from last year, primarily driven by supply chain investments.", "We continue to successfully offset significant transportation and product cost pressures while maintaining our position as a customers' advocate for value. During the third quarter, operating expense as a percent of sales decreased 18 basis points to 18.2%. Our operating expense performance was in line with our expectations, which reflected continued wage investments as well as planned investments designed to drive efficiency in our store environment. Our operating margin for the third quarter was 15.8%, compared to 15.7% in the third quarter of 2021.", "Interest and other expense for the third quarter increased by $80 million to $406 million due primarily to higher long-term debt levels than one year ago. In the third quarter, our effective tax rate was 24.4%, down from 24.5% in the third quarter of fiscal 2021. Our diluted earnings per share for the third quarter were $4.24, an increase of 8.2% compared to the third quarter of 2021. During the third quarter, we opened three new stores, one in the U.S.", "and two in Mexico, bringing our total store count to 2,319. Retail selling square footage was approximately 241 million square feet. At the end of the third quarter, inventories were $25.7 billion, up $5.1 billion compared to the third quarter of 2021. Inventory turns were 4.3 times, down from 5.4 times last year.", "And our inventory growth primarily reflects product cost inflation and strategic decisions in response to continued global supply chain disruption. Turning to capital allocation. After investing in our business and paying our dividend, it is our intent to return excess cash to shareholders in the form of share repurchases. During the third quarter, we invested $770 million back into our business in the form of capital expenditures.", "And during the quarter, we paid approximately $1.9 billion in dividends to our shareholders, and we returned approximately $1.2 billion to shareholders in the form of share repurchases. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 43.3%, down from 43.9% in the third quarter of fiscal 2021. Now, I will comment on our guidance for fiscal 2022. As you heard from Ted, we are very pleased with the solid performance we saw during the third quarter.", "Today, we are reaffirming our guidance for 2022. We expect comp sales growth of approximately 3% for fiscal 2022. We expect comp sales to be positive for the fourth quarter. We expect our fiscal 2022 operating margin to be approximately 15.4% for the year.", "And we expect mid-single-digit percentage growth in diluted earnings per share compared to fiscal 2021. As we've said throughout the year, we find ourselves in a unique environment with many crosscurrents. We are operating in a broad-based inflationary environment not seen in four decades while managing through constrained global supply chain conditions all against the backdrop of monetary policy shifts intended to moderate demand. To date, our customer has proven resilient.", "We feel confident that we will continue to manage with flexibility through a dynamic environment while growing faster than our market and delivering exceptional shareholder value. Before opening the call for questions. We are pleased to announce that we will be holding an investor conference on June 13th, 2023, in New York City. We will share more details in the near future.", "But for now, please hold the date. Thank you for your participation in today's call. And, Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conducting a question-and-answer session. [Operator instructions] One moment, please, while we poll for questions. Thank you.", "Our first question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. The sentiment and narrative around your stock is so heavily focused right now on factors that are out of Home Depot's control, like the state of the housing market and its ultimate impact on home improvement demand. So, can you help frame what is in your control? If home improvement demand, for example, was down 5% next year, is the state of your initiatives such that Home Depot could gain a couple hundred basis points of market share, and in that environment, you'd only be down, call it, 3%? And if your comps were only down 3%, given the flexibility that you have with your cost structure, coupled with your current capitalization that affords you to buy back a lot of stock, you could actually grow earnings in that sort of scenario." ] }, { "name": "Ted Decker", "speech": [ "Hey, good morning, Michael. Thanks for the question. A lot of detail there that I won't get into specifics, but -- but assure you that, you know, we look forward to taking share in any environment. There is a lot of noise around housing and home improvement, and -- and you've heard some of this before.", "But if I can just step back a minute and lay out the environment the way we see it. I mean, we still feel very good, Michael, about our business. We just reported another strong quarter and reaffirmed our guidance for the year. And remember, we've grown this business $47 billion in the last two and three quarters a year.", "From our core customer, we think our customer is still healthy. I mean, our customer tends to have a good job, growing wages, strong balance sheets. They own their home and have seen increased home equity. However, as Richard said in his prepared notes, I mean, it is -- it is a unique environment with lots of crosscurrents of inflation, rising interest rates, etc.", "But given all that, our customer has remained resilient and engaged. As we said, both our pro and DIY customers grew again in this past quarter. Project demand in particular is very strong. Our pro sales are strong, and our pro intercepts with our customers indicate that the backlogs are still very healthy.", "Customers are still spending lots of time at home. We're not all back at work five days a week. These homes continue to age, and they're worth 40% more than they were pre-pandemic. Now, I'm sure we'll get into some housing questions.", "In housing, values may go down a bit, but we're still going to be up meaningfully on a two-year basis. We did see some deceleration in certain products and categories. And again, that's -- that's difficult to get at the root cause. Is it -- is that consumer pulling back in general? Is there a reaction to price inflation? Do we have some pull forward in certain categories that people bought so much in certain categories during the pandemic, or are they moving on to other projects? Our transactions have been stronger than initially thought with this inflation.", "I mean, that's why we have -- we have raised guidance throughout the year is that the price sensitivity wasn't as strong as we thought it would be. However, our guidance implies that fourth-quarter comps will be the lowest for the year, albeit positive. And we have tougher comps from Q4 last year. So, with all that as a backdrop, I mean, as I said in my comments, we believe we have the team, the strategy, the initiatives with each of our consumer and pro, and we'll continue to take share in any operating environment.", "And while there -- there may be some -- some of these crosscurrents in these next X quarters in housing, we still feel the backdrop of housing, the fundamental shortage of housing in this country and the aging of homes is incredibly strong for our space in the medium to long term." ] }, { "name": "Michael Lasser", "speech": [ "That's very helpful framework. But in light of some of the deceleration that you're seeing, one might assume that that might be a prelude to what -- what could be a -- a more pronounced deceleration into '23, especially as some of the material benefit from inflation that the Home Depot has experienced this year fades. So, is it best to recalibrate our expectations and -- and think and model more about a negative comp in 2023 for the Home Depot even if it's just slightly negative?" ] }, { "name": "Ted Decker", "speech": [ "Well, we'll talk about '23 after our fourth-quarter earnings call in February. You know, again, we -- we remain incredibly bullish. There are certainly factors outside of our control. Are the Fed actions going to ultimately, you know, take us to a recession? If so, how deep that might be? Those are things that, you know, we're all wrestling with and everyone has an opinion.", "But we're focused on what we can control, rolling out our strategies, delighting our customers, and taking share in any environment." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much and have a great holiday." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Good morning, everyone. Focusing on housing. So, housing metrics are decelerating much quicker than your comps or your comp stack. Is this just a lag effect? I don't know if this -- this lag is longer than other lags or -- and, Ted, you just made the case that -- that maybe sales decouple from these metrics.", "I assume it's temporary because of home equity and we're spending more time in our home. Or are you suggesting that maybe it's not temporary because we're spending more time on our home?" ] }, { "name": "Richard McPhail", "speech": [ "So, Simeon, it's Richard. Good morning. Just to maybe sort of put some further points on -- on Ted's backdrop, you know, a lot is made of -- of home prices. And, you know, home price appreciation, the change in home price appreciation, we think, has always driven home improvement demand.", "And we've held that view for a long time. But what we also really ran into even, I'd call it, the middle part of the last decade, was that as -- as -- as home prices began to, call it, become more steady, price discovery, in our view, became a little bit harder. And so, the question has always been, number one, is there a lag to spending? Are you going to spend in that specific period when you know your home price is appreciated? Or is there a halo effect that lags over multiple periods? And my hypothesis is, yes, that's what we saw in the last decade. And I think that that just sort of holds true from an intuitive perspective.", "But I think there's another -- there's so many points that are important. Yeah, I think we are all somewhat anchored to what we observed in 2008 and '09. And many of the folks on this call -- in fact, almost all of us were here during 2008 and 2009. You had a situation where 25% of homeowners were underwater on their mortgages.", "You had really a relationship that we saw in our comp sales driven by acceleration in foreclosures. So, it wasn't -- we were not in the period of home price depreciation that you're talking about, single digits. We had a massive price correction in 2006 to 2008. There was price discovery every single day on the front of the newspaper and millions of forced sellers that were creating that price discovery.", "When I look at the situation now, as Ted said, we have home price appreciation of essentially 40% year-over-year -- sorry, over the last three years. In fact, year over year, home prices are up 13%. Since December, home prices are up 8%. It is decelerating.", "But I think if you ask or you listen to most observers, I think most people are calling for if there is a correction, a modest one. So, my question is, how will the price discovery occur? And then, second is -- is that price depreciation actually meaningful enough to change folks' spending behavior? Because, as Ted said, if you're a homeowner, you've done quite well from a balance sheet perspective, you likely have a job, you likely have cash in the bank. And then, we're seeing another just interesting dynamic where, with mortgage rates increasing, our customer is becoming more and more likely to stay in place and begin a project. So, improve in place.", "And so, just sort of going back to the health of the homeowner back in over a decade ago, 25% of mortgages were underwater back then. Let's look at the credit standing of the housing stock in the U.S. now. Of owner-occupied households, 40% are owned outright, no mortgage.", "Of the 60%, they do have a mortgage, 90% of those mortgages are fixed rate, 73% of those mortgages are fixed rate below 4%. So, we are now seeing a dynamic of stay in place and improve your home. And that's what our customers are telling us, and that's what the pros are telling us their customers are telling them." ] }, { "name": "Simeon Gutman", "speech": [ "That's helpful. A follow-up on another very easy-to-forecast variable: inflation. Can you -- can you frame maybe what percentage of your sales could be at risk from disinflation? Is it 100? Or it shouldn't be 100 because some parts of your -- of your product mix aren't going to be vulnerable." ] }, { "name": "Jeff Kinnard", "speech": [ "Hi. Good morning. It's Jeff Kinnard. We are watching inflation very carefully.", "We have seen some deceleration in inflation in the recent months, which is -- which is good for our consumers. But broadly, we are still experiencing some inflation in some specific categories. I'll call it the lumber market. We have seen a deflationary market in lumber over the recent weeks.", "In fact, we've seen a lot of stabilization in that industry versus the prior two years. I did call it an impact from inflation in lumber for the quarter. That was more representative of the early days -- the early days in the quarter. But we're looking at it carefully.", "We're managing category by category. We're working closely with our suppliers in terms of managing cost and cost components. We have a very good and deep understanding of virtually all cost components of all products that we sell. And again, we're managing it very closely." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chris Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, everybody. So, maybe to summarize your comments today, I guess, it's that you're -- you are incrementally more cautious because you're seeing certain categories maybe become slowing or more volatile. But it's not dramatic and it's more the uncertainty of what the Fed, you know -- the Fed's rate raising is going to affect the business in the future potentially." ] }, { "name": "Ted Decker", "speech": [ "That's -- yeah, I think that's a fair representation, Chris." ] }, { "name": "Chris Horvers", "speech": [ "OK. And then, you know, so, can you talk about some of the KPIs you're watching? You know, I guess, what categories specifically are concerning you? Are you seeing DIY trade down? Are you seeing maybe unit trends in the project business slowing? It seems like, you know, the commodity inflation is driving some of -- some of your best project categories. And are you seeing any more sort of volatility from the consumer, I guess, over the past couple of months that -- that is adding that element of caution?" ] }, { "name": "Ted Decker", "speech": [ "Well, I would say that the healthiest thing we're seeing -- as you can imagine, we look at every -- every data set and by geography and category, etc.. The -- the healthiest thing about the business is the project nature of the demand. Now we are a project-oriented business. And, you know, all the categories that Jeff called out that is -- that is driving that project demand remains incredibly strong.", "And we look at it with both our pro customers and with household pros versus consumers. And that project demand remains strong with each of the pro and the consumer. You know, some of the -- the caution is in, again, you know, was it pull forward, is that finally some price sensitivity on some of these, you know, whole good items. You know, we talked about certain appliance categories or grills.", "You know, those -- those definitely have -- have come off the boil. And, you know, again, is it -- is everyone has purchased in the last three years a lot of those categories, and they've -- they've moved into more project and home improvement, or is there, you know, a reaction to -- to inflation. That -- that's what's a little harder to tease out. Here's a case in point.", "Look at our indoor garden business. Two -- two big categories, you might say, are more discretionary: grills and patio. Grills was down. But patio, we had one of the strongest patio quarters that I can remember.", "So, there are definitely some mixed signals. It's -- it's definitely caught our attention, and that's why we're cautious." ] }, { "name": "Chris Horvers", "speech": [ "Then, I guess just following up, you talked about consistent three-year trends over the month. You know, obviously, October was an incredibly strong month last year. I guess, you know, is that -- was that just, you know -- we've heard a lot about the consumer shopping early last year and the holiday season is normalizing. To what extent do you think that maybe the election has had an impact on the business in November? And -- and just overall, how are you thinking about, you know, the positioning today and then into the holiday season?" ] }, { "name": "Jeff Kinnard", "speech": [ "Hi. Jeff -- Jeff Kinnard. What -- you know, we see some normalization back to 2019 in terms of the consumer trend. In the last couple of years, we've seen a pull forward and concerns of supply chain-driven shortages across retail.", "So, we do see -- we do see, potentially, just a return back to kind of more normal holiday spend by the consumer. As I commented in our prepared remarks, we feel very good about our Black Friday, our Gift Center, our -- our -- our decorative holiday assortments. And we're excited about the overall Black Friday season." ] }, { "name": "Richard McPhail", "speech": [ "And just in case you don't have the numbers in front of you -- you know, Chris, you called monthly cadence. So, really our comps were consistent across the month, so not just the three-year, but also the two-year basis. Just keeping in mind that last year's comps in August, September, and October were 31, 45, and 99 sequentially So, you know, if you look at a two- or three-year basis, maybe smoothing some of that out, you know, that one year mostly don't tell you quite as much." ] }, { "name": "Chris Horvers", "speech": [ "Got it. That's very helpful. Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Zaccone with Citi. Please proceed with your question." ] }, { "name": "Steven Zaccone", "speech": [ "Good morning. Thanks for taking my questions, guys. Congrats on the strong results. To follow up on Chris' commentary about the recent performance, has there been any impact from the hurricane recovery spend to call out maybe at the end of the third quarter and, thus far, 4Q?" ] }, { "name": "Richard McPhail", "speech": [ "It was -- it was relatively minimal. So, we think we had about $120 million impact from -- from hurricanes this quarter. But keep in mind, we're overlapping a similar amount from last year. So, these hurricanes and storm impacts extend across quarters.", "You know, what we're more concerned about is the health and safety of our customers and our associates. And our -- our minds and hearts are serving with them right now." ] }, { "name": "Steven Zaccone", "speech": [ "OK. Thanks. A lot of discussion around the top-line outlook given the housing uncertainty, but I wanted to focus on margin. You know, I know there's not a target in place on a multiyear basis, but can you help us think through the levers to protect margin rate if sales growth were to weaken in the future? I guess specific to gross margin, is there an opportunity for gross margin rate improvement as supply chain costs ease?" ] }, { "name": "Ted Decker", "speech": [ "Well, we're managing margin closely, Steven. We look at it quarter on quarter. There's a lot of ins and outs when it comes to -- when it comes to margin as we look forward." ] }, { "name": "Richard McPhail", "speech": [ "You know, we look-- I'll just add that we -- we think we have the tools and the experience and the people to manage price and cost as well as anyone else here. We've proven that over the last three years. There's been immense disruption right in our value chain. And I think the proof is in the pudding when you look back at our history." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, everyone. So, I think everyone here kind of understands there's some uncertainty around the broader home improvement environment given what's happened with interest rates. But how are you guys thinking about the growth potential prospects of the large pro business as we roll into '23? You guys will obviously have a lot more infrastructure and more relationships built at that stage." ] }, { "name": "Ted Decker", "speech": [ "Thanks for the question, Scot. We couldn't be more excited as we've identified a $450 billion addressable market and an understanding of what capabilities we need to deliver to get a larger share of wallet with that large pro repair remodeler. I've been here, as you may know, over 22 years, and we've always known what we needed to do to capture or share a wallet with that pro. And what's so exciting is that Hector and his team right now are actually building out the capability set to get more share of wallet with that large pro.", "And as we build out these capabilities and introduce them to the customers, we're seeing the engagement and the incrementality of sales growth take off. And, Hector, if you give us a little more insight of what you're building, that would be great." ] }, { "name": "Hector Padilla", "speech": [ "Yes. Just we continue to be super excited about the response from our pros as we continue to enable capabilities to remove friction from our ecosystem. I'm very excited about the expansion of our outside sales resources and the growth that those customers are driving. We're seeing those customers grow, not just with direct sales, with our outsize -- outside sales associates, but they're also engaging more on our digital platform and engaging more in our stores for that online purchase.", "And as we continue to grow around other capabilities, whether it's in the B2B, digital platform, or in-store platform, we just continue to be super excited about the response of our pros. And we are just removing friction where we were in friction from all the different channels, and our customers continue to engage with us more and more." ] }, { "name": "Scot Ciccarelli", "speech": [ "Is there a way to potentially size or at least for us to, you know, contextually think about kind of what those potential revenue ramp is as these capabilities get built out?" ] }, { "name": "Hector Padilla", "speech": [ "You know, the -- as Ted said, we're excited. One of the reasons we're so excited because it's such a fragmented market -- such a fragmented market of suppliers. And so, we just think the opportunity is, is exciting and tremendous. And part of the excitement is it's hard to size." ] }, { "name": "Ted Decker", "speech": [ "But -- but I can say, I mean, we don't break out these numbers. But, you know, each of pro and consumer grew again this quarter. And, you know, the pro yet again grew meaningfully faster than the consumer. In our large pro, the ones who are engaging with -- with Hector and team, are developing, are growing the fastest yet." ] }, { "name": "Scot Ciccarelli", "speech": [ "Very helpful. OK. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey. Thanks. Good morning. Great quarter.", "Overall transactions down a little over 4%. I was wondering if you could pack that for us across the pro and DIY customer base." ] }, { "name": "Ted Decker", "speech": [ "I don't know if we -- we break that out, but the -- the strongest, again, was the large pro." ] }, { "name": "Chuck Grom", "speech": [ "OK. All right. No problem." ] }, { "name": "Richard McPhail", "speech": [ "You know, what I'd say -- I mean, the way to put it, too, is our pros shop across our assortment. So, you're going to sort of see similar dynamics in our ticket transaction across the business, generally speaking. But as Ted said, the -- the strength --the strength is with pro." ] }, { "name": "Chuck Grom", "speech": [ "OK. Makes sense. And then, on -- on the cost pressure front, as costs start to ease, how do you think about the pricing environment? Do you think you and peers are likely to hold on to prices as costs start to moderate and you retain that margin as a result? Or are you likely to lower prices and try to maintain the same gross margin -- gross profit margin dollars?" ] }, { "name": "Jeff Kinnard", "speech": [ "Chuck, we -- we watch this very closely. You know, we are the customers' advocate for value, and we watch the market and our competitors very closely. I will say that there has been an enormous shift to trading up to more innovation and more innovative products. We see that in our tool category.", "We see that in the outdoor gardening business. We could see it across multiple categories. We still see that willingness to trade up for great value and great innovation." ] }, { "name": "Ted Decker", "speech": [ "But -- and on the cost side, Chuck, it's definitely easing. So, you look at commodities in particular, commodities have been down six, seven months in a row. You know, lumber is obviously way down, peaking at nearly 1,500 dollars to now under 500 from peak to current during these last three years. However, we still see inflation across the store.", "So, while some will be coming down in certain categories with costs and retails, our forecast at this point is that net inflationary cost pressures continue into 2023." ] }, { "name": "Chuck Grom", "speech": [ "OK. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hey, good morning. Nice quarter. Congrats." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Brian Nagel", "speech": [ "So, my first question, I think -- I just want to ask Chuck's question maybe a little differently. Well, with regard to inflation, what we've seen now for a while was Home Depot has done a remarkable job of kind of strategically passing along inflation. So, Ted, you mentioned a few times now you're starting to see some inflationary pressures ease. The question I have is, are you seeing -- or would you expect that, as inflationary pressures ease even if price doesn't necessarily go down, you see some type of elasticity in demand, means that unit demand would pick up in that type of environment?" ] }, { "name": "Ted Decker", "speech": [ "Well, you know, it's a -- it's a great question. And you could say, hey, if elasticities weren't as sensitive on the up, would they also likely not be on the moderation, if you will. You know, it's -- it's to be determined. I think, you know, broadly, the price sensitivity wasn't as sharp as we expected the last two years.", "That's why, you know, we started each year with more or less a flat forecast expectation and beaten that each of the past two years. On certain commodities lumber, copper wire, where we're pricing to market weekly, you see a much more classic reaction to price and unit productivity. With other categories -- and I -- I hate to bring up grills again, but, you know, there are some classic price points on sort of classic grills. And when we saw those -- those grills get up over $600, you know, we saw a more dramatic drop-off in engagement.", "And Jeff and the team worked those prices down, you know, even -- even to the low 400s -- or high 400s, well, 500s, you saw a response with -- with unit productivity. Across the board, though, there has been, you know -- Jeff mentioned this. There has been so much innovation across our categories. You think of the dramatic shift of outdoor power equipment and power tools and appliances and what the features and benefits of these products are, the technology embedded in these products.", "You know, I'm not sure it's quite an iPhone, but, you know, we're -- we're getting close to -- to power tools being, you know, in that -- in that genre. And people love the newness and the innovation there, albeit higher prices. But people are responding and buying. So, I think it's -- it's a mix, Brian, across the -- the categories.", "And that's what Jeff and our merchant teams do such a great job managing every day." ] }, { "name": "Brian Nagel", "speech": [ "Got it. That's very helpful. Then my follow-up and a quick one just for Richard. You gave us the cadence of comps through the quarter.", "So [Inaudible] guidance, but any commentary, more specifically, on just the trend in business here into Q4?" ] }, { "name": "Richard McPhail", "speech": [ "You know, nothing in the first two weeks of Q4 changes our view on 2022 guidance. And as we said, we expect comps to be positive in the quarter." ] }, { "name": "Brian Nagel", "speech": [ "Got it. Appreciate it. Thank you." ] }, { "name": "Richard McPhail", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hi. Good morning. As you think about your DIY customer specifically and the well-documented challenges in the first half of the year, is it fair to say that your DIY customer improved on a one- and three-year basis this quarter? And as you think about consumer behavior in tighter economic and housing conditions ahead, is there a scenario where the DIY category outperforms pro, as customers trade down or maybe pull back on bigger projects?" ] }, { "name": "Jeff Kinnard", "speech": [ "Zach, I may have to get you to repeat the second part of the question. On the first part of the question, look, we're really pleased with our consumer business through the year in Q1. We had what we always refer to as bathtub effect in some respects. And so, we had a seasonal impact to consumer in Q1 of this year.", "Q2 and Q3 have both been positive. And we're very happy with that business. Could you could you -- would you mind repeating the second part of your question?" ] }, { "name": "Zach Fadem", "speech": [ "Yeah. Is there a scenario where DIY outperforms pro as -- as customers trade down or pull back on bigger projects?" ] }, { "name": "Jeff Kinnard", "speech": [ "Well, you know, I don't think there's any way to conjecture that. I, I do think that what we love about this business is it's all -- it's all in customer demand regardless of the channel it appears through. But, you know, we are -- we don't have a target for pro penetration for the business. And what we've seen through cycles is that, number one, we do very well with both.", "And you can see some fluctuation between the two. But really, what we have going on right now is what we're observing, which is the pro business is leading the company that shows us that the demand for large projects is very healthy right now." ] }, { "name": "Ted Decker", "speech": [ "And we -- you know, someone asked this question before, I'm not sure we answered it. We are not seeing trade down. You know, if you take my -- my grill or appliance example, it's not that people ultimately bought and they traded down. I think it's that people have already purchased, you know, in the past few years.", "And when people, you know, do purchase, again, they're -- they're buying innovation. Our trader business, for example, is incredibly strong. And as they bring out innovation, customers respond." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And when you think about your sixth straight quarter of transaction declines and the fact that there is a more stable repair and maintenance component of your business, to what extent do you believe we fully cycled away from all the pull forward and excess discretionary category demand in 2020 and 2021? And when would you expect this to translate to a more normalized, positive transaction cadence?" ] }, { "name": "Ted Decker", "speech": [ "Well, you know, that's such a great question, and it's something we observe in and build our theories of the case. When you go back now, what are we, we're 11 quarters of of this pandemic. And, you know, the first five, six, we had tremendous transaction growth rate. We all know the story of what happened, not necessarily a lot of cost inflation at that point.", "And then, the last six quarters, you know, we start to lap that tremendous activity but also saw -- for all the reasons we know, supply chain commodities, you know, global cost pressures, we saw significant cost in our business. And comps were driven, as they were this past quarter, with -- with ticket over transactions. What we've seen now, as you step back approaching three years, is our transaction run rate, our sort of three-year CAGR this point is more or less pre-pandemic rates. And you could look at that at one hand and say, wow, here's the slowdown.", "On the other hand, you know -- Richard used the term holding serve. You can look and say, oh, my gosh, this industry erupted with demand for a year and a half. Then you had cycled significant cost increases. The customer hung in there and was resilient.", "And your net over this three year period, up in transactions, in units, despite what we believe you'll hold on to these price levels. I think that all goes back to my, you know -- my opening comments of what is the dynamic of this overall industry and the health and the engagement level of this customer. And if we normalize from here, you know, gosh, more than great. You know, there's obviously all these questions about, you know, recession that -- that we can't answer any better than you all can.", "But when you digest and look back at what's happened in the last three years, you'd say, wow, that's a pretty incredible market segment." ] }, { "name": "Zach Fadem", "speech": [ "Appreciate the thoughts. Best of luck." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Mike Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Mike Baker", "speech": [ "OK. Hi, thanks. Appreciate the color you gave on the fourth-quarter outlook. But the -- you've done such -- such a great job improving your holiday business.", "In fact, in 10 of the last 13 years, your fourth-quarter comp has been better than your third-quarter comp. And by definition, that's occurring on tougher comparisons. Can you talk about, you know, what you've done to make the fourth quarter such a bigger quarter for you and why that might be different this year?" ] }, { "name": "Jeff Kinnard", "speech": [ "Mike, it's Jeff. Yeah, we had an exceptional fourth quarter. In past years, we've built the business on the backs of a decorative holiday. And, you know, we are the customers' advocate for value in that category.", "And we have great innovation and great -- again, great value for our customers. Second, we've built the business of gifting in our gift centers. And you look at the innovation that we're delivering to our pro and to our consumer, it's exceptional. I spoke earlier about the M18 Milwaukee drill and driver combo kit.", "The innovation is just exceptional, as Ted -- as Ted spoke to earlier. And then appliances, you know, appliances is a enormous category for the Home Depot. It's been a category that we've built at an incredible rate. We're investing in capabilities, like I spoke earlier, in terms of delivery.", "We're investing in dot com capabilities in terms of our -- our-- our customers' willingness to -- to review and purchase online. Then I'd also say we're building a great project and business in the fourth quarter. The fourth quarter is a great time for a project. We see a lot of consumers taking, doing smaller projects around their home and getting ready for the holidays.", "And then, finally, I'd say, you know, storage, storage organization, we have incredible storage events. We, again, are customers' advocate for value when it comes to storage across the business. And then, finally, we built an incredible dot-com business. And, you know, this is -- we called the performance in Q3.", "We're expecting a great Q4 with Cyber Monday. And a big part of that is our digital performance, our app performance. And Hector will be here, our president of online. Hector, you want to make comments around the app?" ] }, { "name": "Hector Padilla", "speech": [ "Yeah, sure. Yeah. Thanks, Jeff. I mean, Ted had called out the -- the experience is where -- what it's all about.", "We love the experience, improvements we've made. A lot of it's around in-store connectivity. We talked about store mode. We talked about military.", "We talked about loyalty. We've got some features coming out on pro for in-store checkout experience, and our customers really respond. I mean, we love the ratings in the App Store, 4.8 for the Apple, 4.7 with Google. But we see it in our numbers as well, strong double-digit performance and growth in downloads and the use -- monthly average users in our traffic.", "It's our fastest-growing online property. We're doing billions of dollars of sales through the app. We couldn't be more excited." ] }, { "name": "Mike Baker", "speech": [ "Great. If I could ask one more follow-up. Your buyback did slow a little bit this quarter. Is that maybe a function of of higher borrowing costs? Or how should we think about buybacks going forward? Thanks." ] }, { "name": "Richard McPhail", "speech": [ "Now, you know, we -- we don't ascribe to necessarily a smooth cadence of buybacks. And that will typically reflect just sort of how we think about working capital investment through the year and the cash buffer throughout the year. So, there's really nothing to read into there." ] }, { "name": "Mike Baker", "speech": [ "OK. Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Welcome." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of David Bellinger with MKM Partners. Please proceed with your question." ] }, { "name": "David Bellinger", "speech": [ "Hey, thanks for the question. So, going back to some of the category comments, are you seeing some evidence that the, call it, more discretionary items are turning lower and at a faster pace? I know, last quarter, you mentioned some of those higher-ticket, the $300 to $400 Halloween items, being pretty much as discretionary as it gets and performing pretty well. We saw some discounts on those items in the weeks preceding Halloween. So, any indications that those, you know, splurge items are starting to cool off and more quickly than the rest of the business?" ] }, { "name": "Ted Decker", "speech": [ "David, you know, we had -- we have commented earlier we had record sales both in-store and online in Halloween that included the infamous Skelly, which has been one of our best sellers in terms of the innovation and value we offer our customers. It's really unmatched in the marketplace. And we couldn't be happier with our Halloween performance. If I turn to the fourth quarter, we're really excited about our decorative holiday assortment.", "We've got great innovation and great value for our customers across the assortment of trees, of its lights, of its decorations. We feel very good about the category, and our consumers are reacting exceptionally well to it." ] }, { "name": "David Bellinger", "speech": [ "Got it. I have a Skelly, so, I know exactly what you're talking about. My -- my follow-up, just on the inventory levels, how much of that growth is aimed at pro customers? So, is there a piece of that inventory that's not sitting in the stores? Maybe it's at facilities like in Dallas or the number looks to be a bit more elevated to us at the store level? Just help us unpack the 25% inventory growth number and just get us comfortable that you aren't sitting on too much at this point, especially with some of the deceleration you're now seeing." ] }, { "name": "Richard McPhail", "speech": [ "Well, so, what's investment in inventory and our one supply chain facility is certainly one of the factors in inventory growth year over year. But the primary factor is really just inflation as part of the inventory value. And then, we made strategic decisions to land inventory earlier in the year than we have prior. And really, just to give you some -- some numbers around that and to reflect the fact we feel fantastic about our inventory position, in Q2, we grew our inventory 38% year over year.", "In Q3, that number dropped to 27% year over year. And actually, if you look throughout our history, we actually typically build inventory from Q2 to Q3. In this case, our inventory actually came down by $400 million from Q2 to Q3. Our inventory is healthy, and we're happy with our position." ] }, { "name": "David Bellinger", "speech": [ "Thanks, Richard. Appreciate it." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question will come from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. Maybe just to follow up or focus on the quarterly performance. If I look at the press release, the selected sales data obviously excludes HD supply. So, curious, Ted, if you can expand on the performance of that asset in today's backdrop as it looks like it may be driving some upside to the overall performance of the business." ] }, { "name": "Ted Decker", "speech": [ "Yes. Steven, thanks. Yeah, another great quarter for HD supply. We mentioned this last quarter.", "And they are -- they are just doing a terrific job. Shane O'Kelly and his team are running the largest and the best-focused MRO business for multifamily housing and hospitality, extended living, etc. We are well -- we remain well ahead of all our financial projections when we made the acquisition. The integration is -- is tracking.", "They're integrating sales forces, customer records, and now starting to work or -- on their way in the work of integrating the supply chain. So, that one is -- has just been a terrific acquisition that we're super happy about." ] }, { "name": "Steven Forbes", "speech": [ "And then, if I may, just a quick follow-up for Richard or Ted. Given the performance, can you -- can you remind us on what percentage of sales that business is today? And then, as we -- as we look at the sort of spread between comp and net sales growth, any reason to think that the current sort of year-to-date spread doesn't hold into the fourth quarter?" ] }, { "name": "Richard McPhail", "speech": [ "Well, we don't break HD supply out. As Ted said, we're so happy with it. On the difference between sales and comps, we've always seen a gap there. It just -- comp reflects sales for the POS.", "Sales reflects sales as they're actually delivered or installed. You're going to see that number there. Well, probably through the year, sales will be a little higher than comp. But the important guide here is comp because that's our activity-based metric around sales." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Richard McPhail", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine. And thank you for joining us today. We look forward to speaking with you on our fourth-quarter earnings call in February." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day." ] } ]
HD	2021-05-18	[ { "description": "Vice President-Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chief Executive Officer", "name": "Craig Menear", "position": "Executive" }, { "description": "Chief Operating Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Chief Financial Officer & Executive Vice President", "name": "Richard McPhail", "position": "Executive" }, { "description": "Credit Suisse -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Gordon Haskett -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Senior Vice President, Supply Chain", "name": "Mark Holifield", "position": "Executive" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Liz Suzuki", "position": "Analyst" }, { "description": "Guggenheim -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "Zelman & Associates -- Analyst", "name": "Dennis McGill", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" }, { "description": "R5 Capital -- Analyst", "name": "Scott Mushkin", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to The Home Depot's first-quarter 2021 earnings call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded.", "It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Welcome to Home Depot's first-quarter 2021 earnings call. Joining us on our call today are Craig Menear, chairman and CEO; Ted Decker, president and chief operating officer; and Richard McPhail, chief executive president and chief financial officer. Following our prepared remarks, the call will be open for questions.", "Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our investor relations department at 770-384-2387. Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.", "These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentation will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and good morning, everyone. We appreciate you joining us on our call this morning. Fiscal 2021 is off to a strong start as we grew the business by over $9 billion compared to the first quarter of last year. Sales for the first quarter were $37.5 billion, up 32.7% from last year.", "Comp sales were up 31% from last year, and our U.S. stores had a positive comp of 29.9%. Diluted earnings per share were $3.86 in the first quarter, up from $2.08 in the first quarter last year. Our results this quarter were once again driven by broad-based strength across the business and geographies.", "All of our top 40 markets posted double-digit comps, while Canada posted comps above the company average, and Mexico posted double-digit comps. Both ticket and transactions were up double digits in the quarter. And as Ted will detail, we saw strong double-digit growth from both our Pro and DIY customers. We continue to effectively manage the outsized demand for home improvement products seen throughout most of last year despite disruptions in global supply chains that were further exasperated by port congestion during the quarter.", "We leveraged the scale of our supply chain and partnered with our vendors to maintain our in-stock positions and prioritized key SKUs in high-demand categories. While we continue to see strong level of engagement across our digital platforms, we saw more of our customers return to our stores. Sales leveraging our digital platforms increased approximately 27% versus the first quarter last year, and approximately 55% of online orders were fulfilled through a store. We continue to roll out new capabilities, such as mixed-cart selling from store, that remove friction for both our customers and associates.", "The mixed cart feature enables associates to more efficiently and effectively serve the total project needs for a customer as products from both the website and store can be added to a single transaction. We also continue to drive interconnected enhancements in other areas of the business to solve customer pain points. In tool rental, for example, we will soon expand our rent online pilot chainwide, enabling rent online, pick up in store capabilities for all 1,300-plus tool rental locations in the U.S. and Canada.", "This will enhance the experience for our busy Pro and DIY customers and complement additional investments we are making to expand our rental footprint and increase our assortment and delivery capabilities. We are focused on continuing to leverage the momentum of our strategic investments to further enhance the interconnected shopping experience. Our efforts will continue to support what we believe is our winning formula: deliver the best shopping experience in home improvement, extend our position as a low-cost provider with a relentless focus on productivity and be the most efficient investor of capital in home improvement. We believe this strategy will help us deliver returns by driving growth faster than the market in any environment.", "The build-out of our One Home Depot supply chain vision is a wonderful example of our strategy in action. Enhanced fulfillment capabilities will not only create a better customer experience, but they will also expand the breadth of our current opportunity set from both a product and customer standpoint. The ability to combine this growth potential with scale to create the low-cost network in home improvement is a formula that we believe delivers long-term value creation for our customers, supplier partners, and shareholders. During the quarter, we continued to build out our One Supply Chain vision by opening several new facilities, and we are very excited with the progress we continue to make on this key strategic priority.", "We have now been operating in this unprecedented demand environment for over a year and continue to align around a few key learnings: first, the investments we have made in the business over the past decade were the right ones; and second, they have enabled agility and flexibility to execute on critical business decisions in a challenging and dynamic operating environment. As a result, we have managed unprecedented levels of web traffic, record levels of product flow through our supply chain, all while improving customer service levels in our stores. These factors, coupled with our world-class associates and strong partnership with suppliers, have enabled us to meet outsized demand week after week. Our cultures remain our North Star as their decisions are anchored to some of our most important values: do the right thing and take care of our people.", "Our ability to continue investing for the future while also managing the most fluid environment in our company's history is a direct result of our associates and their extraordinary efforts. I want to close by thanking them for the many ways they continue to live our values by serving our customers, communities, and each other during these challenging times. With that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their commitment to serving our customers and communities. We continued to experience unprecedented levels of demand during the first quarter, with comps accelerating to more than 30% when compared to the first quarter of last year. This elevated demand and transportation headwinds are pressuring parts of the supply chain, but our teams continue to work together with our supplier partners to manage through these pressures.", "Moving to our comp performance during the first quarter. Thirteen of our 14 merchandising departments posted comps at or above 20%, led by our lumber and kitchen and bath departments. Our comp average ticket increased 10.3%, and comp transactions increased 19.1%. Similar to what we reported in our previous three quarters, the growth in our comp average ticket was driven by elevated project demand, customers trading up to new and innovative products, and continued inflation in many product categories, including lumber.", "This was another record-setting quarter for lumber prices. Let me give you an example of what that means for one of our core lumber SKUs. At the end of the first quarter last year, a sheet of seven-sixteenths OSB was approximately $9.55 As we exited the first quarter this year, that same sheet of OSB more than quadrupled in price to $39.76. Inflation from core commodity categories positively impacted our average ticket growth by approximately 375 basis points during the first quarter.", "Our interconnected retail strategy is resonating with our customers as evidenced by strong growth from both in-store and online transactions, and we are pleased with our ability to meet widespread demand across our selling platforms. As you heard from Craig, sales from our digital channels grew by 27% during the first quarter, which equates to more than 100% growth on a two-year stack basis. Big-ticket comp transactions or those over $1,000 were up approximately 50% compared to the first quarter of last year. We saw widespread big-ticket strength across our business, with notable outperformance in lumber, vinyl plank flooring in many of our installation services.", "From a customer standpoint, we saw double-digit growth with both our Pro and DIY customers. Growth with both customer groups accelerated during the first quarter, with Pro sales growth slightly outpacing DIY. Sales to our Pro customers continue to strengthen, posting the fourth consecutive quarter of accelerating growth and the best quarterly growth rate on record. Pros continue to tell us that project demand is strong, and their backlogs are growing.", "Shifting over to our DIY customers. The strong demand we saw during the back half of last year continued during the first quarter. From gardening to garage and organization, new and existing customers are engaging with home improvement. And during the quarter, we were also well positioned for the start of the spring selling season.", "We took decisive action earlier than usual to proactively lean into our inventory position. This paid off as spring began breaking across the country, and our associates were well equipped to service customers across key outdoor and garden categories. And the strength in gardening was more than just plants and shrubs. We posted a record quarter in categories like planters and hardscapes.", "Additionally, while outdoor categories exhibited significant growth during the first quarter, we've continued to see strong momentum with interior projects around the house. Interior projects like countertops, vanities, blinds, and home decor all showed significant growth in the first quarter. As we look forward to the rest of the year, we are focused on continuing the momentum we are seeing with our customers. We're particularly encouraged with the strong demand we're seeing from our Pro customers.", "And for our Pros, we know that brands matter. Brands like Milwaukee, Klein, and Carlon have significant market share in their respective categories and are trusted by our Pro customers to get the job done. Milwaukee recently expanded their powerful M18 battery platform to include a full line of cordless nailers that deliver pneumatic performance with no compressors, no gas cartridges, and rapid-fire rates to keep Pros productive. The M18 platform now features over 200 tools that are exclusive to The Home Depot and the big-box home improvement channel.", "And at a time when Pros are busier than ever, we are thrilled that we are the destination for Carlon's PVC electrical boxes and Klein Tools. These brands are two of the most widely used by electricians. We've enjoyed a long exclusive partnership with Klein, being first to market with their new and innovative products, and we are now the exclusive national partner of Carlon in the big-box home improvement channel. And while we don't know how the demand environment will ultimately unfold, as we look forward to the rest of the busy spring season, we feel great about our position, and we look forward to serving our customers, both in-store and online.", "With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ted, and good morning, everyone. In the first quarter, total sales were $37.5 billion, an increase of $9.2 billion or 32.7% from last year. During the first quarter, our total company comps were positive 31%, with positive comps of 19.8% in February, 36.2% in March, and 34.3% in April. Comps in the U.S.", "were positive 29.9% for the quarter, with positive comps of 19.9% in February, 35.6% in March, and 32% in April. During the first quarter, all 19 of our U.S. regions, as well as Canada and Mexico, posted strong double-digit comps. In the first quarter, our gross margin was 34%, a decrease of approximately 10 basis points from last year.", "Mix pressure from higher lumber sales alone negatively impacted our gross margin by approximately 35 basis points. During the first quarter, operating expense as a percent of sales decreased approximately 390 basis points to 18.6%. We were pleased with our operating leverage during the first quarter as it reflects disciplined expense control, along with a couple of other expense items that I'd like to highlight. First, our operating leverage in the first quarter of this year reflects the impact of several one-time expenses that we incurred in the first quarter of 2020, including additional compensation and benefits to support our associates.", "These expenses were partially offset by underspend in other expense items in the first quarter of last year, notably payroll, as we worked to staff up labor to meet the surge in demand. Together, the net impact of these factors resulted in approximately 240 basis points of operating expense leverage during the first quarter of 2021. Second, during the first quarter of 2021, we incurred approximately $80 million of COVID-related expenses, which created approximately 20 basis points of operating expense deleverage. And lastly, our operating expense leverage during the first quarter also includes pressure from higher accrued bonus expense primarily related to our outperformance for our store Success Sharing program in store and field-based management bonuses for the first half of fiscal 2021.", "Our operating margin for the first quarter was 15.4%, compared to 11.6% in the first quarter of 2020. Interest and other expense for the first quarter increased by $26 million to $333 million due primarily to higher long-term debt levels than one year ago. In the first quarter, our effective tax rate was 23.9%, down from 24.4% in the first quarter of fiscal 2020. Our diluted earnings per share for the first quarter were $3.86, an increase of 85.6% compared to the first quarter of 2020.", "During the quarter, we opened one new store in the U.S. and one in Mexico, bringing our total store count to 2,298. Selling square footage at the end of the quarter was 239 million square feet. At the end of the quarter, inventories were $19.2 billion, up $4.2 billion from last year.", "And inventory turns were 5.5 times, up from five times last year. Turning to capital allocation. Our long-term principles for how we think about deploying capital have not changed. First and foremost, we will invest in our business.", "During the first quarter, we invested approximately $525 million back into our business in the form of capital expenditures. And second, it is our intent to return excess cash to shareholders through a balanced approach of paying a healthy dividend and repurchasing shares. During the first quarter, we paid approximately $1.8 billion in dividends to our shareholders, and we returned approximately $4 billion to shareholders in the form of share repurchases. Our share repurchases during the first quarter partially reflect an elevated cash balance in 2020 when we paused share repurchases to temporarily increase our liquidity levels as we navigated the pandemic.", "Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 45.1%, up from 40.8% in the first quarter of fiscal 2020. Moving to the broader demand environment for home improvement. The strong demand that we've seen for more than a year now has continued. During the first two weeks of May, on a two-year stacked basis, we've seen comps in the U.S.", "above 30%. Housing remains strong. Homeowners' balance sheets are healthy, and our customers continue to tell us that they are planning on spending on a variety of home improvement projects. With that said, we cannot predict how the external environment will evolve and how it will ultimately impact the consumer.", "We will continue to execute with flexibility and focus on what has driven our successful performance. Our relentless focus on the customer and our ability to remain flexible and agile has enabled us to serve our customers and to meet demand in this dynamic environment. Longer term, we remain committed to what we believe is the winning formula for our customers, our associates, and our shareholders. We intend to provide the best customer experience in home improvement.", "We intend to extend our position as the low-cost provider. And we intend to be the most efficient investor of capital in home improvement. If we do these things, we believe we will grow faster than our market, and we will deliver exceptional shareholder value. Thank you for your participation in today's call.", "And Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conducting a question-and-answer session. [Operator instructions] One moment, please, while we poll for questions. Thank you.", "Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Hi, everyone. My first question is, is there anything that changes your view on housing, more or less constructive compared to the underlying assumptions that you built through '21 plan against?" ] }, { "name": "Craig Menear", "speech": [ "No. Simeon, I'd say, yeah, the housing environment continues to remain very strong. So it's only strengthened, I think, from last year. And the current shortage of new housing clearly is helping to drive improvements in the home values, which is a good thing for spending in the home." ] }, { "name": "Simeon Gutman", "speech": [ "OK. And then my follow-up is actually more on operating profit and margin. And I think your message is very clear, that you're focused on growing faster than the market. And I think Richard told us last quarter, you're managing operating profit dollars and margins fall where they fall.", "Can I ask about the two -- I think about incremental drivers going forward. It's about interconnected retail and then somewhat in MRO and Pro because some of the investments and acquisitions you've made. Is there anything about the margin structure of those businesses and incremental growth that would hold back margins?" ] }, { "name": "Craig Menear", "speech": [ "No. I mean, when we look at the business overall, interconnected, we manage as a portfolio approach. And 55% of the orders are flowing through our stores. And then as it relates to the structure in Pro, we've shared in the past -- and you look at Pro in total, Pro is a very similar margin profile to the DIY customer when you're looking at a complete project.", "And so really, nothing there that's dramatically different." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "Hi. Thanks, guys. And I appreciate the fact that you didn't really update your outlook in your press release or talk to it too much. But I guess, let me ask this.", "It seems, and correct me if I'm wrong, you're probably ahead of where you thought you would be at this point. So is there any update to that idea of -- that trends continue -- will be -- I think it was, what, flat to up slightly in margins, at or above 14%? Can you update that comment that you gave in the first quarter? And I guess related to that, is the right way to think about comps for the quarter and, I guess, the year somewhere in that 30% two-year stacked rate? Would that be a fair sort of assumption to model for the rest of the year?" ] }, { "name": "Craig Menear", "speech": [ "Michael, let me share with you -- I mean, clearly, the first-quarter performance was stronger than what we anticipated. We did not think that we would deliver a 31% comp in the quarter. And as it relates to the framework that we provided, Richard, you might want to speak to the framework." ] }, { "name": "Richard McPhail", "speech": [ "Sure. And just to remind everyone, we actually -- at the end of the fourth quarter last year, we felt unable to provide an outlook due to level of uncertainty in the environment. So we did not provide an outlook. We did feel that, given the significance of nonrecurring expenses in 2020, we could provide our view on our margin profile at a hypothetical level of sales.", "So looking forward, we continue to believe that the environment and the consumer response to it is difficult to predict. With respect to Q1, we're very pleased with the operating expense leverage and earnings flow-through that we drove. And we're going to keep operating the business with discipline and keep a focus on driving operating expense leverage." ] }, { "name": "Michael Baker", "speech": [ "OK. Thank you. I appreciate the commentary." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "If you look at your months of May and April, your two-year stacks were running around or even better than 40%. And now, you mentioned May, so far, is up above 30%. So do you think that we're starting to see the stimulus impact to your comps dissipate and such that -- and I know this was asked a couple of different ways, but 30% run rate in a two-year stack is a good way to move forward? Or is it better for us to expect that that 30% two-year stack run rate on an arithmetic basis should slow from here?" ] }, { "name": "Richard McPhail", "speech": [ "Well, Michael, we can't extrapolate results to future periods. It's just too difficult to predict how the environment might evolve and how the consumers' response to that might evolve. When you look at the progression from March and April and you think about stimulus impact, it's very difficult to quantify the impact from stimulus. What we do know is that of the $402 billion that the government announced would be paid directly to individuals as part of the American Rescue Plan, of that $402 billion, $325 billion of it hit bank accounts in March.", "And so while we can't quantify the exact impact, it probably did have some sort of impact on that March to April progression." ] }, { "name": "Craig Menear", "speech": [ "And, Michael, I'd say while we really can't extrapolate to future periods, the one thing that we're very encouraged about is, when you look at the overall kind of backdrop for home improvement on a longer-term basis, we feel very good about that." ] }, { "name": "Michael Lasser", "speech": [ "Anything you want to point to specifically, Craig, from a longer-term basis that you --" ] }, { "name": "Craig Menear", "speech": [ "Well, again, when you -- Mike, when you think about -- we're at post-World War II housing availability, so two months of supply versus historical average of six, that situation won't be resolved in near term. It's going to take time for that to be resolved. So I think that supports home values and the continued growth in home values, which we know, as home values grow, people feel good about investing in their home overall. So that alone is, I think, a very positive outlook for home improvement as you move forward." ] }, { "name": "Michael Lasser", "speech": [ "OK. My follow-up question is, how do you think your market share unfolded in the first quarter from an online perspective, recognizing that you had a very difficult comparison? Do you think you kept pace with the overall market? And is this the right run rate for the online growth to think about moving forward?" ] }, { "name": "Craig Menear", "speech": [ "I mean, again, we look at this as a total and run this as a portfolio because it's so interconnected. And if you look at the data, it appears that we picked up about 170 points in share overall based on the March data that was put out by the government." ] }, { "name": "Richard McPhail", "speech": [ "And you know, just to kind of talk about e-commerce, e-commerce is a capability. It is not a business. And so I think it's very important to always look at the top-level demand in the environment and what we've delivered. So we don't break the business down like that.", "We intend to be there for the customer however they like to shop. There's been a lot of dynamism in that as we worked through the last 12 months, but we're satisfied that we've been there for them. And as Craig said, it's because of the investments we made in interconnected retail over the last few years." ] }, { "name": "Ted Decker", "speech": [ "And, Michael, as you think of last year in the first quarter, the interest in buy online, pick up in store and we stood up curbside, again, our customers chose to shop that way in a contactless or as least contact as possible in the early days of the pandemic. So that's returning to some more natural run rates." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much. Good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey, good morning. I'm curious if you guys are surprised that your basket trends have held in so strong even as your traffic has improved so much." ] }, { "name": "Craig Menear", "speech": [ "I mean, we are seeing customer engagement in all segments of our business. And when you -- we shared that through the progression of the last four quarters, our Pro business has been strengthening as customers get more comfortable having folks in their home. Our services business has been strengthening for three quarters consecutively in a row now. Those are all big-ticket drivers.", "And then as Ted called out, innovation has been a driver of expansion in our ticket, as well as inflation. And, Ted, I don't know if you have any other comments." ] }, { "name": "Ted Decker", "speech": [ "And I think it also speaks to projects. You know, again, people are engaged in projects, and they're engaged in projects across the whole store. So with projects comes basket and ticket, and we're certainly enjoying that." ] }, { "name": "Chuck Grom", "speech": [ "Got it. And then just a quick follow-up for me would be -- you spoke about the big increase in lumber prices. Curious what you're seeing on the demand side unit volume if it's starting to compress a little bit as those prices rise." ] }, { "name": "Ted Decker", "speech": [ "Well, the lumber environment is certainly unique. And the way we're thinking about it right now, Chuck, it's really a storm environment. It's very tough to look at traditional elasticities. Certainly, prices are up.", "As I referenced in the call, a sheet of OSB has quadrupled in price, and it's up even more since the end of our fiscal quarter. But at the same time, demand has kept pace. And when we bring the product into the store, it sells. And the mills are at capacity.", "We have plenty of wood fiber in the supply chain. The relative bottleneck is in the sawmill cutting capacity. We don't see a lot of capacity coming online. So we're probably not going to see a lot of finished lumber product in distribution.", "So as soon as that product hits our stores, it sells. Certainly, price is up. And you would think there'd be supply and demand, traditional elasticity equation there, but it's hard to determine the impact given the storm nature of the demand." ] }, { "name": "Chuck Grom", "speech": [ "Thanks, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with RBC. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning. So we know that you've been working on your One Home Depot, One Supply Chain at least for a couple of years now. Obviously, the overall industry is extremely strong. But I'm curious, are there any examples you can share regarding how these new capabilities may be enabling you to either increase penetration rates in existing markets or penetrate new markets where maybe you couldn't compete as well in the past?" ] }, { "name": "Craig Menear", "speech": [ "Well, I'd say a couple of things, and I'll turn it over to Mark. So first of all, the ability to meet the kind of demand we've seen on direct fulfillment, I think, has been a direct result of the investments that we've made in the business. And the customer satisfaction and efficiency that we're seeing through our new flatbed distribution centers indicates to us that we're making real progress with the customer there. And Mark, I don't know if you want to add to that." ] }, { "name": "Mark Holifield", "speech": [ "Sure, Craig. Yeah. We had a great first quarter in our supply chain development, and we're on track based on that, so continue to increase our fulfillment square footage over 70% this year. Specific to the results we're getting in terms of the flatbed delivery centers, maybe I'll highlight that.", "That was really designed to provide store relief, increase our customer satisfaction and service to customers, expand our available assortment and delivery capabilities. And we now have four flatbed DCs open now in various stages of ramping. Dallas is the furthest along. It's ahead of our plans in terms of the flatbed sales comp, which are very strong and not just in dollars, but also in units and in number of deliveries.", "Our customer satisfaction has improved by 11 percentage points. We've improved our on-time and complete. And notably, our Pro penetration is very strong. In fact, the preponderance of sales out of that facility are, in fact, Pro.", "So really helping us to capture the Pro there in Dallas." ] }, { "name": "Scot Ciccarelli", "speech": [ "And I guess a follow-up would just be -- I guess my understanding, at least historically, has been the new HD Supply capability -- supply chain capabilities should enable you to penetrate markets where you really couldn't play before. You just didn't have that capability to be competitive. Are there any examples of where you're making progress on that front?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. I mean, the focus of the capabilities that we're building on is to be able to expand our reach into the pool customer. We've been very strong over the years with the smaller Pro and the unplanned purchase with a larger Pro. And what we're building is capabilities to actually extend into that planned purchase, and we're seeing that beginning to play out.", "So we're pleased with what we're seeing in the early stages." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question. Ms. Short, your line is live." ] }, { "name": "Karen Short", "speech": [ "Oh, sorry. Hi. Can you hear me?" ] }, { "name": "Craig Menear", "speech": [ "Yes." ] }, { "name": "Richard McPhail", "speech": [ "Yes." ] }, { "name": "Karen Short", "speech": [ "All right. I just wanted to ask a couple of questions on the market in general. I'm wondering if you could frame how big you think the DIY market is versus the Pro market during, I guess, post pandemic versus pre pandemic? And then I had another slightly different angle on a different question." ] }, { "name": "Craig Menear", "speech": [ "Yeah. I mean, we really don't have data as it relates to what we think the growth in the market is. That's a pretty tough number to come by at this point. I mean, obviously, we play in a big market, straight out of the blocks.", "It's a $600-plus billion market in the MRO space that we play in, which is largely focused on multifamily, is another $55 billion. But I don't -- have no way of knowing how much that's expanded as a result of the pandemic." ] }, { "name": "Karen Short", "speech": [ "OK. And then, Richard, I just wanted to ask a question on the actual -- that 14% framework that you had given. And I realize that was just an attempt to give a framework. But when you look at your sales growth this quarter versus your EBIT growth, EBIT grew more than double sales growth.", "Whereas when I look at prior quarters, even if I add back COVID costs, you kind of had like 10% spread. So I'm wondering if that is the right relationship to think about going forward, especially because even in 1Q, as you noted, you had the higher bonus accruals." ] }, { "name": "Richard McPhail", "speech": [ "Well, what I'd say is the reason that we laid out the 14% was because we knew that we were coming to a year where COVID expenses were rolling off and investment expenses were rolling off. And so it was going to be and is the first year where we said, look, we are returning back to operating expense leverage that you could see in the P&L. We feel like we delivered that in Q1. We're very happy with the operating expense leverage and the flow-through relative to sales.", "And like we said, we're going to keep operating with discipline, and we're going to drive operating expense leverage just as we intended. Margin will be a function of sales volume, obviously, but we're pleased with the relationship in Q1." ] }, { "name": "Craig Menear", "speech": [ "Yes. Karen, we naturally leverage with volume." ] }, { "name": "Karen Short", "speech": [ "Sorry. Say that one more time." ] }, { "name": "Craig Menear", "speech": [ "We naturally leverage with volume. There is natural leverage built into the business with volumes." ] }, { "name": "Karen Short", "speech": [ "Yeah. I understand that. I mean, it's all a function of sales. But it is definitely a much wider gap on the two because it would imply full-year numbers are way too low, depending on how that relationship continues." ] }, { "name": "Richard McPhail", "speech": [ "Well, just -- I think, you know, one of the other reasons that we laid out a hypothetical was because it is harder to read through only one or a two-year comparison in operating expense because of the fact that we were still in the middle of an investment program in 2019 and exiting it at the end of 2020. So again, the best comment I can give is we were very happy with Q1 and how we drove operating expense leverage and flow-through." ] }, { "name": "Karen Short", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, everybody. So my first question is, do you think stimulus helps the DIY side of the business more than the Pro? And not sure if you looked at it this way, but on a two-year basis, did Pro accelerate more than the DIY side of the business?" ] }, { "name": "Craig Menear", "speech": [ "You know, I'd say, Chris, on the stimulus situation, it's all consumer demand, whether it is the Pro buying for the consumer because the consumer is doing something or the consumer buying for the Pro. So we kind of look at it as total demand." ] }, { "name": "Christopher Horvers", "speech": [ "And then I guess anything on a two-year -- I guess my thought on that is Pro, you got to get them in your house. And there's a lot of backlog. So it would seem like there could be a near-term bump on DIY versus Pro. And you also had some Pro comparisons last year where the Pro was nonessential.", "So I was just curious if you had teased out what it looked on, on a two-year basis." ] }, { "name": "Richard McPhail", "speech": [ "Well, the two-year stack plainly is the consumer -- you know, outgrew the Pro modestly on a two-year basis. But I don't know that that provides information that's more helpful than saying that the Pro has come back to the job site. Demand seems to be potentially more easily fulfilled through the Pro than it was a year ago. But like Craig said, I think you have to look at top-line demand.", "Ultimately, this is all or almost all consumer demand that is being fulfilled in different ways. So if anything, we're happy with the fact that the Pro seems to be -- seems to have easier access to the job site and is getting to the job site easier." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Makes sense. And then May was a funny month last month. You had sort of stimulus spillover into the first half.", "You had Pro restrictions. I know you talked about on a two-year basis north of 30%. But can you maybe tease out how that month played out relative to the 27% total and -- or even talk about one-year comp trends quarter to date?" ] }, { "name": "Richard McPhail", "speech": [ "I'm not sure I understand your question." ] }, { "name": "Christopher Horvers", "speech": [ "You talked about in May being north of 30% on a two-year basis. Last year, you did 27% in May, but there was a lot of noise. So boiling it down, can you talk about on a one-year basis what the business looks like so far in May?" ] }, { "name": "Richard McPhail", "speech": [ "No. We're two weeks in. It's just too early. But as we said, demand remains strong." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Understood. Have a great rest of spring. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. Richard, could you talk about performance at the gross margin line versus your initial plan? And to what extent was lumber an incremental headwind? And when you think about the other moving parts around promo, underlying comp leverage, maybe mixing and HD Supply, is there anything in Q1 that changes your thinking for the full-year gross margin framework?" ] }, { "name": "Richard McPhail", "speech": [ "So versus last year -- again, just to recap, we saw a decrease of approximately 10 basis points in gross margin, 35 of which were from the increased penetration of lumber in our sales. And so the net of that obviously shows margins up. There's no doubt there is cost pressure in the economy and in our environment, but hats off to our merchants and our supply chain for managing through that. And, Ted, maybe I'll turn it to you for a little bit of color." ] }, { "name": "Ted Decker", "speech": [ "No. The merchants and the supply chain team did a fantastic job. Over the years, we've built tools and processes that give us terrific visibility and great partnership with our finance teams. And as Craig has always said, we run the business as a portfolio.", "And we're a project business, and we're always looking to provide the best value to our customers on a project basis. Having said that, we certainly saw transportation pressure. Shrink on a relative basis was slightly improved, but we are still seeing shrink pressure. And then we're seeing some commodity, as in lumber, and noncommodity cost pressures, but the team has worked through that.", "Believe it or not, there's still cost out in the portfolio. So we still work on cost out and optimization of supply chain flows. And given the strong demand, our promotional cadence was slightly higher than last year. There were some early spring participation that we had completely canceled last year.", "And so we were up in some activity on promotions. The overall level of promotions and any required clearance activity was down meaningfully. So that is what gave the balance of the offset of the cost and mix pressures." ] }, { "name": "Zach Fadem", "speech": [ "Got it. That's helpful color, Ted. Another one for you and also Craig. As you think about all the drivers of home improvement spending today, could you comment on how much of the industry you would quantify as repair and maintenance spending? How much is being driven by housing turnover? And then what would you call discretionary?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. Honestly, we have not taken the time to try to break that out in this demand environment. So I really couldn't give you a breakdown on that. We know that repair and remodel is the essence of what our business is all about.", "And then, of course, we're there to help customers fulfill their dreams in terms of updating their homes. And clearly, over the last year, as customers have spent more time in their homes, they've told us that their home is never more important than it is today. And many of those customers, like myself, we got to see a whole lot of things that needed to be done around the home, and they've been going after that. When times got difficult in 2007 and 2008, repair became more important than remodel.", "But we're certainly not in that kind of environment today. So I just don't have any way of knowing that expansion by those breakdowns at this point." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Appreciate the time." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Liz Suzuki with Bank of America. Please proceed with your question." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you. Can you just talk about new customer growth and whether you're seeing a greater degree of growth in new Pros versus new DIY-ers?" ] }, { "name": "Ted Decker", "speech": [ "Yes. We are very happy with our overall customer portfolio, both DIY Pro and [Inaudible] capabilities. While I won't give any specific numbers and breakouts, I can tell you that our customer files of both Pro and consumer have grown. The health of [Inaudible] are really strong with a repurchase rate of developed customers growing faster than the new customers.", "So the new customers gained last year, we've been able to keep packaging in our – you know, at terrific rates. And our Pro customers, [Inaudible] the activity we're seeing in engagement with our Pro customers with our B2B website, delivery capabilities, our new loyalty program, all of those are also adding to stickiness of the Pro customer." ] }, { "name": "Liz Suzuki", "speech": [ "Great. And just on the services side, I mean, how big is that now as a percent of sales? I know it's probably relatively small. But I mean, are there areas where you think you can expand into services without competing with your Pro customers?" ] }, { "name": "Craig Menear", "speech": [ "Yes. That business is in the 4-ish, 5% range of sales. We are very pleased with the growth that we've seen in that business. And we think we can do that without competing with our Pro customers." ] }, { "name": "Liz Suzuki", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. Maybe just start with a quick follow-up on the broader supply chain initiatives. Ted, I think you mentioned 70% increase in distribution footage this year. So maybe if you can update us on how many facilities that correlates to.", "And any color on the cadence or the planned cadence of openings?" ] }, { "name": "Craig Menear", "speech": [ "Mark, do you want to take that?" ] }, { "name": "Mark Holifield", "speech": [ "Sure. You know, we're on our way to 35 FDCs, flatbed delivery centers. We have four open today. We're opening several more through the end of the year.", "We've got a very solid pipeline there. Our MDOs, we ended 2020 with 39. We opened eight in Q1. And we're opening more there, on our way to roughly 100.", "And then MDCs, we've got two of those open. We opened Houston during Q1. We have a healthy pipeline there, opening several more through the year as well and on our way to 20-ish or so MDCs." ] }, { "name": "Steven Forbes", "speech": [ "Thank you. And then maybe just a quick follow-up for Richard. I don't believe you called out the incremental strategic investment spend impact when you walked through the expense line items. So maybe, if you can, just remind us on where we are, right, in terms of the trajectory of that strategic investment spend that's captive within the model." ] }, { "name": "Richard McPhail", "speech": [ "Well, at the end of Q4 last year, we announced that our strategic investment program that stretched from 2018 to 2020 was materially complete. And so going forward, our stance is that we will look to invest approximately 2% of sales every year in the form of capex. There'll be associated expense with that, but I would just consider that part of our expense structure going forward." ] }, { "name": "Steven Forbes", "speech": [ "Thank you. Best of luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Dennis McGill with Zelman. Please proceed with your question." ] }, { "name": "Dennis McGill", "speech": [ "Thank you. Ted, on the lumber side, when we think about -- I guess that's the biggest driver of the commodity inflation. Is it fair to assume that that impact accelerated through the quarter and was largest in April and then, as we think about the impact so far in May, would be similarly above what you experienced in the first quarter?" ] }, { "name": "Ted Decker", "speech": [ "Yes. Literally, week on week, it's gone up. And as we sit last week, framing and panel are effectively quadrupled in the market index pricing. And again, each of those went up last week." ] }, { "name": "Dennis McGill", "speech": [ "OK. Perfect. And then anything else to learn from the category performance? As you look at passing the April comp of last year and looking at that on a two-year basis, any categories actually accelerating on a two-year basis versus decelerating? And I guess just on the quarter itself, the one category that wasn't 20%, just curious on what that was." ] }, { "name": "Ted Decker", "speech": [ "So the category that was not 20% was paint. We were very pleased with the performance in paint. But last year, I think everyone stayed home and painted. So we had incredibly tough compares.", "So we didn't quite hit the 20% mark. Overall, on what's accelerating, I would say continued outdoor living has been very strong. So if all of you are interested in things like grills and patio sets, those are going to be in shorter supply as we get into the spring because the demand is incredibly strong. And in things like patio, we do a fixed buy as most of that is import, and we had to make the decision on the buy level quite some time ago.", "So that's been particularly strong." ] }, { "name": "Dennis McGill", "speech": [ "Anything else on the other side besides paint that you'd call out as being a decelerating trend?" ] }, { "name": "Ted Decker", "speech": [ "No." ] }, { "name": "Dennis McGill", "speech": [ "Much appreciate it. Thank you, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Greg Melich with Evercore. Please proceed with your question." ] }, { "name": "Greg Melich", "speech": [ "Richard, if we think about that operating leverage and compare it to 2019, you're up 180 basis points. As we think about it going forward, is it fair to say that now are where we want to be going forward? In other words, in the second quarter, you normally are a few billion more sales. And usually, your operating margin is a little higher than the first quarter if you look over the last five years. Is there any reason why we shouldn't assume that sort of flow-through now?" ] }, { "name": "Richard McPhail", "speech": [ "Well, with respect to sales, we're not going to extrapolate what we've seen into the future. Obviously, there's a degree of uncertainty on how the consumer is going to respond this year. I'll just say it again, Greg. When you compare the first quarter of this year to the first quarter of last year and you adjust for nonrecurring expenses, we feel very pleased with the operating expense leverage that we drove and the flow-through that we drove at this level of volume." ] }, { "name": "Greg Melich", "speech": [ "Got it. And then if I could follow up on inflation and mix. If the commodity part of it, it wasn't just lumber, right? The 375 bps was lumber and maybe copper and other commodities? Or was it specifically lumber? And then as part of that, if you -- that was just lumber?" ] }, { "name": "Ted Decker", "speech": [ "Lumber and copper primarily, yes." ] }, { "name": "Greg Melich", "speech": [ "Got it. And so then if we look at that average basket up 10%, is it fair to say that overall inflation or average AUR was 500, 600 bps of that basket increase?" ] }, { "name": "Richard McPhail", "speech": [ "No." ] }, { "name": "Craig Menear", "speech": [ "It was also driven by project nature of the business, the innovation that the merchants have brought to the market." ] }, { "name": "Richard McPhail", "speech": [ "You've got mix. You've got a percentage of basket. I mean, it's -- yes." ] }, { "name": "Craig Menear", "speech": [ "Yes. All done by lumber." ] }, { "name": "Greg Melich", "speech": [ "So inflation isn't widespread across the store. Across the store, it's more mix?" ] }, { "name": "Craig Menear", "speech": [ "If you think about it from a ticket standpoint, the ticket is being driven by a multitude of things. Yes, there is inflation, and we've been able to pass-through. But again, it's also driven by the fact that our Pro business strength drives a higher average ticket. Our services business drives a higher average ticket.", "And so there's a number of factors that drove the ticket strength overall in the business, innovation within categories. So as you continue to expand and grow in cordless capability and outdoor power equipment, for example, the average price in a lawnmower that is a cordless versus gas is significantly higher. All of that contributes to driving that growth in ticket." ] }, { "name": "Greg Melich", "speech": [ "Got it. Thanks a lot. Good luck, guys." ] }, { "name": "Craig Menear", "speech": [ "Thanks, Greg." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Scott Mushkin with R5 Capital. Please proceed with your question." ] }, { "name": "Scott Mushkin", "speech": [ "Hey, guys, thanks for taking my question. So I was just wondering if you could talk about labor inflation and just the overall inflation as you guys think about the back half of the year. So that's number one question." ] }, { "name": "Craig Menear", "speech": [ "Yes. I mean, as you know, we converted part of our COVID expense into permanent labor cost in the November time frame of 2020. And so obviously, all of that is in the performance that we just delivered. As it relates to labor in total, this is spring.", "We're hiring up. We've been able to hire more folks this year than last year, even though we were ramping last year to cover the demand. And so that's something that we work on a week-to-week basis. To be flexible and agile right now is incredibly important.", "And the two areas that we're focused on, not knowing exactly how all this will play out, is inventory flow and labor. Those are the two things that we're focused on. Both are relatively short-cycle planning. And so that's really what we're trying to make sure we can cover the demand that's out there." ] }, { "name": "Scott Mushkin", "speech": [ "And are you guys having any trouble getting labor and having to raise labor rates a lot in certain markets? Or is that really not an issue for you guys at this stage?" ] }, { "name": "Craig Menear", "speech": [ "No. I mean, there's always variances by market, and some markets are more challenging than others in any given year. But as I said, we've actually hired more folks this year than we did last year." ] }, { "name": "Scott Mushkin", "speech": [ "Great, guys. That was my question. I appreciate the answer. Thank you." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you all for joining us today. We look forward to speaking with you on our second-quarter earnings call in August." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2021-11-16	[ { "description": "Investor Relations", "name": "Isabel Janci", "position": "Other" }, { "description": "Chairman and Chief Executive Officer", "name": "Craig Menear", "position": "Executive" }, { "description": "President and Chief Operating Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Guggenheim Securities -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Mike Baker", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "JPMorgan Chase & Co. -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Zelman and Associates -- Analyst", "name": "Dennis McGill", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings. And welcome to The Home Depot's third quarter 2021 earnings conference call. [Operator instructions] It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine and good morning, everyone. Welcome to Home Depot's third quarter 2021 earnings call. Joining us on our call today are Craig Menear, chairman and CEO; Ted Decker, president and chief operating officer; and Richard McPhail, executive vice president and chief financial officer. Following our prepared remarks, the call will be open for questions.", "Questions will be limited to analysts and investors. And as a reminder, please help yourself to one question with one follow up. If we are unable to get to your question during the call, please call investor relations at 770-384-2387. Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.", "These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel and good morning, everyone. We appreciate you joining us on our call this morning. I'm pleased to report that we had another strong performance in the third quarter. Sales for the third quarter were $36.8 billion, up 9.8% from last year.", "Comp sales were up 6.1% from last year with U.S. comps of positive 5.5%. Diluted earnings per share were $3.92 in the third quarter, up from $3.18 in the third quarter last year. Home improvement demand remains strong.", "Our customers remained engaged with projects around the home and we continue to focus on delivering the best experience in retail. As we mentioned last quarter, we continue to see customers taking on larger home improvement projects as evidenced by the continued strength with our Pro customer, which once again outpaced the DIY customer. As been the case for the last 18 months, the team is doing an outstanding job of navigating a fluid and challenging operating environment. Ultimately, this is what has allowed us to respond to the strong home improvement demand that has persisted.", "We had positive comps every week despite unprecedented comparison last year and grew sales by $3.3 billion in the third quarter, bringing total sales growth year to date to more than $15.5 billion through the third quarter. From a geographic perspective, all of our 19 U.S. regions posted positive comps versus last year and both Canada and Mexico posted positive comps. These results were driven by our associates who have maintained a relentless focus on our customers, while simultaneously managing industrywide supply chain disruptions, inflation and a tight labor market.", "While these factors present challenges for retail as a whole, we will use our experience, tools and our scale to manage through this environment with the intent to deliver a strong value proposition to our customers. We are thankful for the tenure and strength of our relationships with our supplier and transportation partners. Our respective teams have worked tirelessly to build depth in key product categories and to flow products to our stores and distribution centers as quickly and efficiently as possible. I would like to thank them for their ongoing efforts as we continue to navigate one of the most challenging environments we have ever faced.", "Beyond the current environment, we are focused on positioning ourselves for growth. We are investing in stores to drive further productivity, which Ted will discuss. We are enhancing the interconnected shopping experience by investing to remove friction for our customers wherever possible. And the build-out of our supply chain vision continues to progress and we remain on track with our plans.", "We are encouraged by the results that we're seeing from buildings that we have stood up as we optimize and assort these facilities to unlock their full potential. We believe that the network we are building is unique to the market. It will not only enhance the customer experience from a delivery standpoint, but also expand the opportunity to capture wallet share gains with both new and existing customers, drive efficiency end to end and leverage our scale to further extend our low-cost position in home improvement. In the near term, we remain focused on being flexible and agile as we navigate this dynamic environment.", "But we also continue to leverage the momentum of our strategic investments to further enhance the interconnected shopping experience in support of our goals to drive growth faster than the market in any environment, further strengthen our position as a low-cost provider and home improvement with a relentless focus on productivity and efficiency and deliver exceptional shareholder value. Our ability to invest for the future while also managing the most fluid environment in our company's history is a direct result of our associates and their extraordinary efforts. I want to thank all of our associates for the many ways they continue to live our values by serving our customers and communities. In conjunction with Veterans Day last week, the Home Depot Foundation announced that it has now surpassed $400 million invested in support of U.S.", "military veterans since 2011. This brings us closer to achieving our goal to invest $0.5 billion in veteran causes by 2025. We honor and support our military veterans and families and we thank them for their service to our country. And with that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig and good morning, everyone. We had a great third quarter. I want to start by thanking all our associates as well as our supplier and transportation partners for their unwavering commitment to serving our customers and communities in what remains a very challenging operating environment. There is no question that pressures on global supply chains increased over the last 18 months.", "That being said, we could not be more pleased with how our cross-functional teams responded. The teams took a number of decisive actions to secure more product for our customers while continuing to find new and different ways to flow that product. Beginning in the second quarter of last year, our merchant inventory and supply chain teams leveraged tools and analytics and work with our vendor partners to adjust our assortments and in some cases, introduced alternative products. The teams also built depth in job lot quantities and high-demand products.", "We improved our in-stock levels in the back half of last year and we've been able to sustain and in some cases, improve our levels, even as home improvement demand remains elevated. In addition to the challenging supply chain environment, we are also seeing rising cost pressures across several different product categories. Our seasoned teams of merchandising, finance and data analytics associates are working with our supplier partners to manage through these pressures. We have effectively managed inflationary environments in the past and we feel good about our ability to continue managing through the current environment while being our customers' advocate for value.", "Turning to our comp performance during the third quarter, 12 of our 14 merchandising departments posted positive comps. Appliances, plumbing, electrical, building materials, tools, kitchen and bath, decor and storage, millwork and flooring had comps above the company average. Paint, outdoor garden and hardware were positive but below the company average. Indoor garden was essentially flat and lumber posted a high single-digit negative comp compared with lumber comps of more than 50% in the third quarter of 2020.", "On a two-year basis, each of our departments posted healthy double digit positive comps. Our comp average ticket increased 12.7% and comp transactions decreased 5.8%. Growth in our comp average ticket was driven in part by inflation across several product categories. Our commodity categories positively impacted our average ticket growth by approximately 70 basis points in the third quarter driven by inflation in copper and building materials, which was partially offset by deflation in lumber.", "On a two-year basis, both comp average ticket and comp transactions were healthy and positive. Big ticket comp transactions or those over $1,000 were up approximately 18% compared to the third quarter of last year. During the third quarter, Pro sales growth continue to outpace DIY growth. On a two-year comp basis, growth of both our Pro and DIY customers was consistent and strong.", "Similar to the second quarter, we saw many of our customers turn to Pros for help with larger projects. We see this in the strength of several Pro-heavy categories like drywall, pneumatics, pipe and fittings and several millwork categories. We remain encouraged by what we are hearing from our Pros as they tell us their backlogs are healthy. Sales leveraging our digital platforms grew approximately 8% for the third quarter, which brings our digital two-year growth to approximately 95%.", "Our customers continue to shop with us in an interconnected manner as approximately 55% of our online orders are fulfilled through our stores. While we navigate these challenging environment, we continue to invest in our business to enhance the customer shopping experience while also driving productivity and efficiency. We believe we have a significant opportunity to further optimize space productivity in our stores by balancing the art and science of retail. This is a continuous process that we believe leads to better, more productive assortments and space allocations, which ultimately drives value for our customers.", "Let me take a moment to comment on some unique capabilities we've built that showcase what I mean. More than a year ago, we started to test in some of our higher-volume stores. The idea was, how can we further drive space productivity and improve the shopping experience at the same time. Our cross-functional teams applied a combination of space optimization models in conjunction with the expertise of our local field merchants, many of whom have more than 30 years of tenure with The Home Depot to create store-specific outcomes that adjust assortments and improved space utilization.", "The results exceeded our expectations. Sales per square foot improved, on-shelf availability improved, Voice of the Customer scores improved, labor utilization improved. And during the process, we were able to add net new base to the stores. As a result, we went from a small test to now targeting more than 400 stores this year with more in the pipeline for next year.", "I want to recognize all the teams helping drive this success. As we turn our attention to the fourth quarter, we are excited about the upcoming holiday season. During the third quarter, we hosted our Halloween event and cannot be happier with the results. We saw record sales and sell-through as customers responded to our exclusive product offerings and innovative approach to the category.", "During the fourth quarter, we intend to continue this momentum with our annual holiday, Black Friday and gift center events. Like last year, we extended these events to cover a longer period and not just focus on one day. With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ted and good morning, everyone. In the third quarter, total sales were $36.8 billion, an increase of $3.3 billion or 9.8% from last year. Foreign exchange rates positively impacted total sales growth by approximately $190 million. During the third quarter, our total company comps were positive 6.1% with positive comps in all three months.", "We saw total company comps of 3.1% in August, 4.5% in September and 9.9% in October. Comps in the U.S. were positive 5.5% for the quarter with comps of 2.2% in August, 4% in September and 9.6% in October. In the third quarter, our gross margin was 34.1%, a decrease of approximately 5 basis points from the same period last year.", "While there are many factors that impact gross margin, during the third quarter, our gross margin was negatively impacted by higher transportation costs and mix of products sold, which was partially offset by higher retail prices. During the third quarter, operating expense as a percent of sales decreased approximately 130 basis points to 18.4%. Our operating leverage during the third quarter reflects the lapping of significant COVID-related expenses that we incurred in the third quarter of 2020 to support our associates, as well as payroll leverage. Our operating margin for the third quarter was 15.7%, an increase of approximately 125 basis points from the third quarter of 2020.", "Interest and other expense for the third quarter was essentially flat with the same period last year. In the third quarter, our effective tax rate was 24.5%, up from 24.1% in the third quarter of fiscal 2020. Our diluted earnings per share for the third quarter were $3.92, an increase of 23.3% compared to the third quarter of 2020. At the end of the quarter, inventories were $20.6 billion, up $4.4 billion from last year and inventory turns were 5.4 times compared with 5.9 times this time last year.", "Turning to capital allocation. After investing in our business, it is our intent to return excess cash to shareholders in the form of dividends and share repurchases. As we have mentioned on previous calls, we plan to continue investing in our business with capex of approximately 2% of sales on an annual basis. We also plan to maintain flexibility to move faster or slower depending on the environment.", "A good illustration of this is what you heard from Ted. We built capabilities to drive productivity across some of our higher-volume stores, we tested them, we saw strong results across key performance metrics and we moved quickly to expand the investment. During the third quarter, we invested approximately $700 million back into our business in the form of capital expenditures bringing year-to-date capital expenditures to approximately $1.7 billion. And during the quarter, we paid approximately $1.7 billion in dividends to our shareholders and we returned approximately $3.5 billion to shareholders in the form of share repurchases.", "Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 43.9%, up from 41.6% in the third quarter of fiscal 2020. As you have heard from Craig, we're very pleased with the strong performance we saw during the third quarter, particularly as we lap the unprecedented growth we saw this time last year. Customer engagement remains strong and demand for home improvement is healthy. We've been pleased with our team's ability to navigate the challenging environment.", "However, we do not believe we can accurately predict how the external environment and cost pressures will evolve and how they will ultimately impact consumer spending. As we've mentioned on previous calls, our teams are managing our business on a relatively short cycle and we will continue to execute with flexibility and focus on what has driven our successful performance to date. Longer term, we remain committed to what we believe is the winning formula for our customers, our associates and our shareholders. We intend to provide the best customer experience in home improvement.", "We intend to extend our position as the low-cost provider. And we intend to be the most efficient investor of capital in home improvement. If we do these things, we believe we will continue to grow faster than our market and we will deliver exceptional value to our shareholders. Thank you for your participation in today's call.", "And Christine, we will now open the call for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Hi, everyone. Good morning. Nice quarter." ] }, { "name": "Craig Menear", "speech": [ "Thanks." ] }, { "name": "Simeon Gutman", "speech": [ "Welcome. My first question is actually something I've asked last quarter and it's around demand reversion and whether the industry goes through some digestion phase or it continues to compound. And just to add, this quarter, it looks like there was very little reversion and demand seems to be holding even though we're probably getting out of stimulus. So curious if you have any different thoughts about the demand progression." ] }, { "name": "Craig Menear", "speech": [ "Simeon, I wish we actually knew the exact answer to that. Clearly, we don't. And so one of the things that we've stayed focused on as a result then is how do we make sure that we're as flexible and agile as possible and deal with whatever comes our way. That has worked well for us so far.", "I think we've delivered strong performance. We're going to continue to be as nimble as we possibly can. Candidly, we had expected that as the year progressed, you might see customers reverting back and spending in other areas. And that may have affected us, but we really haven't seen that.", "Demand continues to remain strong. Customers continue to tell us that they have projects on their list. Pros tell us that their backlogs are significant. So we're going to stay focused on filling that demand." ] }, { "name": "Richard McPhail", "speech": [ "And then Simeon, to add. Just to add something, obviously, we saw acceleration in October. What's interesting to note is that we saw improvement in both ticket and transactions sequentially from September to October. So we think that's a sign that the customer is engaged and demand is healthy." ] }, { "name": "Simeon Gutman", "speech": [ "Yup, that's right. And then maybe the follow-up is on the profit outlook or operating income. And I know we're not -- we don't really cling to margin goals anymore. It's more of operating profit dollar growth or EBIT growth.", "I was curious if this environment inhibits your ability to grow at the rates you want to grow in terms of operating profit, or the consumer tends to take price in this segment and you can pass along price OK. And therefore, over time that shouldn't have an impact, meaning the operating profit dollar growth doesn't get touched." ] }, { "name": "Richard McPhail", "speech": [ "What I'd say is for the quarter and for the year to date, Simeon, we're very pleased with our performance. And I think that our teams and Ted alluded to this, but the job we do in understanding and mitigating cost pressures and then as appropriate, using a portfolio approach to cover those costs has been impressive. And so we're happy with the P&L we delivered in Q3." ] }, { "name": "Simeon Gutman", "speech": [ "OK, thanks. Good quarter." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my questions." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Michael Lasser", "speech": [ "Home Depot's gross margins declined 10 out of the last 11 quarters. There was a moderation in the decline this quarter. Is the period of gross margin degradation coming to an end? And has this line item stabilized given the retail price increases that you're passing along? And what was the impact from non-commodity related inflation to your comp and gross margin this quarter?" ] }, { "name": "Richard McPhail", "speech": [ "Michael, I'd say one of the things we've shared with you all is we're very, very focused on how do we drive incremental op profit dollars. And there's multiple ways to get there. And so that is our No. 1 focus.", "It's not that we completely ignore rate, we obviously don't ignore rate in total, but you don't take rate to the bank. So we are really laser-focused on the incremental operating profit dollar growth. And we're very pleased. We said that in 2021, it would be a year of much more transparency on operating expense leverage and that's where we've been focused on delivering.", "On the last part of your question, we don't take the approach that we pass costs on, on a unit basis and retails and costs move independently. And so if Ted, if you think about just how that relationship worked." ] }, { "name": "Ted Decker", "speech": [ "Yeah, Michael, I would say from a gross margin perspective, there was very little net impact from product cost pressures. So as Richard said, we don't look at things necessarily on a unit-to-unit basis, but our merchants are well versed with running their portfolios. And while we have certainly seen non-commodity cost impacts, those have largely been offset by increases overall in the retail portfolio. Our cost pressures -- margin pressures that we've seen in the past have been more related to our supply chain build-out, delivered sales, mix of product sales, we've talked about the appliance business in the past as an example, which is an incredibly productive high-growth business with extremely high GMROI because of our inventory position, but not necessarily the highest gross margin category.", "If you look at our ticket growth, certainly, there's an AUR, significant AUR double digit growth. Certainly a -- essentially half of that is from product costs that we have passed on. But it's important to note that our Pro and consumer customers remain incredibly engaged in this category and innovation and newness still sells in this marketplace. And the equal amount of our AUR was driven by mix and new product innovation.", "So think of things like appliances, the technological features and benefits that have been introduced into appliances, grills and pellet grill smokers, our outdoor power equipment and power tools with our battery platforms. We just launched a new exclusive paint from Behr and DYNASTY. This is the best paint that Home Depot has ever introduced. It's over $50 a gallon on shelf.", "It's performing incredibly well as customers trade up to the innovation, etc. So yes, there's cost pressures that the merchants have offset, but equally doing a terrific job finding new and innovative product that our customers are engaging in." ] }, { "name": "Michael Lasser", "speech": [ "That's very helpful. Thank you so much. My quick follow-up is the planning period associated with the One Home Depot is coming to a conclusion. Should we expect a step up in operating expense investments as you move to 2022 and beyond as you have to continue to build out the capabilities that you've been deploying plus wage inflation is going to continue to be quite high?" ] }, { "name": "Richard McPhail", "speech": [ "So as we've said, we look at investment principally through the proxy of capital expenditures and what we believe an appropriate level will be is around 2% of sales and that can vary. But you can think of that in your mind as where we expect to be. Beyond that, the associated operating expense is embedded in our cost structure now. And so it's just a -- it's a normal part of our cost structure moving forward.", "There will always be fluctuations quarter to quarter. We have productivity initiatives, we have investment initiatives. There's a nice flywheel there of self funding. And again, quarter to quarter, you may see fluctuation.", "But operating expense investment, that's just part of us now." ] }, { "name": "Michael Lasser", "speech": [ "Understood. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. I wanted to start with Pro customer trends. So curious if you could discuss whether you're seeing an acceleration in new Pros maybe of all sizes migrate to Home Depot's offering given the industrywide supply chain challenges. And then also the pricing environment, which I believe, really weighs on the value proposition of the independents.", "So just any comment on growth in new Pros and if there's any difference among the size of the Pros themselves?" ] }, { "name": "Craig Menear", "speech": [ "Yeah, we're actually very pleased, Steven, with our overall continued growth with the Pro customer. Obviously, our larger Pros were more challenged during the pandemic and we've seen that recover. What's really nice to see is on a two-year basis, really the conversion of both our Pro and our consumers growing at pretty comparable rates. And that's -- that is what we always strive to do.", "We are attracting new Pros into the business. And Ted, I don't know if you want to comment on that?" ] }, { "name": "Ted Decker", "speech": [ "Yeah, we're happy, Steven, across our progression with our larger Pros and our smaller Pros. We've talked about their pipelines being healthy, record levels of remodel indexes in the marketplace. And what we like about the Pros are they're responding to capabilities that we've been building. So we've relaunched our Pro loyalty program.", "We're seeing record enrollment and engagement with the new loyalty program. The Pros are responding to our capabilities in terms of delivered sales in our new supply chain. And if you take a category like paint, for example, where we've had a Pro paint program for some time, we're in a terrific position with our two key paint suppliers, PPG and Behr and we've seen a terrific uptake with our Pro paint volume as Pros continue to respond to the Pro paint itself, the formulations, the pricing and the service levels. So our Pros are active across the business in engaging in all categories." ] }, { "name": "Steven Forbes", "speech": [ "That's helpful. Maybe leads to the follow-up on the B2B website. I don't know if you can comment on what you're seeing in regards to repeat behavior retention rates. The point that I'm trying to get to, it almost appears that this is a great environment for share capture and new customer growth for you.", "And I don't know if you're sort of seeing elevated share or elevated repeat rate and retention rate within the B2B website that makes the stickiness of new customer growth apparent for you. Any comment there would be helpful." ] }, { "name": "Ted Decker", "speech": [ "Yeah, absolutely. The ecosystem we're putting in place when you think of the B2B website, when you think of the new loyalty program or the revamped loyalty program, also translating into the Pro app. We're seeing record traffic on the app. The app traffic is growing.", "The Pro traffic on the app is growing. Basket sizes and tickets and engagement is growing. And our teams are doing an excellent job in stitching what we call households together. So our understanding and knowledge of all our customers, but particularly our Pro customers because they're engaging with us at a much higher frequency than the average consumer, we're able to stitch all that behavior together in a much more robust understanding of that customer and able to make direct contact with them through our digital marketing channels and our outreach with our field sales teams, as well as our Pro associates in the store.", "So that the entire Pro ecosystem, with heavy emphasis on the digital capabilities, is coming together extremely nicely in driving that stickiness and share of wallet." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Mike Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Mike Baker", "speech": [ "Thanks, guys. And so I know you're probably not talking about fourth quarter guidance. But one thing I've noticed is that your fourth quarter very often, in fact I think 9 in the last 12 years, has been better than your third quarter. I think that's because of you guys continuing to lean more and more into holiday product.", "But I'm wondering what you think of that? Why is your fourth quarter typically such a strong quarter? And maybe while we're talking about that, I know you said you're pleased with the beginning of the quarter. Oftentimes, you give a little bit more color on the first couple of weeks. I'm wondering if you're willing to share any of that. Thanks." ] }, { "name": "Craig Menear", "speech": [ "So the fourth quarter and why has fourth quarter been stronger? I think we've brought tremendous value to the customer in the fourth quarter through the events that Ted talked about that we've done for multiple years now. Our merchants continue to focus on innovative products. As Ted mentioned in his prepared remarks around the Halloween event, that was largely driven by just amazing innovative product that they brought into the marketplace. So I think -- in general, I think our team has done an outstanding job of delivering value to the customer in the fourth quarter.", "As we look forward into the fourth quarter, we know that there's continued pressure that we're facing around costs, which our teams will work to manage. We're still working some replenishment goods on our events out of the ports. And so we've got work to do there as well. And of course, in Q4, winter hits, so you never know how that's going to play out.", "And over the past few years, that hasn't been a big impact. So we've been very, very pleased to your point on how our fourth quarter has progressed over the years." ] }, { "name": "Richard McPhail", "speech": [ "And just to give you some color on how the fourth quarter has begun, the comp sales for the first two weeks of the fourth quarter are running a little higher than what we reported for the entirety of the third quarter. But as Craig said, we're managing this on a short cycle basis in the current environment and are happy with how we've done it to date, but we attack this thing every day." ] }, { "name": "Ted Decker", "speech": [ "And Mike, I would say just can't give enough credit for the merchants and the programs they put together over several years for the fourth quarter in leveraging our lay down space in the front of the store, in developing a gift center that truly just gets better and better each year. And if you walk our stores and you see the product and the values that the merchants are bringing to the merchant -- are bringing to the marketplace and you just look at the brand statement to see the RYOBI and the Milwaukee and the Makita and the DeWalt and the Klein and the Diablo, I mean these are just the premier brands in the industry that the merchants bring unbelievable value in the most powerful gift center in our industry. And just hats off to the merchant team and the great work they're doing." ] }, { "name": "Mike Baker", "speech": [ "Thanks. That's great color. One more completely unrelated question. But Walmart, a lot of us just on the Walmart call, they just said that they've actually seen it a little bit easier to hire people over the last couple of weeks or months since some of the employment stimulus has run out.", "Are you seeing anything along those lines?" ] }, { "name": "Craig Menear", "speech": [ "I mean, we've been fortunate in the sense that we've been able to hire a lot of people throughout 2021. And we use everything at our disposal as it relates to our brand, to our culture, to the total offering that we have, the growth opportunities for our associates. That's not to say that we don't have markets where there's pressure, there's always been markets that are more pressured than others, but we've been very pleased with our ability to hire folks." ] }, { "name": "Mike Baker", "speech": [ "OK, thanks. I'll pass it on to someone else." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey. Thank you very much. Great quarter. I was wondering if we can get an update on the one supply chain rollout, I guess, where you are in the development of that, when we should expect to see better inventory availability and also some efficiencies on the distribution side?" ] }, { "name": "Ted Decker", "speech": [ "Sure, Chuck. We're very pleased. We're right on schedule with the rollout. And as you know, this is a number of platforms.", "So I'll try and give a quick rundown, our transition to our new bulk distribution centers where we're replenishing our stores with lumber and building materials is going incredibly well. Our flatbed distribution centers that are often tied to those bulk distribution centers, we have seven or eight of those up and running now. Those are relieving the stores of the delivery volume out of the stores, as well as being a capability to capture more share of the Pro wallet. Our direct fulfillment centers, again, we've opened up about seven of those.", "Those are going to be an expansion of -- we had three or four purpose-built pick, pack and ship facilities. And as we look to cover 90% of the country's same- or next-day delivery what will ultimately be 20-odd-plus direct fulfillment centers will allow us to cover 90% of the country in parcel same and next day. And then finally, our MDOs, which is our flow-through for big and bulky product, particularly appliances, we're about halfway through the rollout there and we've taken over the delivery of about half of our appliance volume at this point. So all are on target, progressing nicely and performing at expectation." ] }, { "name": "Richard McPhail", "speech": [ "I think it's also important to note, Chuck, that, as Ted said, we're progressing nicely. Our teams are doing an incredible job. We also reserve the right to move appropriately. We've pivoted a few times during this development as we learned kind of the -- how to optimize the commercial offering.", "And I don't think we're done learning yet. So we're going to roll out at the right pace and the right pace means doing this right, learning, pivoting and optimizing the commercial promise of the network." ] }, { "name": "Chuck Grom", "speech": [ "That's very helpful. Thank you very much. And then just one near-term question. You talked about the Pro backlog being healthy.", "Just wondering if you could put that into some context for us. Has it actually increased to a degree, given that maybe some people put off projects due to the rise in number and now the numbers come down, have we started to see an increase? Just wondering if you could put some context on that." ] }, { "name": "Craig Menear", "speech": [ "No. I mean the conversations that we have with our Pros, they have basically been multiple weeks and months in backlog and that continues. So I have not seen any major shift." ] }, { "name": "Chuck Grom", "speech": [ "OK, thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, everybody. So it looks like ex the Labor Day ship, August and September were pretty consistent and then you had that really strong acceleration in October and on a two-year basis. So can you talk about what you think drove that to your acceleration? How much do you think maybe was priced and do you have any concern that maybe we pull forward some of the holiday and seasonal spending given all the local news around you better get to the store and pick up your fake Christmas tree? Thanks." ] }, { "name": "Craig Menear", "speech": [ "Sure. Chris, I'll start and then let some other comments come in. I'd say the first thing to recognize is that, that acceleration was broad based. We saw Pros, consumers, online, it all accelerated as we moved through the quarter.", "So we're very pleased to see that. I think in part, as we're still high compared to norms, but as lumber came down to more reasonable levels compared to the last couple of years, we certainly saw an acceleration there and that always carries across the store. Lumber is a driver of projects throughout the business and that certainly carries on. So we're really pleased with the broad base, it was geographic as well.", "We actually saw a narrowing of geographic variance during the quarter. So we're very, very pleased with how that played out." ] }, { "name": "Richard McPhail", "speech": [ "And as we said, ticket and transaction both improved sequentially. The open question obviously will be how the consumer reacts in the future. But at least for October, both of those moves in positive direction." ] }, { "name": "Ted Decker", "speech": [ "There's a lot of the season to come. So we're certainly pleased with the response to the gift center, as I mentioned, in our decorative holiday program. The Christmas sets are following the strength of the Halloween. But we're earlier in the ramp-up toward where the volumes come in starting next week, Thanksgiving week.", "So a lot to go in the fourth quarter, but the ramp looks good." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And then as a follow-up, you alluded a little bit to price elasticity. Are you seeing any of it? You have some pretty rapid inflation in areas, like major appliances. I would assume anything coming in from Asia has a lot of freight-driven inflation.", "So in some of those bigger ticket areas or anywhere in the mix, are you seeing any price elasticity, which sort of is compressing volume perhaps down, which I think Whirlpool talked about, but more than offset just by price?" ] }, { "name": "Ted Decker", "speech": [ "Yeah. I would say, certainly, we watch it very carefully. We have not seen it broadly. I think lumber was the best example, as Craig just alluded to, when lumber prices were three and four times the near-term levels, we clearly saw units drop off, which then leads to project dropping off across the store as lumber prices came down.", "And as we sit today, for example, framing is up only about 5% on last year and panel is slightly below last year. And if you look back at the end of the second quarter, those prices were up significantly over prior years. Framing it had peaked out at roughly $1,500 and we're down at about 575. So lumber, clearly, a commodity, very representative of elasticities across the rest of the business.", "We haven't seen specific falloffs in categories because of overly robust, if you will, cost moves. Watching it carefully. But so far, have not seen it." ] }, { "name": "Richard McPhail", "speech": [ "And I think it's important to note, look, the cost environment still dynamic, pressures are building. And so as Ted says, we haven't seen specific instances to date, but we're in a unique cost environment." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And just sneak in one last one is, as you think about mix in the fourth quarter, does that generally have more of products that's sourced as out of Asia, such that sort of that supply chain pressure that's hung up in inventory is a bigger pressure as we look at the fourth quarter?" ] }, { "name": "Ted Decker", "speech": [ "The mix -- yes, Chris. So you think of the mix of gift center product, less outdoor product, which is -- you think of the garden department and pressure-treated lumber and more outdoor lumber-oriented projects, those are suppressed somewhat in the fourth quarter. So your mix of of tools and the like that are largely sourced from overseas does impact Q4. And as Craig said, we've received most of the goods for the fourth quarter.", "But there is still product and we have 95-odd ships in total parked outside L.A. Long Beach and we track our containers on those ships and also getting onto the ports and off the port. So we're not too terribly concerned. There is a huge amounts of Q4, but there is Q4 products still working through the supply chain." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Have a holiday season. Thanks." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. So one bigger picture question is just, I think I've definitely heard from investor pushback that this elevated demand that we've seen is basically just going to be reduced back to the normal TAM once we get into 2022. And I'm wondering what your perspective is on that because that doesn't seem likely.", "It just seems to me that the actual TAM is significantly higher on a much more permanently embedded basis. And then I had another quick question." ] }, { "name": "Craig Menear", "speech": [ "Karen, I think most people and if you looked at what economist were saying as the year started, everybody believed during 2021 that we'd see a significant shift away from goods back to services as the economic environment opened up as we got our arms around the pandemic. Clearly, we have not seen that. I say that from the standpoint that yes, you've seen things like travel and restaurants open up, but the customers continue to spend in the home improvement space. nd to date, we have not seen that dramatic shift back that everybody predicted.", "So we're going to stay focused. We think that the underlying factors for the home improvement industry are strong. And we're going to do everything we can to serve that demand going forward." ] }, { "name": "Richard McPhail", "speech": [ "Yes. I think long term, when you look at all the factors we believe have driven home improvement demand, we're in a very supportive environment. Short term, harder to know where that demand moves. But long term, there's a lot of support." ] }, { "name": "Craig Menear", "speech": [ "And Karen, to your point on total market, we're actually doing some refresh work on that right now. We'll probably talk more about that to you later on in the year, but we're resizing the market right now." ] }, { "name": "Karen Short", "speech": [ "OK. Great. And then just on this quarter, in particular. So sales growth versus EBIT growth, that relationship is obviously very volatile given all the moving parts.", "But EBIT growth relative to sales growth certainly widened in 3Q relative to 2Q. Wondering just how to think about that relationship in 4Q." ] }, { "name": "Richard McPhail", "speech": [ "Well, so there really -- there is no typical quarter, I think. We're pleased with the quarter. We're pleased with year to date. There's always going to be fluctuation quarter to quarter.", "If you think about Q3 flow-through, there are really three significant dynamics. The first is that we're anniversary-ing significant COVID-related compensation and benefits from last year. But recall that we reinvested a good bit of that in the form of permanent wage increases at the end of last year. The second dynamic is just the comparison between ticket and transaction comp.", "When ticket comp is higher than transaction because our payroll model is activity-based, you're going to see more leverage than when you see in the converse when transaction outpaces ticket. So we saw a leverage benefit there. And then finally, to a much lesser degree, as Craig said, we've hired a lot of people this year and feel great about how our stores are operating. We at the same time, probably could have seen staffing a little higher if we had, had our preference.", "And we'll continue to work on that." ] }, { "name": "Ted Decker", "speech": [ "Yes. We didn't -- candidly, we did not expect October acceleration at the rate that it was. And so we probably had some opportunities from a staffing standpoint in October." ] }, { "name": "Richard McPhail", "speech": [ "But as far as flow-through goes, again, we do have cost pressure in the environment. We see product cost. We see transportation cost. We see wage pressure.", "And all those things are real elements of today's economy. So we'll continue to manage our best through it. But yes, we're very pleased with the quarter." ] }, { "name": "Karen Short", "speech": [ "Great. Thanks very much. Have a great holiday." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey. Good morning. As you think about all the favorable long-term indicators around housing, be it turnover, home price appreciation, contractor backlogs, etc. Are there any of these items more front and center in terms of driving demand today? And as you think about the strength of your performance in the quarter, what would you attribute to the robust external environment versus what would you categorize as share gain?" ] }, { "name": "Craig Menear", "speech": [ "I mean I'd say a couple of things here. First of all, when you look at the constrained availability of new housing, that clearly is having a positive impact on the home values. And when customer's home values are in a positive side of the ledger, they feel good about investing in their homes. So I think that is for sure an element that is helping the overall home improvement dynamic.", "That new housing availability shortage probably isn't going to get solved anytime soon at the rate that we're building homes, even though it's an accelerated rate from where it's been, that backlog is going to be there for quite some time." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And then as you look to 2022 and beyond, I realize you aren't providing any guidance. But as you think about all the drivers of your business today, what do you think will be the primary areas of upside, be it from the Pro, DIY, innovation, your strategic initiatives? Any thoughts there?" ] }, { "name": "Craig Menear", "speech": [ "Yes. I mean we think it's kind of all of the above. We know we have an enormous opportunity with our Pro customers, particularly as we enhance our capabilities to grab a larger share of spend with the planned purchase with larger Pros. And we believe that innovation, which is a huge element of both Pro and consumer, but is certainly a driver for the consumer as well.", "And people have spent a lot of time around their homes. They tell us that they've got project list that are things that they want to get done. And so we feel good about the opportunity that exists with both the Pro and the consumer looking forward." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Thanks for the time, Craig." ] }, { "name": "Craig Menear", "speech": [ "Sure." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Congratulations, nice quarter. So a quick first question I have, you have talked maybe a quarter maybe two ago that -- just about how consumers were shopping in your stores. And as the pandemic was sort of say beginning to ease and what you saw as a shift in kind of weekend spending to weekday spending. I guess just from -- just to help us understand better, I mean, how this is -- how your traffic is progressing, obviously, continue very strong.", "But are you seeing any further shift in just the way people are shopping the stores?" ] }, { "name": "Craig Menear", "speech": [ "Yes. Actually, throughout the third quarter, we saw a reacceleration of weekend traffic flow, with no real deceleration during the week. And as I mentioned earlier, that we saw consumer growth go up, Pro growth go up, online growth go up, geographically narrowed, so we were very, very pleased with the broad-based improvement that we saw in all of those segments of our business and the increase on the weekends." ] }, { "name": "Brian Nagel", "speech": [ "Got it. That's helpful. But the second question I have, look, recognizing it's difficult to gauge market share in short periods of time, particularly against such a fluid backdrop. But just given the extraordinary lengths that Home Depot is going to manage the supply chain pressures, you've done so well, do you think or do you see in your data that you're actually capturing increased share now from competitors out there, maybe some of the ancillary competitors that are just not managing the supply chain as well as you are?" ] }, { "name": "Craig Menear", "speech": [ "I mean when we look at share, it's obviously a triangulation. There's no perfect data, but when you look at multiple different data points, whether that's from government data, from independent third parties that track share and then, of course, as our conversations with our suppliers and what they're putting into the marketplace, we believe that we're continuing to gain share. We think that our investments that we've made have helped us be in a position to continue to grow share. That was the objective behind why we made the investments.", "We want to be able to grow faster than the market in any environment whatsoever. And we feel like we're doing that right now. Exactly who we're taking that share from, is a little bit hard to know. We play in a really big market and it's highly fragmented.", "And so we think that we're capturing share, but based on category that can be very, very different." ] }, { "name": "Ted Decker", "speech": [ "Yeah, Brian. I would say if you look at the NAICS data, that's -- the cleanest look would indicate yet another quarter of taking share. But as we think about our scale and our position in the marketplace, with the shortage of goods and particularly in certain categories, we've been very pleased with responses from long-term supplier partners and in some cases, supplier partners saying, we can't service the industry. So we'd rather focus on the best partner.", "And we've called out in prior quarters with LP, Louisiana Pacific, moving with us on OSB an exclusive' manner, Carlon, which is the box in electrical PVC boxes, moving to us exclusive, Henry roof coatings, just thrilled to mention this today, just announced that they will be moving to us exclusive as well. Leverton which is the share leader in wiring devices, another robust category exclusive to The Home Depot. And I mentioned earlier the position we're in with having joint supply from from Behr and Masco as well as PPG and paint has given us great flow of liquid paint product as well. So I think our suppliers are leaning into the Home Depot and we couldn't be happier and more thankful for those relationships." ] }, { "name": "Brian Nagel", "speech": [ "Thanks, everyone. I appreciate the color. Congrats again. Thank you." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Our final question will come from the line of Dennis McGill with Zelman. Please proceed with your question." ] }, { "name": "Dennis McGill", "speech": [ "Hi. Thank you guys. Just a couple of quick ones and then a bigger picture. On the acceleration from September into October, Richard, can you have any specifics behind how comp transactions trended? How much of an improvement you saw?" ] }, { "name": "Richard McPhail", "speech": [ "Do want to break that out with the degree of improvement in transactions and ticket were roughly equivalent." ] }, { "name": "Dennis McGill", "speech": [ "OK. Perfect. And then any impact from the Northeast Ida storms that you see in the data?" ] }, { "name": "Richard McPhail", "speech": [ "Maybe $100 million, not necessarily that material, but obviously, proud that we can be there for our community..." ] }, { "name": "Dennis McGill", "speech": [ "OK, perfect. And then, Ted, maybe a bigger picture on the supply chain. Just curious, a lot of people obviously speculating how long some of these challenges can persist. How do you think about maybe the bigger bottlenecks and how long those are maybe going to persist and how you guys would be able to maintain some of these advantages it seems you have in the marketplace with our superior supply chain infrastructure?" ] }, { "name": "Ted Decker", "speech": [ "Well, I think from the market, I mean, hard to judge. But I would say this goes well into, if not through 2022. And we'll keep doing what we're doing. The innovation we've talked about in leveraging our scale as well as our new assets.", "I mean, when you think of our inventory growth, part of that is stocking these new facilities. So not only have we improved our in-store stocking levels and been able to meet the accelerating demand through the quarter, but we're also starting -- not starting, we are stocking all those new facilities that I talked about. So we're clearly getting disproportionate flow and that's where our merchants and supply chain teams will continue to push." ] }, { "name": "Dennis McGill", "speech": [ "OK, thank you. Good luck guys." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Thank. you." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thanks, Christine and thank you all for joining us today. We look forward to speaking with you on our fourth quarter earnings call in February." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2022-08-16	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chief Operating Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Jeff Kinnaird", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Executive Vice President, Outside Sales and Service", "name": "Hector Padilla", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "Senior Vice President, Finance", "name": "Jordan Broggi", "position": "Executive" }, { "description": "D.A. Davidson -- Analyst", "name": "Mike Baker", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "MKM Partners -- Analyst", "name": "David Bellinger", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to the Home Depot second quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded.", "It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Welcome to Home Depot's second quarter 2022 earnings call. Joining us on our call today are Ted Decker, CEO and President; Jeff Kinnaird, executive vice president of merchandising; and Richard McPhail, executive vice president and chief financial officer. Following our prepared remarks, the call will be open for questions.", "[Operator instructions] If we are unable to get to your questions during the call, please call our Investor Relations department at (770) 384-2387. Before I turn the call over to Ted, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission.", "Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thank you, Isabel, and good morning, everyone. We appreciate you joining us on our call this morning. In the second quarter, we delivered the highest quarterly sales and earnings in our company's history. Sales for the second quarter were $43.8 billion, up 6.5% from the same period last year.", "Comp sales are up 5.8% from the same period last year and our U.S. stores had positive comps of 5.4%. Diluted earnings per share were $5.05 in the second quarter, up 11.5% from $4.53 in the second quarter of last year. From a geographical perspective, each of our 19 U.S.", "regions delivered positive comps versus last year while Mexico and Canada posted comps above the company average. The team has done a fantastic job serving our customers while continuing to navigate global supply chain disruptions, inflation, and a tight labor market. Our results in the second quarter reflect continued strong demand for home improvement projects. As Jeff will detail, the business was strong across our departments while our seasonal business posted positive comps as spring broke in the second quarter, these categories underperformed our expectations for the first half of the year.", "This was more than offset by strength in project-related categories that outperformed our expectations. We also saw growth with both our Pro and DIY customers in the quarter and are encouraged that project backlogs remain healthy. While the business performed very well and our consumers remain resilient through the first half of the year, we are navigating a unique environment. We can't predict how the evolving macroeconomic backdrop will impact our customer going forward.", "However, we continue to closely monitor elasticities and trends across our respective categories and believe we have the tools, team, and the experience to effectively manage in any environment. Despite near-term uncertainties, we believe that the long-term underpinnings of demand for home improvement remains strong and that we are well-positioned to leverage our distinct competitive advantages to capitalize on compelling growth opportunities in our space. For the Pro customer. We continue to invest in ecosystem of capabilities, including enhanced fulfillment, more personalized online experience, as well as other business management tools to drive deeper engagement with our Pro customers.", "And we believe our efforts are resonating. In May, we launched new capabilities on our B2B website to enhance the interconnected shopping and quoting experience for our Pros. In the past, our website was not integrated with our ordering and quoting systems, so an associate could not seamlessly modify an order if a customer had questions or changes before placing the order. Our new interconnected capabilities remove friction for both Pros and associates, allowing them to collaborate on orders both in-store and online.", "Sales leveraging our digital platforms increased 12% versus the second quarter last year. We also saw record downloads, traffic, and sales via our mobile app. We continue to see improved conversion rates as ongoing enhancements within our digital properties are resonating with our customers. Our team is focused on what is most important: our associates and customers.", "Our merchants, store and met teams, supplier partners, and supply chain teams did an outstanding job delivering value and service to our customers throughout the quarter. Based on first half results, 100% of our stores qualified for Success Sharing, our profit sharing program for hourly associates. I'd like to close by thanking them for their dedication and hard work. With that, let me turn the call over to Jeff." ] }, { "name": "Jeff Kinnaird", "speech": [ "Thank you, Ted, and good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their ongoing commitment to serving our customers and communities. As you heard from Ted, during the second quarter, we continued to see strong demand for home improvement projects and strong execution from our teams and supplier partners. Turning to our comp performance during the second quarter, all of our merchandizing departments posted positive comps, building materials, plumbing, millwork, paint, and hardware were all above the company average.", "Electrical decor and storage, kitchen and bath, outdoor garden, tools, appliances, indoor garden, lumber and flooring were positive, but below the company average. As you heard from Ted, while our seasonal businesses posted positive comps in the second quarter, they underperformed our expectations for the first half. First half of the year, driven by categories like grills, fertilizers, chemicals and mowers. Keep in mind that we were up against very tough comparisons versus the last two years.", "And in these categories when our customers focus on outdoor living, and these were some of our best performing departments. During the second quarter, our comp average ticket increased 9% and comp transactions decreased 3.1%. The growth in our average ticket was driven primarily by inflation across our product categories, as well as demand for new and innovative products. On a three-year basis, both comp average ticket and comp transactions were healthy and positive.", "Deflation from core commodity categories negatively impacted our average ticket growth by 14 basis points during the second quarter, driven primarily by lower lumber prices. Big ticket comp transactions for those over $1,000 were up 11.6% compared to the second quarter of last year. We saw big ticket strength across many Pro heavy categories like pipe and fittings, gypsum, and fasteners. During the second quarter, both Pro and DIY sales growth was positive with Pro outpacing DIY.", "We're encouraged by the continued momentum we are seeing with our Pros and they tell us their backlogs remain healthy. During the quarter, we saw a robust project demand across the business. This can be seen in the double-digit comp performance of our building materials, plumbing, and millwork departments, as well as in certain project-related categories like fencing, siding, conduit boxes, and fittings, tubs and showers, and countertops. We continue to introduce new and innovative products aimed at simplifying the project, saving our Pros time and helping them take on more jobs.", "One example, in building materials, where we launched nationally Henry's Tropi-Cool Roof Coatings. This new formula offers maximum reflectivity, helping reduce cooling costs. Henry's Tropi-Cool can be applied in any season, 100% waterproof, and rain-safe within 15 minutes of application. And this product is exclusive to the Home Depot in the big box channel.", "In bath, we're excited about the success we're having with our great assortment of Delta tub and shower wall combinations. Delta Classic 500 series is a simple tub or shower system that delivers a big transformation to a bathroom in a fraction of the time. It's easy to install and its acrylic surface makes it easy to clean. The series is exclusive to the Home Depot and the big box channel.", "Turning to our online sales, we are very pleased with the performance of our digital assets as we deliver the highest sales dollar volume in company history. Sales leveraging our digital platforms increased 12% during the second quarter. This is driven by our continued investments, which are resonating with our customers. Enhanced search capabilities and improved Pro site experience, the more robust fulfillment capabilities helped drive online conversion.", "For those customers that chose to transact with us online during the second quarter, more than 50% of our online orders were fulfilled through our stores, a testament to the power of our interconnected retail strategy. As we look forward to the back half of the year. We remain committed to being our customers advocate for value. Last quarter, we highlighted several new innovative products for our customers.", "This quarter, we're excited to announce the launch of Makita XGT 40V and 80V Max system of cordless equipment and tools in our outdoor power categories. The XGT system is engineered to achieve the optimum power required for heavier load applications without sacrificing runtime. And these one-battery solution tools are exclusive to the Home Depot and the big box channel. We're also excited to build on the success of our Hubspace smart home platform, expanding our assortment across several categories such as door locks, lighting control, fixtures, and ceiling fans.", "Hubspace makes it easier to set up and manage your smart home products and pairs well with voice-controlled operating systems. This platform is exclusive to the Home Depot. In our garage organization, we'll be rolling out our MILWAUKEE PACKOUT and RYOBI LINK wall systems, utilizing the same locking technology across the system. They can be customized to meet your organizational needs from the workshop to workplace.", "We're also excited about our lineup for Halloween. Our merchants have worked with our supplier partners to put together an expanded assortment of product offerings for this Halloween season. These products bring excitement to our stores and help drive traffic. And our sneak preview of our Halloween lineup was a tremendous success.", "We are thrilled for the full rollout in the upcoming weeks. With that, I'll turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Jeff, and good morning, everyone. In the second quarter, total sales were $43.8 billion, an increase of $2.7 billion, or 6.5% from last year. During the second quarter, our total company comps were positive 5.8% with positive comps of 5.2% in May, 4.9% in June, and 7.1% in July. Comps in the U.S.", "were positive, 5.4% for the quarter with positive comps of 4.1% in May, 4.7% in June, and 7.2% in July. In the second quarter, our gross margin was approximately 33.1%, a decrease of approximately 15 basis points from last year, primarily driven by supply chain investments. We continue to successfully offset significant transportation and product cost pressures while maintaining our position as the customers advocate for value. During the second quarter, operating expense as a percent of sales decreased approximately 50 basis points to 16.6%.", "Our operating leverage during the second quarter reflects solid expense management for the quarter. Our operating margin for the second quarter was 16.5%, compared to 16.1% in the second quarter of 2021. Interest and other expense for the second quarter increased by $58 million to $379 million due primarily to higher long-term debt levels than one year ago. In the second quarter, our effective tax rate was 24.3%, up from 23.9% in the second quarter of fiscal 2021.", "Our diluted earnings per share for the second quarter were $5.05, an increase of 11.5%, compared to the second quarter of 2021. Our total store count at the end of the quarter was 2,316 and selling square footage was 240 million square feet. At the end of the second quarter, inventories were $26.1 billion, up $7.2 billion, compared to the second quarter of 2021. Inventory turns were 4.5 times, down from 5.7 times last year.", "Approximately half of the year-over-year increase in inventory reflects product cost inflation. Our inventory also reflects deliberate investments in higher in-stock levels and pull forward of inventory for back half events in response to continued global supply chain disruption, investment in our new supply chain facilities, and carryover of some spring seasonal inventory. Turning to capital allocation. After investing in our business and paying our dividend, it is our intent to return excess cash to shareholders in the form of share repurchases.", "During the second quarter, we invested approximately $750 million back into our business in the form of capital expenditures. And during the quarter, we paid approximately $2 billion in dividends to our shareholders, and we returned approximately $1.5 billion to shareholders in the form of share repurchases. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 45.6%, up from 44.7% in the second quarter of fiscal 2021. Now I'll comment on our guidance for fiscal 2022.", "As you heard from Ted, we're very pleased with the strong performance we saw during the second quarter, which was in line with our expectations. Today, we are reaffirming our guidance for 2022. We expect sales growth and comp sales growth of approximately 3% for fiscal 2022. We expect comp sales to be stronger in the first half of the year than in the second half of the year.", "We expect our fiscal 2022 operating margin to be approximately 15.4% for the year. And we expect mid-single digit percent growth in diluted earnings per share compared to fiscal 2021. We find ourselves in a unique environment with many cross-currents. We're operating in a broad-based inflationary environment not seen in four decades, while managing through constrained global supply chain conditions, all against a backdrop of monetary policy shifts intended to moderate demand.", "We also see engaged and resilient homeowners who have strong balance sheets, consumer spending more time in their homes, and continued structural support for home improvement project demand. We feel confident that we will continue to manage with flexibility through a dynamic environment while growing faster than our market and delivering exceptional shareholder value. Thank you for your participation in today's call. And Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. Are you seeing any signs that housing is having a negative impact on the business? Could it be that some of the seasonal performance that fell short of your expectation is a sign that some of the underlying challenges in housing are starting to leak its way into home improvement?" ] }, { "name": "Ted Decker", "speech": [ "Hey, good morning, Michael. We we have not seen that yet. In fact, with the strong performance this quarter, the variability across our regions has been the lowest in markets, has been the lowest that we've seen in some time. So we all appreciate the headlines and follow those very closely, but we have not seen anything in our business yet from macro housing." ] }, { "name": "Michael Lasser", "speech": [ "Is there a case, Ted, where it's not evident in the business because you're generating a very healthy return on the investments that the Home Depot has made over the last couple of years? Perhaps you could frame this as what's going on in the Dallas market, which is where some of the distribution facilities and Pro efforts that have been in place for the longest versus what you've experienced in the rest of the market." ] }, { "name": "Ted Decker", "speech": [ "Sure. And Michael, we'll get to Dallas, and Hector will take us through some of the things we're seeing with our Pro, which is incredibly strong. But what we're seeing overall in the business, the questions about housing and the economy, all very real questions. Again, things we're following closely, but I mean we just couldn't feel better about our business.", "We just reported record quarterly sales and profits and reaffirmed our guidance. And that's on top of the 40 billion in growth in the past two years. We see a very engaged customer, each DIY and Pro. And as Richard said though, we are operating in a unique environment with many crosscurrents, inflation and interest rates and supply chain disruptions and the like.", "But given all that, our customer in our markets has been incredibly resilient. As Jeff said, project demand is incredibly strong. Our Pro in particular is very strong and their backlog remains healthy. In DIY, we did see some seasonal weakness.", "But as we pass through that, it's difficult to say is that weakness in the seasonal businesses, the overlap of the two prior incredibly strong years? Is it the weather where we had a really bad in late spring and then it turned incredibly hot across the country? Or are they fundamental demand pressures? Again, we have not seen a broad based fundamental demand pressure in the business. So we couldn't be happier with the overall business, watching it very closely. And I can just say, as I said in my comments, Michael, whatever comes, we are an agile business, an experienced management team, and we look to take share in any environment. And Hector, if you can give us some color on overall Pro and specifically Dallas would be great." ] }, { "name": "Hector Padilla", "speech": [ "Yeah. And Michael, as you know, we're building a unique, interconnected Pro ecosystem to capture more of that propylene purchase. To serve our Pros, it's really about removing friction through a multitude of enhanced product offerings and capabilities. And it all starts with brands, assortments, and drop low quantities.", "And as these new supply chain assets allow us to do that at a different level. But it also includes digital tools and personalized experience, multiple fulfillment options for reliable delivery, our Pro Xtra loyalty tool and other value-added offerings such as credit, tool rental, quote center. And for our larger Pros, we have to serve them with a single point of contact. Hence, why we're expanding our onsite sales team and building an onsite sales team.", "And I will tell you specifically to Dallas, Dallas is the most advanced market and is performing extremely well. We're thrilled to see our Pros trying our capabilities, are growing their spend quarter over quarter. And I will share with you that other top markets for us are markets where we have the new supply chain assets and other parts of the ecosystem live." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much and good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from a line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Good morning, everyone. Hope you're good. I wanted to ask an oldie but goodie on reversion, given the significant gains that have occurred post COVID. One of the ways that we've been looking at it suggests that most of the unit reversion has basically in the base.", "So we've kind of rebase lined a significant part of the business in '22 and that, it opens the door to growing next year. I'm not asking for any endorsement on '23, but curious how you're looking at this reversion question and anything interesting on units as you look at it." ] }, { "name": "Richard McPhail", "speech": [ "Well, Michael. Sorry. Sorry, Simeon. It's a it's a good question.", "I think we have to return to Ted's commentary that the consumer -- our customer, consumer and Pro, has been more resilient than we even expected in the beginning of the year. When we expect -- when we issued guidance at the very beginning of the year, we assumed that we'd see ticket growth driven by inflation and really sort of like-for-like offset in transactions. We haven't seen that. And so that led to our our increased guidance in Q1 of a 3% comp.", "We've reaffirmed that guidance today. It does assume some level as -- it assumes that inflation persists at current levels and that we may see a slightly greater offset in transactions through the year. But that's a conservative assumption and not really based on observation right now. So the consumer is -- and customer, are resilient." ] }, { "name": "Ted Decker", "speech": [ "And Simeon, we've been watching obviously all those metrics in PCE and share on goods and in share on services, and clearly the U.S. consumer has reengaged in activities outside the house. And travel is incredibly strong right now and eating out and hospitality. So there has been the movement of PCE to services as we thought.", "But home improvement in particular has been, again, just incredibly strong, as Richard laid out, which led us to increase our guidance from what was essentially flat at the start of the year to the 3% we just affirmed. But we just don't -- we don't see a slowdown from that and remain incredibly bullish about the engagement level. It's really all the dynamic of the home improvement against so many cross-currents in the economy. But when you think of the wealth that our core customers and their home equity up nine-odd billion dollars, the excess savings rates, the strong jobs and earnings growth of wages, and the fact that we're just continuing to spend more time at home in general, people are still super engaged in improving that home that they're spending more time in.", "So we're certainly benefiting from that longer term dynamic." ] }, { "name": "Richard McPhail", "speech": [ "And I think there's a emerging interesting dynamic that kind of pushes against reversion. And you think about those who may have look to move into another house. A few years ago, we're looking at their fixed rate mortgage and saying, I like that mortgage and I like my equity position in my home. I want to stay in place and remodel.", "We see that in the survey data where customers say their intent to do projects of all sizes is still very high." ] }, { "name": "Simeon Gutman", "speech": [ "Yup. And my follow up, I think Ted and Richard, you basically answered it. I was going to ask why you think the backlogs are still so healthy because looking at the other high ticket spending across the consumer complex, a lot of it is contracting. And yet you're basically saying we're not really seeing that or expecting it.", "I think it's partly the vibrancy of the housing market, to your point. I don't know if it's income cohort, but if there's anything else because you mostly answered it in the response to the last question, but curious if there's more." ] }, { "name": "Richard McPhail", "speech": [ "Our customer skews heavily homeowner. Our Pros spend on behalf of homeowners and our DIY customers, over 90% of that sales is to a homeowner. And as Ted said, when you look at the wealth creation over the last two years and price appreciation of almost 40%, our customer is just in a really good place right now, and I think that also carries over to income. If you were to take a look at real purchasing power of our customer, it compares favorably." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. So at the sake of asking, I guess, a shorter term question here, it's hard not to notice that July sales ticked up a couple of hundred basis points on a stack basis. And I guess I'm wondering, would you guys point to anything specific be it weather, the slight easing we've seen in interest rates or gas prices? Any kind of color on that might be helpful." ] }, { "name": "Ted Decker", "speech": [ "Yeah. Scott, good morning. On a on a three-year basis, it's more or less stable. So July had a relatively easier compare.", "But I will say one thing we have noticed, because our strength has continued into Q3 here in the first couple weeks. We think, again, I mentioned, PCE and people traveling and service spending going up. As people have come back, particularly in the south. We start school very early down here, early August.", "And as people, including Pros, came back from vacations, we saw it in acceleration in the business midway through July, and that has continued into August. I think people are back home and home from the beach, the mountains, etc., and back engaging in home improvement projects." ] }, { "name": "Scot Ciccarelli", "speech": [ "OK, that's helpful. And then just can you size the adverse impact on seasonal in the first half? Obviously, you came a little short of expectations. Is there a way to provide a magnitude of that for us?" ] }, { "name": "Richard McPhail", "speech": [ "We -- as Ted says, we're accustomed to offsets in our business and we look at home improvement demand in total. And so, as we said, we met expectations. There's always -- we never hit a quarter exactly the way we think we are, but we feel great about the demand that we saw out there." ] }, { "name": "Scot Ciccarelli", "speech": [ "Roger that. Thanks, guys." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Zaccone with Citi. Please proceed with your question." ] }, { "name": "Steven Zaccone", "speech": [ "Good morning, guys. Thanks for taking my question. Ted, I was just hoping we could revisit your comments about the macro backdrop. Are you concerned there could be a lag in the sense of demand control over time? Because in the past you've looked at home price appreciation as a key factor for home improvement demand.", "You're concerned that home prices could stay flattish or potentially decline from here. Does that alter your view on the demand outlook for the near to medium term?" ] }, { "name": "Ted Decker", "speech": [ "So it hasn't as of yet, and this is what we're seeing. I mean, we talk about home price appreciation transactions, household formation, etc., multiple inputs on housing. But the strongest and most correlated for our sales is home price appreciation. Now that's gone up, as Richard said, 30, 40% in the last couple of years, which we believe translates to, high $8 trillion, $9 trillion of increased wealth with what is our core customer base.", "So when mortgage rates touched at 6% there for a minute, certainly you saw new home construction and mortgage rates feel that immediately. If we have a couple years of holding serve, if you will, on this incredible price appreciation in the home. We don't see that impacting demand the fact that we're not going up year after year after year is less the point that we've gone up so much in the past two years and the equity position in these homes are so strong, coupled again with people spending more time in their homes, so repair and remodel. Demand is going to increase from wear and tear.", "You're going to want more space and just improvements in the home because you're there more often. And then the fact that the U.S. home stock is aging and -- of course, it ages every year, but it's aging disproportionately because we had so many those years where we under built in housing. So now we have well over half the homes in the United States over 40 years old.", "So all those factors with that incredibly strong run-up in value, we think supports home improvement for some time to come, regardless if you have appreciation beyond these levels in the near term." ] }, { "name": "Richard McPhail", "speech": [ "And we never thought or saw home price appreciation correlated period to period. We've always seen and heard there is a lag effect there that stretches over multiple periods. So as Ted said, we think fundamentals here are strong." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Very helpful. Just a quick follow up on inventory levels, maybe how much was inventory up on a unit basis, if you could share? And do you feel like you're at the right level of in stocks in the business now?" ] }, { "name": "Jeff Kinnaird", "speech": [ "Morning, Steven. It's Jeff Kinnaird. From an inventory perspective, we are -- if you look at our total inventory, half of that is inflation as we manage through this inflationary environment. Second is just in-stock improvement.", "To your point, we're happy with our improvement, our merchants, our supply chain team, our suppliers have work hand-in-hand in building a better in-stock this year versus last year. We still have a ways to go in terms of improvement, but very happy with our -- where we -- how we progress. We are still having to pull inventory forward. If you think about today's supply chain environment, our focus is to be there for our customers, to be there for our Pros in terms of the right job by quantities and the right timing of events and other activities.", "So part of our inventory overage is obviously due to that work in terms of being there for our customers. We do have some carryover inventory from the spring season, but it is really low risk inventory that we're managing through and ensuring that we're ready for next season. But overall, we feel very good about our in-stock position. We're managing the inflationary environment in inventory and we'll be there for our customers in terms of in-stock." ] }, { "name": "Steven Zaccone", "speech": [ "Thanks very much. Best of luck in the back half." ] }, { "name": "Operator", "speech": [ "Our next question comes from line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hi. Good morning. Nice quarter. Congratulations." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Brian Nagel", "speech": [ "So I've a couple of questions. First off, historically, having followed Home Depot now for a long time, your company has done a very good job of, sort of say, understanding the macro endpoints and building model and then you're forecasting your own sales off of that. So the question I have is this is somewhat of a follow up from the prior questions, but as you -- with your models right now, you look at the variable, the various variables out of various macro factors, is your business tracking consistent with where it should be or are you actually -- is there some type of break where you're actually performing better right now than the macro variables would dictate?" ] }, { "name": "Richard McPhail", "speech": [ "I think, Brian, we're in such a unique environment that to try to build models off of macroeconomic factors is probably less valuable than spending our time managing in an agile way. What we are confident in is that we've been taking market share consistently and that we are positioned now better than ever to take market share in any environment. As Ted said earlier, we've watched the same housing statistics for over a decade now, and we think directionally we understand what's going on here. There's just a very positive environment with respect to the homeowner.", "But we're not going to, at least at this moment, given the dynamism in the economy, tie to any given macroeconomic factor." ] }, { "name": "Ted Decker", "speech": [ "Yeah, Brian. And if I can add to that on, are there any parts of the business doing better than we expected? I mean, we truly are just thrilled with what we're doing with the Pro. As Hector outlined, this Pro ecosystem that we're building, I mean, we are truly building a set of capabilities that is not seen in our marketplace. And in talking to our Pros and the research we did, they are they are more than comfortable to do more with Home Depot as we develop capabilities to serve their larger planned purchase.", "And Hector talked specifically about Dallas, but as different parts of this Pro ecosystem come online, we have a number of one supply chain buildings now open in many large metro markets. We're starting to increase the size of the sales force, our quoting capabilities and integration of our B2B website, which I mentioned in my prepared remarks, all of this is really coming together to drive what is that incredibly strong Pro and larger Pro comp. So as we updated our TAM to 900 billion earlier this year with 450 of that being in Pro, we just see tremendous opportunity. And I would say, yes, that is a category that we are outperforming and happy for it." ] }, { "name": "Brian Nagel", "speech": [ "No, it's very, very, very helpful. And just a follow-up question I have, unrelated, but with regard to inflation -- so once again, inflation has been a driver of your business. I guess the question I have is, are you seeing any incremental evidence that the consumer is trying to push back somewhat on these higher price points?" ] }, { "name": "Jeff Kinnaird", "speech": [ "Brian, we are -- we have higher average unit retail growth and that's higher than inflation. So really, no, not seeing any trade down. We've got strength in our ticket above $1,000 and that speaks to the project and to the Pro customer. We all say in categories like grills, mowers, laundry, and a few other bigger ticket items, it's possible there is a price sensitivity.", "But as Ted commented, there's COVID pull forward, there's stimulus effect, we went from a very wet and cold spring to a very hot summer in the majority of our markets, and the consumer is focusing on other projects. You think about that consumer has shifted. You think of -- last year, it was all about the backyard. This year it's about categories like paint and other large renovation categories, and we're seeing that across our business.", "And I also see where you see the consumer in the pro trade up around innovation and couldn't be more proud of the merchants and our supply partners and what we've delivered around innovation for our customers. We've got a lot of products helping our Pros finish the job faster and simplifying the project for our consumers. So, no significant trade down taking place." ] }, { "name": "Brian Nagel", "speech": [ "I appreciate it. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from line of Chris Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, everybody. So a follow-up question on the Pro. Can you talk about the relative performance among a large pro versus the smaller pro? Is a large Pro outperforming? What would you attribute to that? And then overall, I'm not sure if you can track this, but are you seeing Pro transaction growth? Because overall transaction growth has grown down.", "Presumably that was DIY." ] }, { "name": "Hector Padilla", "speech": [ "Yeah. Chris, I would share with you that -- is the performance of our high spend Pro has been very consistent over the last several quarters. So we're very pleased to see that. We're seeing other areas of our Pro business as far as the customer size accelerate quarter over quarter.", "So we just feel really good. We've spent a substantial amount of time with them talking about backlogs and we feel very good about where they're positioned for the next couple of quarters." ] }, { "name": "Chris Horvers", "speech": [ "So -- sorry, just to interpret. So you're saying that the large Pro has been the best performer?" ] }, { "name": "Richard McPhail", "speech": [ "Where -- our large Pros were the best performers this quarter. That's right, Chris." ] }, { "name": "Chris Horvers", "speech": [ "Got it. And then are you able to look at on a transaction level? Were transactions up for the Pro?" ] }, { "name": "Richard McPhail", "speech": [ "We're not going to break that out any further, but let's just say that demand is strong with the larger professional customer." ] }, { "name": "Chris Horvers", "speech": [ "Got it. And then a follow-up on that sort of, Ted, your point on, people came back from vacation and have reengaged in the category. Last year that seemed to happen more in the September timeframe where DIY reengaged. How are you thinking about the DIY business into the fall versus maybe people come back and there's some things that need to get done and the kids are going back to school.", "But how do you think about the risk on DIY maybe fading as we get into September in the fall?" ] }, { "name": "Ted Decker", "speech": [ "Well, Chris, that's a great question. And frankly, when we -- given the strong first half and the strong second quarter, to reaffirm guidance, which implies a lower comp in the second half, that's really the question for us. And frankly, we don't know the answer. We're super comfortable with Pro.", "That continues to motor on. But the question for the second half and the opportunity to do better, that implied comp is if the consumer hangs in there is just said of the various potential reasons for seasonal relatively underperforming in the first half if it's things more like whether and having focused for so long in the backyard for two years that they went and did other things, go to the beach, etc., and then they get back in the fall and reengage, that will obviously be great news. But with these cross-currents, we just haven't called that, and that's a little bit of conservatism in the second half." ] }, { "name": "Chris Horvers", "speech": [ "Got it. Thanks very much. Best of luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey, thanks. Just to kind of a bit off Chris' question, I'm just curious how you're planning the business from a category perspective over the next couple of quarters and maybe into early '23? And is it your expectation that the Pro continues to lead, or do you think that what you've seen over the past few weeks that we start to see maybe a shift on that front?" ] }, { "name": "Jeff Kinnaird", "speech": [ "Chuck? Good morning. Look, we are prepared for the continuation of the project customer. When it comes to innovation and value, I point out Halloween and how we launched Halloween a few weeks ago and saw just, just great success in the early launch and will set in stores in the upcoming weeks and look forward to that category performing. When it comes to the Pro, we'll be there in terms of innovation and job-like quantities and leveraging our supply chain capabilities and the other capabilities that Hector spoke to.", "So planning the continuation of the project business, the Pro business and we'll be there for our consumer when it comes to Labor Day, coming up in a few weeks. We've got a great program planned for Labor Day that's moved through Halloween. As we head into the Black Friday timeframe, we'll be there for our customers with great value and that will continue being the advocate for value for our customers." ] }, { "name": "Ted Decker", "speech": [ "Chuck, it's interesting. On something like Halloween, it's not a huge category. It's not going to, move the needle on 150 billion in sales per say. But the level of excitement that category brings to us in the traffic and when you think about resilience of the customer and willingness to spend on clearly discretionary items, we had two releases of some of that product very, very specific limited quantities leading up to this period and we sold out in -- I don't even know if it was hours, how quickly, people are spending $300 for a clearly discretionary item.", "But a lot of fun, great innovation in value. But clearly, people snapped up, in minutes a pretty decent price point, 100% discretionary item." ] }, { "name": "Chuck Grom", "speech": [ "So that's obviously good to hear. Just switching gears a little bit to the next couple of years. Just wondering if you guys can discuss the new facilities that you've opened up across the country and the benefits you're seeing. You touched on it in Dallas a little bit, but how much of a tailwind can that be over the next couple of years as you largely complete that rollout?" ] }, { "name": "Richard McPhail", "speech": [ "Yeah, I'll start off. Our supply chain is an important component of the ecosystem that we're building to serve our customers and drive productivity. And our intent is really to build the fastest, most efficient, and reliable delivery network in home improvement, reaching 90% of households with a same-day, next-day service on parcel and big and bulky. Our original plan was to open up 150 new buildings.", "And while many of these will be complete by the end of this year, some are going to take us a little bit longer. And that's a function of our HD Supply acquisition, which we paused and reevaluated our needs and facilities that serve similar capabilities as well as some of the impact that we had associated with COVID. We're very pleased with the performance of the buildings. We've got about 85 of our 100 planned market delivery operations.", "We've got 11 of our planned DFC expansions. And those facilities will serve, both the parcel and the big and bulky customer in local markets. And then lastly, and Hector referenced this, our flatbed distribution centers that will finish the year with about 15 or half of our intended goals are right on track. And Dallas was the first market that we set up these capabilities.", "It's been operational for over two years, and we really like what we're seeing out of that ecosystem in the Dallas market that Hector mentioned. We're learning a great deal and we're winning, that Pro planned purchase. And so we're excited about the possibilities that remain with our investment in our our One Supply Chain strategy." ] }, { "name": "Ted Decker", "speech": [ "Chuck, you asked, what do we think, tailwinds are as we build this out and John mentioned HD Supply is part of a pivot and what we are building from One Supply Chain. I'd like to all just say that we couldn't be happier with the HD Supply acquisition. Shane O'Kelly and his team are just doing a terrific job. That integration is going incredibly well on product catalog, on customers, and sales force integration.", "And they are just off to a great start and that business is performing incredibly well. Remember, we put together the #1 and two multifamily players and have a leading position in multifamily. And then with the supply acquisition picked up, additional verticals in hospitality, in healthcare, government, etc. All of them are doing incredibly well and we couldn't be happier with HD Supply." ] }, { "name": "Chuck Grom", "speech": [ "Thanks, Ted." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. Ted, Jeff, I was hoping to expand on the Pro loyalty program and the B2B website experience, really looking for any specific data points you can provide to help us better understand the maturation benefits of these initiatives. Like how many members do you have? How often are they engaging in the personalized offers? What's happened to sort of average wallet share of the Pro post onboarding? Is there anything you could provide us to help us understand the opportunity here?" ] }, { "name": "Jordan Broggi", "speech": [ "Hey, thanks for the question. This is Jordan Broggi from the online team. We don't break those out, but what I would say is we're super happy with our loyalty customers. They are outperforming the average and the customers that are logged into our B2B experience online outperform pretty significantly the customers on our consumer site." ] }, { "name": "Ted Decker", "speech": [ "And I'll just jump in on Pro Xtra as well. I'm just thrilled with the second year in terms of performance. We linked our Pro Xtra loyalty to our commercial credit cards this past spring. That's been another leap forward in terms of overall performance.", "We see great existing member engagement, we see great new signups, and the enrollments are strong and the revenue is strong. And then our pros are engaging in the perks. And we are we are seeing significant growth in that level of engagement." ] }, { "name": "Steven Forbes", "speech": [ "And then just a quick follow up maybe for Richard. I think Ted mentioned that 100% of the stores qualified for Success Sharing. Any any color on how that payment compared to last year or I guess to the original plan for the year as we think about the expense build?" ] }, { "name": "Richard McPhail", "speech": [ "Iit was roughly equivalent to last year." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Mike Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Mike Baker", "speech": [ "Hi, guys. So I just wanted to ask a lot of moving parts, obviously, in the environment, but through it all, it looks like at least according to your guidance, you guys are going to comp at about 3% with flattish operating margins. Is that the right way to think about the business longer term? Is that where you sort of target the comp and the margin break even at about 3%, you'd be break even? If something above that, maybe margins go up, etc.? Just wondering about the long term view." ] }, { "name": "Richard McPhail", "speech": [ "We -- thank you for the question. We typically will cover operating expenses into the very low single digit comp. And we would always expect to do so. Leveraging operating expense as a part of our financial model and been a part of how we do business.", "You're going to see fluctuation from quarter to quarter. But we've met expectations this year and feel great about where we sit and how our teams have managed through this environment. Longer term, again, we expect to generate operating expense leverage. Our goal, though, here is to gain market share and deliver shareholder value.", "And we think about delivering shareholder value in terms of driving operating profit dollar growth. That's a formula that's worked for us and we think it's going to keep working for us." ] }, { "name": "Mike Baker", "speech": [ "And so if I could follow up on that, what that sounds like to me, both of those comments, leverage operating expenses but focus on gross profit dollars. Is it fair to say you're willing to let gross margins continue to tick down? I think they've been down something like six of the last 10 quarters and each of the last couple of years, not by much. Just by kind of 20 basis points a year. But is that the idea that we're OK with gross margins ticking down a little bit as long as it's driving comp and leveraging the SG&A?" ] }, { "name": "Richard McPhail", "speech": [ "We -- thank you for the question. Again, we think about dollar growth and we think about cash and cash returns, first and foremost. I think gross margin in particular is kind of a secondary metric. I'll give you an example.", "Over 10 years ago, we identified appliances as a category, where we had a major competitor who was losing steam and where we thought we could make some inroads. The question at the time was that gross margin on appliances carried a gross margin that was below company average, but the return on invested capital, given that model, where we we really don't own the inventory in the model, the return on invested capital was fantastic. And so as we look back at appliances impact on our business, we would say we'd do that again every single time. We will look for opportunities to drive market share, drive operating profit dollar growth and drive return on invested capital." ] }, { "name": "Mike Baker", "speech": [ "Perfect. Makes sense. Thanks for the color." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. I wanted to follow up on your Dallas market. As performance seems to be tracking at or above your expectations and now that you've had some time for your supply chain and facility investments to resonate, is there any quantification you can share in terms of comp lift for the market, new customer wins or wallet share gains versus the overall fleet?" ] }, { "name": "Hector Padilla", "speech": [ "Look, we're not going to break down the specific performance for Dallas. But again, I will tell you that Dallas has been toward the top of our performance when it comes to the Pro segment of our business. We're seeing just great reaction and engagement from our customers and those who are trying our capabilities are repeating purchases with us and those baskets continue to grow. So we're excited to continue to enhance the ecosystem.", "We just expanded for the second time. Our outside sales resources and those team members are doing great, are servicing our Pro customers. So we're just very encouraged about what we're seeing in Dallas and other markets. But again, it's just that it's early in the transformation, early in the build out of the ecosystem, but great signals coming back from our customers and they really want to consolidate their purchases.", "When you think about our per customers coming to our stores over 60 times a year and then having to go to other retailers for compliments on our projects, we can serve those needs of our Pro customers and they want to consolidate their purchases with us." ] }, { "name": "Ted Decker", "speech": [ "Hey, Zach, and if I can add, I've mentioned this before and we have another quarter of this tracking. As we look at the size of the Pro, and we have a pretty good breakdown of -- they're buying, small item emergency infill versus a larger planned purchase, days out that's delivered. And then you look at the various capabilities sites that we're building, what you what you'd hope to see, expect to see is exactly what we're seeing. As these Pros engage in the capabilities, so they, get a sales -- a dedicated professional sales resource.", "They join our credit program, they join our our loyalty program, they rent tools, they they use our larger quoting systems. They take delivery. As they engage with more capabilities, we're seeing larger purchases. We're seeing more repeat purchases.", "Again, everything is sort of mapped out is what would you want to see to demonstrate that this is working? That's exactly what we're seeing. So we couldn't be happier. It's a journey. As we've said, Dallas is the market that is most established but we're in for in many metro markets right now with different levels of these capabilities.", "And we do look at Dallas very specifically and we look at incrementality and we know exactly what we need to drive an NPV positive project, even to add an incremental sales force. A single individual sales rep, we're tracking incrementality of sales to make sure, we're paying for that resource. But this whole ecosystem, again, working in the different -- many different markets now with different levels of capabilities built is what is behind this incredible performance with the Pro and the large Pro in particular. I mean, it's not by accident that we're growing our Pro the way we're growing it." ] }, { "name": "Hector Padilla", "speech": [ "And Zach, it's Hector again. The only thing I would add is that think about the last project that you engage with. Every Pro planned purchase pulls a lot of unplanned purchases for that same project and also advance order pickup, and we're seeing that. We're seeing the customer not only go after the large deliver product, but also coming back to restore for that unplanned purchase to complete the project.", "So the ecosystem is really working well." ] }, { "name": "Zach Fadem", "speech": [ "Got it. That's all helpful. And I just wanted to ask, with the recent leveling out of CPI and also the step down in your commodity basket, if you could just talk through the impact here. As you're freight or input costs start to moderate, is it fair to say that you'll immediately pass that savings on to your customers, or do you view the majority of recent price increases more or less sustainable?" ] }, { "name": "Jeff Kinnaird", "speech": [ "Hey, Zach. Yeah, we manage a large portfolio of goods. We do a lot of work on competitive pricing analysis and we'll stay competitive in the market. And I will also say we have a deep understanding of almost all cost components for almost all of the products that we sell.", "And we're working with our suppliers on what it looks like when we see commodities fall off. As you said, there's been a fall off on the broader commodity index. We're watching that very closely. And we will certainly maintain our competitiveness in the market as we watch what takes place with commodities in the short end, in the mid-term here." ] }, { "name": "Zach Fadem", "speech": [ "Thanks for the time." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of David Bellinger with MKM Partners. Please proceed with your question." ] }, { "name": "David Bellinger", "speech": [ "Hey, thanks for getting me on. A couple of quick ones. So you mentioned a slower pace of sales implied in the back half to get to the 3% comp for the year. So how should we think about operating expense growth in relation to sales growth in both Q3 and Q4? Any specific measures you're taking to get better leverage on cost after the nice result in Q2? And just remind us, if you can, just how much of the expense structure is tied to payroll and your ability to flex that up or down in real time?" ] }, { "name": "Richard McPhail", "speech": [ "We -- take it in reverse order, we don't break out our percentage of payroll to sales although it is our largest operating expense, and we manage it very closely. With respect to the remainder of the year, I'd really just point you to our guidance. You're going to have variability quarter to quarter in operating expense leverage but we feel great about, at least where we think the year is heading. And again, I'd point you to guidance with respect to what we anticipate." ] }, { "name": "David Bellinger", "speech": [ "OK. And then just one other one. Can you talk about the share buyback outlook? Just given where Q2 numbers have landed, is there any potential share repurchase acceleration? We've got this potential 1% added tax coming January 1. Just any change in on the buyback?" ] }, { "name": "Richard McPhail", "speech": [ "There's there's no change in our capital allocation philosophy or approach. We will continue to return excess cash to shareholders." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I'd now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thanks, Christine, and thanks, everybody, for joining us today. We look forward to speaking with you on our third quarter earnings call in November." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2018-05-15	[ { "description": "Vice President of Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, Chief Executive Officer, and President", "name": "Craig Menear", "position": "Executive" }, { "description": "Chief Financial Officer & Executive Vice President, Corporate Services", "name": "Carol Tom", "position": "Executive" }, { "description": "Executive Vice President of Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President, Supply Chain & Product Development", "name": "Mark Holifield", "position": "Executive" }, { "description": "President and Chief Marketing Officer, Online Business", "name": "Kevin Hofman", "position": "Executive" }, { "description": "Morgan Stanley & Co -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS Securities, LLC -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Guggenheim Securities -- Analyst", "name": "Steve Forbes", "position": "Analyst" }, { "description": "Suntrust Robinson Humphrey -- Analyst", "name": "Keith Hughes", "position": "Analyst" }, { "description": "J.P. Morgan Securities -- Analyst", "name": "Tori Oller", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Oppenheimer & Co., Inc. -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Elizabeth Suzuki", "position": "Analyst" }, { "description": "Wedbush Securities -- Analyst", "name": "Seth Basham", "position": "Analyst" }, { "description": "Zelman & Associates -- Analyst", "name": "Dennis McGill", "position": "Analyst" }, { "description": "Jefferies, LLC -- Analyst", "name": "Daniel Binder", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Barclays Capital -- Analyst", "name": "Matt McClintock", "position": "Analyst" }, { "description": "Robert W. Baird & Co. -- Analyst", "name": "Peter Benedict", "position": "Analyst" }, { "description": "Stifel, Nicolaus & Company -- Analyst", "name": "John Baugh", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Matt Fassler", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Gabelli & Company -- Analyst", "name": "Alvaro Lacayo", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good day, ladies and gentlemen. Welcome to The Home Depot first quarter 2018 earnings conference call. Today's call is being recorded. If you would like to ask a question any time during today's conference, please press the * key, followed by the digit 1 on your touchtone telephone.", "At this time, I'd like to turn the conference over to Isabel Janci, Vice President of Investor Relations. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Catherine, and good morning. Joining us on our call today are Craig Menear, Chairman, CEO, and President; Ted Decker, EVP of Merchandising; and Carol Tomé, Chief Financial Officer and Executive Vice President, Corporate Services.", "Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors, and, as a reminder, we would appreciate it if the participants would limit themselves to one question with one follow-up. If we are unable to get to your question during the call, please call Investor Relations at 770-384-2387.", "Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel. Good morning, everyone. Sales for the first quarter were $24.9 billion, up 4.4% from last year. Comp sales were up 4.2% from last year, with U.S. comps of positive 3.9%. Diluted earnings per share were $2.08 in the first quarter. We are pleased with our performance in the first quarter and the fundamentals of our business remain solid. As Ted will detail, excluding weather-impacted categories, our pro and core interior project business remained strong in the quarter, and we saw healthy growth in maintenance and repair categories.", "From a geographic perspective, weather impacts can be seen in the variability of performance across Canada, our 3 U.S. divisions, and 19 regions. Our largest division is the Northern Division, which posted flat comps due to weakness in our seasonal categories. The Southern and Western Divisions saw relatively better weather trends and comped above the company average. On the international front, Canada posted a slightly negative comp in local currency, while Mexico posted positive comps in local currency.", "You've heard us talk about the bathtub effect based upon when spring breaks, where weak seasonal sales in the first quarter are counterbalanced by strength in the second quarter. We expect that effect to be true this year. Over the past few weeks, as spring has finally arrived through the U.S. and Canada, we are seeing strong customer demand. Part of the strength we saw in the business can be attributed to the health of our pro customer. As pro sales once again outpaced DIY sales in the quarter. Investments aimed at deepening our relationship with our pro customers are yielding increased engagement which translates to incremental spend.", "While still early, the combination of enhanced associate tools in the store and expanded delivery capabilities are gaining traction with the pros. In delivery, for example, we augmented our 2-hour and 4-hour delivery window options with same-day car and van delivery in select markets. These efforts helped drive double-digit delivered sales growth in the quarter.", "Our interconnected retail strategy continues to resonate with our customers. Online traffic growth was healthy and our first quarter online sales grew approximately 20% from the first quarter of 2017. During the quarter, we began to launch the customers' ability to attach install services when they buy certain products online in select markets. For example, in certain markets, if you purchase a faucet online and want to include the installation of the faucet in your purchase, we now enable this experience.", "We continue to invest in the interconnected shopping experience and see a positive response from our customers in the form of improved customer satisfaction scores, better conversion, and increased sales. As we continue to make the shopping experience more convenient for our customers, another area of focus and differentiation is our supply chain. The flexibility of our supply chain is a competitive advantage, particularly when unpredictable weather results in spiky demand patterns. In-stock levels are at record highs as our shelves are fully stocked with products our customers need to get their projects done.", "Let me touch briefly on our long-term strategic priorities. You will recall at our investor conference in December, we outlined our commitment to an accelerated investment plan to create the One Home Depot experience for our customers.", "I'm pleased to report that our key initiatives are on track. We implemented our enhanced wayfinding sign and store refresh package in nearly 250 stores during the quarter and intend to pilot our first new supply chain facility starting this summer. It is still early days, but we remain very excited about the work and opportunities ahead as we focus on enhancing the customer experience by investing in our business and in our associates. Our associates consistently execute. A delay in the spring selling season is not without its challenges, but given the companywide alignment and coordination of our store teams, merchants, vendor partners, and supply chain, coupled with a favorable housing backdrop, we are poised to deliver a strong 2018. I'd like to close by thanking our associates for their dedication, hard work, and commitment to our customers. And with that let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning everyone. As you heard from Craig, we are pleased with our performance in the quarter. Excluding our seasonal business, sales exceeded our expectations. We saw significant strength in our pro business, interior projects, and maintenance and repair categories. The extreme winter weather in the quarter had a negative impact on our garden categories, which historically represent around 15% to 20% of our first quarter sales. Our garden departments had negative comps in the quarter, driven by softness in chemicals, fertilizer, mulch, and live goods, just to name few.", "Looking at our departments, appliances, electrical, and lumber had double-digit comps in the quarter. Lighting and our garden departments were negative, with lighting comps a reflection of LED price deflation. All other merchandising departments were at or above the company average.", "In the first quarter, comp average ticket increased 5.8% and comp transactions decreased 1.5%. If we exclude our garden business, we saw positive comp transaction growth. Commodity price inflation in lumber, building materials, and copper positively impacted average ticket growth by approximately 111 basis points. Foreign exchange rates also positively impacted average ticket growth by approximately 41 basis points.", "While cold and wet weather impacted some outdoor-related projects, this didn't prevent our customers from completing the variety of interior projects. Categories like interior doors, bath fixtures, storage and organization, interior paint, door locks, ceiling fans, and window treatments all had comps above the company average. Core maintenance and repair categories also performed well during the quarter, with strong results in safety and security, water heaters, plumbing repair, pipe and fitting, and air circulation.", "As you heard from Craig, in the first quarter we saw continued traction with our pro. Pro-heavy categories like lumber, gypsum, insulation, pneumatics, wiring devices, and flooring tools all had comps above the company average. In addition, we are building engagement and enabling our associates to target specific customers, which is driving expansion of categories and services sold.", "In Interline Brands alone, we saw sales growth ahead of the company average. We also saw healthy customer appetite for big ticket projects. Big ticket sales in the first quarter, or transactions over $900.00, were up 10%. The increase in big ticket sales was driven in part by vinyl plank flooring, appliances, and various lumber and building materials categories.", "In the first quarter, we hosted our Presidents' Day and Spring Black Friday events. Our stores did a fantastic job executing these events, and our customers responded. During the event, we saw great results in several tool categories and cleaning.", "One of our core strategies as merchants is to balance the art and science of retail, both in-store and online. Over the last year, we made several improvements to our interconnected shopping experience, including better product content, a refreshed mobile experience, improved inventory visibility, and faster checkout. These investments have helped drive a more seamless, frictionless customer experience, and conversion rates in the first quarter increased more than 10% year-over-year across all devices.", "Now, let's turn our attention to the second quarter. Just in time for the warmer weather, we are excited to introduce a fantastic, new innovative product in our outdoor garden category. We have partnered with Syngenta and Fernlea to bring our new Rio Dipladenia plants to market. These plants are low maintenance, drought tolerant, and have reoccurring blooms throughout the growing season. Rio is available in all of our U.S. stores and is a big-box exclusive to the Home Depot.", "In addition, we are very happy to announce the extension of our PPG partnership with the launch of Olympic exterior stains. With this launch, Olympic brings 80 years of trust and brand recognition into our stores. This broadens our assortment in our paint department, providing customers choice with a strong lineup of products across the category. We are also thrilled about new product offerings across all of our categories and our upcoming events. During the second quarter, we will host our Memorial Day, Father's Day, and Fourth of July events, where we will be offering more great values and special buys for our customers.", "With that, I'd like to turn the call over to Carol." ] }, { "name": "Carol Tom", "speech": [ "Thank you, Ted, and good morning, everyone. Before we discuss our first quarter results, I want to mention a change in our accounting policy. During the quarter, we adopted ASU No. 2014-09, which pertains to revenue recognition. This standard changes the way we account for certain items related to our private label credit card and gift card programs. While the new standard changes the geography of certain items on our income statement, it has no impact on operating profit. Looking at our first quarter results, the change in accounting caused a $131 million increase to gross profit and a corresponding $131 million increase to operating expenses. Note that the $131 million increase in gross profit was driven by a $33 million net increase in sales and a $98 million decrease in cost of goods sold.", "While we did not recast our historical financial statements to reflect to this accounting change, included in today's press release is a quarterly pro forma view that shows the impact to the accounting standard as if it had been in place during Fiscal 2017.", "So with that, let's move on to our first quarter results. In the first quarter, total sales were $24.9 billion, an increase of 4.4% from last year. Versus last year, a weaker U.S. dollar positively impacted total sales growth by approximately $104 million or 0.4%. Our total company comps were positive 4.2% for the quarter with positive comps of 5.6% in February, 5.9% in March, and 2.2% in April. Comps in the U.S. were positive 3.9% for the quarter, with positive comps of 5.1% in February, 5.5% in March, and 2% in April.", "As you may have personally experienced, April was one of the coldest and snowiest months in more than 20 years. In the first quarter, our gross margin was 34.5%, an increase of 40 basis points from last year. The increase in our gross margin year-over-year reflects the following factors.", "First, we experienced $131 million or 48 basis points of gross margin expansion due to the new accounting standard. Second, we experienced 14 basis points of gross margin expansion due to changes in mix and the gross margin benefits of recent acquisitions. Finally, we experienced 22 basis points of gross margin contraction due to higher shrink and higher transportation costs in our supply chain than what we experienced last year", "In the first quarter, operating expense as a percent of sales increased by 87 basis points to 21%. Our operating expense reflects the impact of the new accounting standard, the impact of this strategic investment plan we laid out at our December investor conference, and ongoing expense control. Specifically, the new accounting standard resulted in a $131 million increase in our operating expenses and cost 50 basis points of operating expense deleverage. Expenses related to our strategic investment plan resulted in approximately 56 basis points of operating expense deleverage.", "Finally, we drove 19 basis points of expense leverage due to ongoing productivity actions in the core business. Our operating margin for the first quarter was 13.6%, a decrease of 47 basis points from last year. For the quarter, interest and other expense decreased by $2 million to $239 million, and our effective tax rate was 23.5% compared to 35.2% percent in the first quarter of Fiscal 2017. The decrease in our effective tax rate reflects for the most part the benefit of tax reform. For the year, we expect our effective tax rate to be approximately 26%. Our diluted earnings per share for the first quarter were $2.08, an increase of 24.6% from last year.", "Moving on to some additional highlights. During the quarter, we opened one new store in Stamford, Connecticut, for an ending store account of 2,285. Selling square footage at the end of the quarter was 238 million square feet. Total sales per square foot for the first quarter were $412.00, up 4.5% from last year. At the end of the quarter, merchandise inventories were $14.4 billion, up 6% from last year.", "Inventory turns were 4.9 times, up slightly from last year. While spring was a reluctant bride, she has arrived and our stores have the inventory necessary to meet demand, which is a good thing. As month to date, for the company our May comp sales are double-digit positive.", "Moving on to capital allocation. In the first quarter, we repurchased $1 billion, or approximately 4.7 million shares of outstanding stock. As of today, we are targeting $4 billion of share repurchases for Fiscal 2018. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 36%, 370 basis points higher than the first quarter of Fiscal 2017.", "As we look to the remainder of the year, we are encouraged by what we are seeing in housing and the broader economic environment. The U.S. economy is strong and housing fundamentals continue to be supportive of our business. Unemployment is the lowest it has been since 2000. Wages are increasing. Home prices are appreciating, buoyed by a housing shortage in the U.S. And while interest rates are rising, this is indicative of a strong economy. At these levels, we do not expect interest rates to lead to a slowdown and customer desires or demand.", "That's why today we are reaffirming the sales and earnings-per-share growth guidance that we laid out at our fourth quarter earnings call, adjusting certain items solely for the change in accounting standards. Remember that we guide off of GAAP. The new accounting standard will not affect our earnings-per-share guidance, but it will impact sales growth and the gross margin and expense growth back to our guidance we gave at the beginning of the year.", "Recall that Fiscal 2018 will include a 53rd week, so the fourth quarter of Fiscal 2018 will consist of 14 weeks. For Fiscal 2018, we now expect sales to increase by approximately 6.7%, with positive comps as calculated on a 52-week basis of approximately 5%. Reflecting the new accounting standard, we now expect our 2018 gross margin to increase by approximately 45 basis points. Also reflecting the new accounting standard, we now expect our 2018 operating expenses to grow at approximately 144% of our sales growth rate. For earnings per share, we expect Fiscal 2018 diluted earnings per share to grow approximately 28% to $9.31.", "I also want to take a brief moment to comment on our long-term financial targets. The new accounting standard does not change our sales growth or operating margin targets for Fiscal 2020. Because the accounting change did affect the geography of certain items on the income statement, we have posted an update to our December investor conference materials on our web site to assist you with your modeling.", "And with that, I'd like to thank you for your participation in today's call. Catherine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. Ladies and gentlemen, as a reminder, *1 for questions. We'll hear first from Simeon Gutman with Morgan Stanley." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning. My first question is all about weather and it's got a couple parts. Can you clarify? You said garden was negative. Is April the largest month for garden? And then you also mentioned that Northern is your biggest division. If we assume it's let's say 40%, I think that would imply Southern and Western would be north of like 6%, 6.5%. Is that fair?" ] }, { "name": "Craig Menear", "speech": [ "So in terms of garden, April is not necessarily the biggest month in garden. Generally, that is May. We actually don't break out the divisional numbers. But the Northern Division is our largest division." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. And maybe just a follow-up. The remaining divisions, I guess Southern and Western, were those trajectories similar or was there a big discrepancy between them? And have their quarter-to-date trends held up? I'm assuming Northern is the one that's breaking out, but has Southern and Western stayed the same or strengthened?" ] }, { "name": "Craig Menear", "speech": [ "Actually, all areas are breaking with the change in the weather." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. My follow-up question. I think the issue the markets contemplating here is the cycle question versus what the weather's doing. And so I don't know how you look at it, but if there is something that's slowing that's more than weather, and it doesn't seem like that's the case, I guess how obvious are these signals and how much lead time do you think you have to be able to see them?" ] }, { "name": "Craig Menear", "speech": [ "First of all, this clearly is really a garden story for us. The miss in terms of garden was significant against what we planned." ] }, { "name": "Carol Tom", "speech": [ "And Craig, maybe we could just quantify that for you. If you backed out the gardens, our comps for the quarter would have been 6.5%." ] }, { "name": "Craig Menear", "speech": [ "Right." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. Well thank you for the color and good quarter, other than the weather." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "And our next question comes from Michael Lasser with UBS." ] }, { "name": "Michael Lasser", "speech": [ "Good morning, thanks for taking my question. So, of that 230 basis point impact from the weather, is that a net number? So, that's net of the hurricane benefit? And what percentage of those sales do you expect to recoup in the second quarter?" ] }, { "name": "Craig Menear", "speech": [ "The storm-affected sales were a roughly 135 basis point impact. And we actually expect to capture the majority of those sales. We're seeing that happen in May." ] }, { "name": "Michael Lasser", "speech": [ "My second question is on the initiatives that you outlined. Both the 200 stores that you touched with your new signage package, what comp are you seeing those stores produce above and beyond the corporate average? And as part of that, can you also touch on your pro-delivery initiatives. Is that helping you work with existing customers or customers who you really haven't done business with the past?" ] }, { "name": "Craig Menear", "speech": [ "I'll touch on the store minute here and then Mark Holifield is here and can speak to the delivery. 250 stores that we implemented the new signing and refreshed package in. We're obviously just completing those. We did that investment for our stores over a couple-year period or are doing that because of the pilots that we ran previous to that. So, we built that lift into our guidance and that's something that we're rolling here over the next two years across all the stores." ] }, { "name": "Mark Holifield", "speech": [ "And Craig, on the new delivery that's out there, the car and van delivery, that's really driving sales across the range. We have a lot of buy-online, deliver-from-store customers who are trying out the car and van delivery, and our pro customers, our existing pro customers and new customers are using the 2- and 4-hour windows." ] }, { "name": "Carol Tom", "speech": [ "Our math isn't perfect, but our modeling would suggest that the majority of these delivered sales are incremental." ] }, { "name": "Michael Lasser", "speech": [ "Incremental for customers that you're already doing business with or more so attracting customers who --" ] }, { "name": "Carol Tom", "speech": [ "Both." ] }, { "name": "Michael Lasser", "speech": [ "Both. All right, thank you so much and good luck." ] }, { "name": "Carol Tom", "speech": [ "Yes, thank you." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll continue on to Zach Fadem with Wells Fargo." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. Could you talk a little bit about the competitive environment in the paint category? Have you started to see any step change there in terms of promotions? And any thoughts on what you think the key drivers are for you to maintain and win share in the category this year?" ] }, { "name": "Craig Menear", "speech": [ "I would say that that paint promotional environment is certainly for us. It's the exact same year-over-year. We're not seeing any more promotion out of others in the marketplace either. We are very happy with our paint performance. Our comp was at the company average. We saw the strongest interior paint comp gallon performance we've seen in a long time. So, we're happy with our brands. We have the best brand with Behr in the marketplace. We're thrilled with our expansion of PPG, and Ann and team are doing a fantastic job of selling in the stores." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And to follow up, as input costs for items like lumber and building materials continue to grind higher, first of all, what are your expectations there for the year? Is there any concern in your mind on your ability to pass along the higher prices to customers in this environment?" ] }, { "name": "Craig Menear", "speech": [ "Well, the two areas we've seen the largest cost requests are in clear commodities. Looking at lumber and copper, for example. Those generally the market passes on. Most of those products are priced weakly in well-known pricing indexes and the market tends to follow that. So we've had no problem passing that on. I will say lumber and panel prices are at historic highs. We don't see that abating at all.", "We're up about 30% year-over-year. We certainly don't want it to go a whole lot higher. But for right now, we've been able to pass on and not seeing degradation in units. The other area in things like laundry, where you had a very specific tariff. The entire industry has accepted that cost increase based on the tariff. You're seeing retails in all competitors that have gone up more or less mirroring the impact from the tariff." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Thanks so much guys, appreciate the time." ] }, { "name": "Operator", "speech": [ "Our next question comes from Steve Forbes with Guggenheim Securities." ] }, { "name": "Steve Forbes", "speech": [ "Good morning." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Steve Forbes", "speech": [ "You mentioned piloting the first new supply chain facility this summer. But can you help us or help expand on that? What type of facility is it? Maybe give us your updated plan for this year as far as how many and what type of facilities you plan on opening in 2018?" ] }, { "name": "Mark Holifield", "speech": [ "It's Mark Holifield here. The facilities were going to be doing first are our market delivery operations, which are the hubs out there. These are stockless locations that will be delivery hubs for big and bulky product like appliances and vanities and things like that. Later this year, we'll be testing our flatbed distribution capability and opening our first local direct fulfillment center." ] }, { "name": "Carol Tom", "speech": [ "Steve, I'd like you to remember that this is a 5-year plan. We've committed $1.2 billion in our supply chain over the next 5 years. We will spend as much in year 4 and 5 as we do in year 1 through 3. So, it's definitely going to ramp up over time, isn't it Mark?" ] }, { "name": "Mark Holifield", "speech": [ "Yes. Perhaps a way to think about this is if you think back to our RDC rollout years ago, in the first year, 2007, we had exactly 1already RDC. In 2008, we did 4. In 2008, we did 7. In 2010, we did 7. So, you'll see a ramp somewhat similar to that across the 5 years of transformation." ] }, { "name": "Steve Forbes", "speech": [ "Thank you. And then just a quick follow-up. On retail services, recognizing the percentage of revenue here, but it's a topic I find interesting as you think about the opportunity to build brand awareness and share of wallet with the DIY consumer here. So, can you can you touch on how that business performed during the quarter?" ] }, { "name": "Craig Menear", "speech": [ "Yeah our services business represents about 4% of our total sales and grew low single-digit. Really driven by HVAC and window treatment." ] }, { "name": "Steve Forbes", "speech": [ "Thank you." ] }, { "name": "Craig Menear", "speech": [ "There wasn't much exterior business happening." ] }, { "name": "Steve Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll continue on to Keith Hughes with SunTrust." ] }, { "name": "Keith Hughes", "speech": [ "Thank you. I have another product question. Specifically on flooring. You did very well in flooring the last couple years, particularly in carpet, which is kind of a declining industry. You've called out luxury vinyl plank, I assume you mean LVT there is growing well. Could you talk about your hard surface offering, how that's growing and what you see for the future?" ] }, { "name": "Craig Menear", "speech": [ "Yes. Overall flooring, again, we're very happy. Our comps in flooring were above the company average. For sure, led by the LVT. That product is just a fantastic product, solid core waterproof product that looks like tile and/or wood. The rest of the business is solid. A lot of sales moving into that LVT product. But the rest of the business is sort of low single-digit comp." ] }, { "name": "Keith Hughes", "speech": [ "Okay, thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Chris Horvers with J.P. Morgan." ] }, { "name": "Tori Oller", "speech": [ "Hi, good morning. This is Tori Oller for Chris." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Tori Oller", "speech": [ "In prior quarters, it seem that pro is comping 10%. Is that fair and can you talk about the performance of pro in the first quarter and if you think that impacted the business?" ] }, { "name": "Craig Menear", "speech": [ "Well, we certainly had a strong pro quarter and it outpaced the DIY business in total, largely due to the fact that the garden business was obviously down dramatically in the DIY space. But we're very pleased with our pro and Bill, I don't know if you want to add to that?" ] }, { "name": "William G. Lennie", "speech": [ "Well, Craig, just kind of a follow-up on engagement. Craig mentioned the tools that we're providing to our account managers in the stores are POSes. As they get more engaged, we are seeing customers expand the number of categories that they purchase. We're seeing them start like more services like delivery, and then as a result, we're seeing accelerated growth in the accounts that are managed by our POSes. So, great strength in pro and top performing pro trades, where our renovator remodeler, property investors, and property managers, so we're pleased with the progress and the trajectory of the business." ] }, { "name": "Tori Oller", "speech": [ "And as my follow up, following up on the May commentary, can you talk about what you've seen from the acceleration from pro versus DIY quarter to date?" ] }, { "name": "Craig Menear", "speech": [ "We're seeing both in May. The whole store is lifting." ] }, { "name": "Tori Oller", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Seth Sigman with Credit Suisse." ] }, { "name": "Seth Sigman", "speech": [ "Thanks. Hey, guys. Good morning. A couple of follow-up questions here. First, just on the delivery from the store. It's continued to grow at this double-digit rate pretty much since you guys have rolled it out. Can you help us understand how meaningful that is today in terms of the overall contribution? And also the influence that it may be having in driving higher transaction size, because it does seem to be a big differentiator for you. Thanks." ] }, { "name": "Craig Menear", "speech": [ "We're pleased overall with what's happening on the delivery side of the business. We don't break out those numbers specifically, but we are seeing very nice growth. As Mark said earlier, that is attracting both incremental business with current customers and new customers into the business." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Then when you look at the online growth this quarter of 20%, obviously very strong again. Is it fair to assume there was really little weather impact there? And you discussed a couple of things that may be helping. Any more insight into where the growth is coming from? The types of categories? And also from a profitability perspective, just the progress that you're making there and improving the margins in that business? Thank you." ] }, { "name": "Craig Menear", "speech": [ "I'll answer the second part of that and I'll turn over to Kevin Hoffman. From a profitability standpoint, we run this on a portfolio basis and it's an interconnected experience, so in many cases, the experience starts in the digital world and may finish in the physical world. Over 45% of our orders the customer chooses to pick up in one of our stores. So, we manage the portfolio, if you will, on a profit basis across the channels." ] }, { "name": "Kevin Hofman", "speech": [ "Just from the health of the online business, we were really pleased with the traffic growth we saw. Ted mentioned we had double-digit improvement in our conversion rates because of the experiential improvements we've been putting in place. But just super excited. Some of our fastest growing sales are what we call those interconnected sales where the customer is buying online, picking up in-store, buying online, shipping to store, and that was some of our fastest growth and really across the store. Flooring did great, plumbing did great, electrical did great. We were very pleased." ] }, { "name": "Craig Menear", "speech": [ "So if there actually is an impact from a seasonal standpoint in the online business, when it's snowing on the ground in April, people aren't really looking online for patio furniture, for example. So it's kind of funny, but there actually is an impact." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Understood. Thanks very much." ] }, { "name": "Operator", "speech": [ "We'll continue on to Brian Nagel with Oppenheimer." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Brian Nagel", "speech": [ "My first question is on ticket growth. Clearly, a lot of discussion here on whether if you look at the ticket growth, it tracked higher in the quarter, and I think with the highest rates in a while. What's behind that and how should we view the sustainability of that metric? And then I have a follow-up." ] }, { "name": "Craig Menear", "speech": [ "I'm assuming you're referring to the $900.00 and above?" ] }, { "name": "Carol Tom", "speech": [ "Or the average ticket of 5.8%." ] }, { "name": "Craig Menear", "speech": [ "Or the average ticket of 5.8%." ] }, { "name": "Brian Nagel", "speech": [ "Yeah, I was talking more about the number in the presser, the average ticket of $5.8%." ] }, { "name": "Craig Menear", "speech": [ "So, if you look at the average ticket of 5.8%, think about the commodity impact plus the FX impact. That gets you back to kind of where we've been running all of 2017 quarter by quarter." ] }, { "name": "Brian Nagel", "speech": [ "Okay. So really has not been much change." ] }, { "name": "Craig Menear", "speech": [ "No, not at all." ] }, { "name": "Brian Nagel", "speech": [ "Okay, that's helpful. Then the second question I have, I guess from a bigger picture perspective, we talk a lot about, you mention a lot just the ongoing strength of the macro environment. Clearly, looking at my screen right now, we do have rates rising, albeit at historically low levels. The question I have for you is, what do you watch? You guys do a very good job of watching a lot of factors out there. What are you watching for maybe some potential early indications of an impact of higher rates upon your business?" ] }, { "name": "Carol Tom", "speech": [ "There are a number of things we look at. Obviously, during the recovery we were always looking for green shoots and now we're looking for red flags. Luckily, we're not seeing any of those. But here's what we're looking at. As you see, rates are going up. 30-year mortgage, I don't know what your screen is showing. The last time I looked, it was about 4.6%. It's on its way up, projected to be at least 5% by 2020. Historically, mortgages over the past 50-some-odd years is 5.8%. So, we are considerably under those historical mortgage rates. But we are super focused on the affordability index and what that means in terms of performance by market.", "If you look at the affordability index for the country at large, it's 152%, which is still very good. The average or again, decades, is about 127. So if the affordability index were to reach 127 or under, that would certainly be a red flag. Then we look at rising home prices coupled with rising mortgage rates. It's the in markets where you might argue there's an overheated housing market, or at least certainly one that's on fire. Is there anything happening to our business?", "I will call out two markets -- Denver, Colorado and Seattle, Washington. Both have seen extraordinary expansion to home price appreciation. Business there is very good. The reason is because the economy is very good. You can't just look at housing prices and interest rates to say uh-oh. You've got to then look at what's happening to the economy. It's getting a bit more complicated than it has in the past because there are all these influences of business. But certainly, if I stop talking and just tell you what we look at every day, we look at ticket and transactions, ticket and transactions.", "If you go back to the last recession, ignoring the housing downturn recession, but the last recession the United States had, 2001, our ticket was flat. So, we're looking at that. And then, of course, transactions. Because transactions can be an indicator of a few things, right? It could be an indicator of a slowdown in demand, or an indicator that a competitor is taking your customer away. Hopefully that's helpful, Brian." ] }, { "name": "Brian Nagel", "speech": [ "No, that's all very helpful. I appreciate it. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Elizabeth Suzuki with Bank of America Merrill Lynch." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Hi, good morning, guys." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Elizabeth Suzuki", "speech": [ "I think you had expected before to experience a similar net sales impact from Harvey and Irma in 2018 and in 2017. Is that still the expectation? Will the benefit be limited to the first half or could there be some residual benefit in the second half as well?" ] }, { "name": "Carol Tom", "speech": [ "Our expectation is that the sales will be the same year-on-year. The majority of the benefit will occur in the first half. There may be some trail-on benefit in the back half because the issues in Puerto Rico are so dramatic, but it won't be material to the company." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Okay. Then shifting over to online, what are the product categories that are doing well online and which are traditionally sold more in store and don't do very well online? And then how frequently are you able to adjust your online pricing to stay competitive?" ] }, { "name": "Craig Menear", "speech": [ "First of all, what I'd say is largely, our business online is incremental sales. We're growing the categories in store at the same time that we're growing online. I'll let Kevin speak to the categories." ] }, { "name": "Kevin Hofman", "speech": [ "Yeah, as mentioned, strengthen our core tools department, our plumbing department, our electrical department, really the core of the store has been performing very nicely. We've got a great bath business online as well.", "Your question around pricing, it's just like how we think about it in the store of being priced competitively every day and making sure that we differentiate not just on price, but on the full-service offering to the customer, the experience, and all the things that we bring to the table. So, very actively monitoring and managing the price situation online, just like we do in the store." ] }, { "name": "Craig Menear", "speech": [ "We can move prices, obviously, online instantaneously. We purposely, because of how it impacts the store environment, moved prices in the store at a different rate than we do online. We don't want to forget the interconnected aspect of our online business as well, because things like the lumber department pages or building material pages are some of our most active pages because the pros are looking at price and the inventory availability. So, while they're not transacting as much online in those departments, we have great traffic on those pages." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Thanks very much." ] }, { "name": "Operator", "speech": [ "We'll continue on to Seth Basham with Wedbush Securities." ] }, { "name": "Seth Basham", "speech": [ "Thanks a lot and good morning." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Seth Basham", "speech": [ "Could you guys give us some color on the growth in comp transactions by ticket size?" ] }, { "name": "Carol Tom", "speech": [ "Yes. We talked about big ticket already, so I suspect you're wanting to know what happened with the smaller tickets?" ] }, { "name": "Seth Basham", "speech": [ "Correct." ] }, { "name": "Carol Tom", "speech": [ "Yes. So, as you would anticipate, for transactions of $50.00 or less, they were down year-on-year. That was because of our garden business. I can make this really real for you if you just think about penetration of tender. You may say why. But if you look at penetration of tender in the quarter, our private-label credit card penetration increased by 50 basis points, while at the same time, our cash tender decreased by 50 basis points. That was all related to our garden business. So the smaller ticket activity." ] }, { "name": "Seth Basham", "speech": [ "Fair enough. If you think about the transaction growth overall at garden, how positive was it and how does that compare to recent quarterly trends?" ] }, { "name": "Carol Tom", "speech": [ "It was a positive 1.1% for the quarter and continues to be positive. As we said, May comps for the company are double-digit positive." ] }, { "name": "Seth Basham", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "We'll now hear from Dennis McGill with Zelman & Associates." ] }, { "name": "Dennis McGill", "speech": [ "Hi, good morning. Thank you. First question just had to do with the pilot program on the delivery from car and van. Can you maybe elaborate a little bit there, what you're seeing from that uptake? And particularly at the category or customer level, are you seeing pro versus DIY being more heavy with that uptake?" ] }, { "name": "Craig Menear", "speech": [ "It's still early days, and customers are choosing to purchase all sorts of things. It could be a pro on a job site needing something, but there's a lot also on the buy online, deliver from store front. It's interesting to see where it goes. It's not taking a real pattern at this point." ] }, { "name": "Dennis McGill", "speech": [ "Okay, great. Then, Carol, can you elaborate on the transportation cost increase that you experienced in the quarter, the deleverage there, is that fuel alone or are you seeing any issue with availability and where do you see that trending for the year within guidance?" ] }, { "name": "Carol Tom", "speech": [ "It wasn't fuel alone. We had 8 basis points of gross margin contraction in transport, of which 3 basis points was fuel and 5 basis points was the pressure on transportation. We're not alone. All companies are facing a higher transportation cost. As you know, as is our practice, we will figure out a way to work through this, but we've certainly got some challenges ahead." ] }, { "name": "Dennis McGill", "speech": [ "Thank you, guys." ] }, { "name": "Operator", "speech": [ "Our next question will come from Dan Binder with Jefferies." ] }, { "name": "Daniel Binder", "speech": [ "Hi, it's Dan Binder. Thank you. Carol, you mentioned a margin mix impact on gross margin. Was that primarily from the seasonal mix and how should we think about that for Q2? Then my second question was around credit. Just curious if we can get your thoughts on demand for credit, use of the credit lines that are out there, average spending on credit, and delinquencies." ] }, { "name": "Carol Tom", "speech": [ "On the margin expansion that came from mix and acquisitions, that was 14 basis points in total, of which 6 basis points was mix and 8 basis points came from our recent acquisitions, those acquisitions being The Company Store and Compact Power. As we look to the second quarter, obviously with an increase in penetration of the garden business, which is the lower margin category that's going to impact gross margins, but we're going to have benefit in other areas too. So, nothing comes to our attention that says we can't deliver the gross margin guidance that we just provided and updated with you today.", "On our private label credit card, really pleased with the performance, as I mentioned. We saw a 50 basis point improvement in penetration year-on-year. What we're seeing is a very healthy portfolio. The average net receivable, which obviously isn't underwritten by us, it's underwritten by a third party, but it's over $12 billion. We had a million new accounts open year-on-year, and we're seeing pretty good utilization on those accounts. For the consumer, the utilization is around 29%. For the pro, the utilization is around 23%. Our approval rates are north of 70% for both the consumer and the pro.", "Part of the change in accounting for us is moving all of the aspects of our private label credit card up to the revenue line. Included in the benefit that we removed out of our selling expenses and moved up to the revenue line was gain share. Gain share is our profit-sharing program with Citi, who underwrites this card for us. The way the portfolio has gains is there's an EBIT threshold it must earn, and then anything over that EBIT threshold, we share in it. That percentage of sharing changes over time.", "Embedded in that EBIT threshold, of course, is that you've got to make sure that the portfolio doesn't have high losses because that could impact your gain share. Our losses -- this is a long-winded answer to your question -- but our losses are running at or below historical averages, so the portfolio is very healthy." ] }, { "name": "Daniel Binder", "speech": [ "Great color, thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Chuck Grom with Gordon Haskett." ] }, { "name": "Chuck Grom", "speech": [ "Hi, thanks. Good morning. Just on the gross margin line, just to follow up on the transportation cost. Just wondering if you could characterize how they came in relative to your original expectations and then I have a follow-up." ] }, { "name": "Carol Tom", "speech": [ "We didn't anticipate deleveraging the supply chain in the first quarter to the extent that we did. The team did an awesome job though of managing spiky demand, pressure coming from all kinds of areas. So managed through it." ] }, { "name": "Chuck Grom", "speech": [ "Okay. So, you would expect that headwind to continue over the balance of the year?" ] }, { "name": "Carol Tom", "speech": [ "There's definitely pressure coming at us for the balance of the year, but we'll manage through it." ] }, { "name": "Chuck Grom", "speech": [ "Okay. Then just on the weather here, obviously you guys have a lot of experience dealing with it. When you think about it, does the business get simply delayed here and you recover most of it or do you lose some of it because the window just simply closes?" ] }, { "name": "Craig Menear", "speech": [ "No, we'll actually recover most of the business. There may be a piece here and there that you miss. Like part of pre-emergence, but even in that, we feel like we're getting most of that business right now, particularly in the North. The majority of this business will be recovered." ] }, { "name": "Chuck Grom", "speech": [ "Okay, thank you." ] }, { "name": "Operator", "speech": [ "We'll continue on to Matt McClintock with Barclays." ] }, { "name": "Matt McClintock", "speech": [ "Yes, good morning, everyone. McClintock." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Matt McClintock", "speech": [ "Carol, I was wondering if we could take the housing question from more of a generational perspective. It seeks like a lot of the long-term optimism for the market to stay strong is driven by the millennial generation forming households. Can you talk about maybe trend changes that you're seeing in the other generations? I only ask because it seems like a lot of the story of baby boomers may be moving, downsizing their household, seems to be kind of minimizing. Thanks." ] }, { "name": "Carol Tom", "speech": [ "Well, as we look at mobility rates, we see mobility rates declining by age cohorts, particularly baby boomers like me. There's been some great research that came out of the Harvard Joint Center for Housing Studies that suggests the desire is to age out in your home. Think about what that means for home improvement. That's nothing but opportunity. That's just one trend." ] }, { "name": "Matt McClintock", "speech": [ "Can you maybe dig into some of how the opportunities do change for you and how you position yourself for some of those changes just a little bit more?" ] }, { "name": "Craig Menear", "speech": [ "Well, yeah. I mean, if you think about flooring, for example. That's something that people look at as they age in their home. How do you make sure you eliminate trip hazards? You think about bath remodels and the ability to put in walk-in showers, for example, so that you don't have to step into a bathtub, where you have the potential to slip. You think about lighting around the home becomes an important factor, both inside and outside the home. You think about security. So, there's lots of factors that go into how somebody thinks about changing their home if they're aging out in their home." ] }, { "name": "Matt McClintock", "speech": [ "Perfect. Thank you very much for the color." ] }, { "name": "Craig Menear", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Our next question comes from Peter Benedict with Baird." ] }, { "name": "Peter Benedict", "speech": [ "Hey, guys. Thanks for taking the question, and appreciate the Stamford, Connecticut store." ] }, { "name": "Carol Tom", "speech": [ "It's a great store. It did $1 million the first week. It's an awesome store." ] }, { "name": "Peter Benedict", "speech": [ "There you go. Well done. Given the traction online with categories like tools, electrical, bath, just can you remind us how you're rethinking the space allocation within the stores to take advantage of the opportunities across different categories? That's my first question." ] }, { "name": "Craig Menear", "speech": [ "As I mentioned earlier, on online business, for all practical purposes, is incremental. So, we actually haven't seen the need to make a lot of shifts in space. It's something that we look at on a continual basis. But we really haven't had to do that at all." ] }, { "name": "Kevin Hofman", "speech": [ "I'd say, Craig, that the space that we're doing speaks more to the interconnected nature of our online business. We're putting lockers in the front of our stores. We'll do about 1,000 lockers this year. We're also adding some bigger holding area for bulkier items near the front of the stores. So, space allocation is more for online pickup than any merchandising changes in the bay." ] }, { "name": "Carol Tom", "speech": [ "46% of our online were picked up in the store in the first quarter." ] }, { "name": "Peter Benedict", "speech": [ "Okay, that's terrific. Yeah, it makes sense. Then, Carol, back to kind of the red flags that you're keeping an eye on out there, how about what are you watching when you think about the leverage guardrail for the business? Interest rates are going up here. Is there a level or a point at which the 2% becomes something that you're not comfortable with? How should we think about that?" ] }, { "name": "Carol Tom", "speech": [ "Well, I'm really pleased with how we've managed our capital structure over the past several years. If you look at the amount of debt that we have outstanding, long-term debt, excluding current maturities, $24 billion, the average maturity of that debt is 13.6 years. The coupon is 3.7%. The latter maturities go out 40 years. We really worked hard to not put any financial risk into the company. With an adjusted debt to EBITDA target of 2X, that implies we could get the debt paid off in a very short period of time. So, comfortable with that leverage. Always going to be mindful of not putting the company into financial distress, but real comfortable with where we are today." ] }, { "name": "Peter Benedict", "speech": [ "Okay. Sounds good. Thank you very much, guys." ] }, { "name": "Carol Tom", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from John Baugh with Stifel." ] }, { "name": "John Baugh", "speech": [ "Thank you. Good morning. Just quickly, since you're hyper-focused on the transactions and thanks for the 1.1 number in April X garden. I know you don't dive to that figure, but it sounds like May is well up. You've been running a 2+%, I believe, fairly consistently. Is there any thought around that number for the year in light of the start to the first quarter? Thank you." ] }, { "name": "Craig Menear", "speech": [ "So the 1.1 was for the quarter X our garden business. It wasn't for April. So that was for the total quarter. We think about the balance between ticket and transactions being relatively even over time. That's how we plan the year." ] }, { "name": "John Baugh", "speech": [ "Great, thank you. Good luck." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Matt Fassler with Goldman Sachs has our next question." ] }, { "name": "Matt Fassler", "speech": [ "Thanks so much and good morning. My first question is for Carol. You spelled out a 56 basis point impact on the expense ratio from your investment plan. Can you spell out here at the outset of that program where some of that money went and whether that's the kind of impact you'd expect to see through the year or whether with a better top line that impact should dissipate a bit?" ] }, { "name": "Carol Tom", "speech": [ "I talked about expense deleverage and leverage as a percent of sales. I really didn't talk about the expense growth factor, but let's use that nomenclature because that's how we've guided for the year. So, the expense growth factor in the first quarter was 202%. The drivers of that were rev rec, which was 57%, investments in the business 70%, and then what we call BAU (business as usual) 75%. In that business as usual, there's about 12% of acquisition-related expenses -- companies that we've acquired.", "So if we focus then on the guidance that we gave for the year, clearly it's going to get better. It's going to get better for a couple of reasons. First, we have $167 million of hurricane-related expenses in the back half that will not repeat. So, you should model a higher expense growth factor in the first half than in the back half. Secondly, and you've heard Ann-Marie talk about this, we have a new labor model which more effectively allocates our hours to our activity. That starts to kick in into June, so we should be driving more labor productivity than we saw in the first quarter.", "Then if I focus simply on the investments in the first quarter, the dollar amount of investments, and I'm not going to call this out every quarter, but because we're just getting into this, I'll give you this color. The dollar amounts of the investments were $144 million in the quarter. Those dollars were used for increased wages for our people, for increased advertising, as we move to a more marketing technology platform, increases in display costs. You heard Craig call out what we're doing inside the stores. Then increase in head count. We've got to have some people on board to help us do all of this investing. In fact, I believe we've hired 350 people alone in our IT organization. So, these are investments that we're making to reach those sales and operating margin targets that we laid out for 2020." ] }, { "name": "Matt Fassler", "speech": [ "That is great detail. If I could follow up on a couple of disclosures you made on the monthly trends. Was there any weather impact on the first two months of the quarter on February and March? Then when you think about the bathtub effect, if April was really the only month that was impacted, do you tend to recapture most of those lost sales in the month of May or does the bathtub effect push out until June or July?" ] }, { "name": "Craig Menear", "speech": [ "There definitely was impact still in the other months as well, and the recovery of that, you'll get a significant piece in May, but it will actually flow into June and July as well." ] }, { "name": "Matt Fassler", "speech": [ "That's great. Thank you, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from Scot Ciccarelli with RBC." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. Are you seeing a greater appetite for job site delivery from your pro customers?" ] }, { "name": "Craig Menear", "speech": [ "Certainly." ] }, { "name": "Scot Ciccarelli", "speech": [ "So, obviously, that is the case. Now, over time, do you think that happens to change your historical real estate advantage that you've had over some of our major competitors or maybe even open the door to higher levels of e-commerce competition because then the physical location or physical structure of a Home Depot store maybe gets partly marginalized over time?" ] }, { "name": "Craig Menear", "speech": [ "Actually, when you think about our location and footprint, we'll actually leverage that as an advantage overall to our business, where we are well positioned across markets, including urban markets, and sit within 10 miles of 90% of the U.S. population. So, no, we actually see this as an advantage. Mark?" ] }, { "name": "Mark Holifield", "speech": [ "You'll recall from the investor conference, we outlined 40 flat-bed distribution centers. We expect to open those to take some pressure off of the stores. But our stores are going to be in the delivery business in smaller markets for a good long time. They're still ideally located and a great place to originate those deliveries from. In urban markets, the flat-bed distribution centers will take a lot of pressure off of those high-volume stores." ] }, { "name": "Craig Menear", "speech": [ "I think the other think you have think about is actually not just the downstream portion of our supply chain network, but the advantage that we actually have as a result o the upstream portion of our supply chain moving goods from our suppliers to our stores and our distribution centers. It's those things working in combination that will create the fastest most efficient delivery in home improvement." ] }, { "name": "Carol Tom", "speech": [ "Catherine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question this morning is from Alvaro Lacayo with Gabelli and Company." ] }, { "name": "Alvaro Lacayo", "speech": [ "Thank you. It's Alvaro Lacayo here. Just one question on the update on the capital allocation, Carol. Last call, you said you were going to provide us with an update later on, given that cash flow from operations was going to be a little bit higher than sort of what was guided on dividends and repurchases and just some commentary around if there's any updated thoughts there." ] }, { "name": "Carol Tom", "speech": [ "We've been working on how to best use the cash that's coming off the business through lower taxes. We aren't announcing anything today. We have a Board meeting this week, so we will keep you apprised. Expect a more thorough update at the end of the second quarter. With that, let me just say that our principles aren't changing. The first use of cash is to go back in support of the business and our strategic imperatives. The second is to pay our dividend and anything left over, goes to share repurchases." ] }, { "name": "Alvaro Lacayo", "speech": [ "Great. Thank you very much." ] }, { "name": "Carol Tom", "speech": [ "Thank you." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "I'll turn the floor back over to our speakers for any additional or closing remarks." ] }, { "name": "Carol Tom", "speech": [ "Thank you for joining us today. We look forward to speaking with you on the second quarter earnings call in August." ] }, { "name": "Operator", "speech": [ "Thank you, ladies and gentlemen. Again, that does conclude today's teleconference. Thank you all again for your participation. You may now disconnect." ] }, { "name": "Alvaro Lacayo", "speech": [ "More HD analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
HD	2019-11-19	[ { "description": "Vice President, Investor Relations & Treasurer", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, Chief Executive Officer & President", "name": "Craig Menear", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "Chief Financial Officer & Executive Vice President", "name": "Richard McPhail", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Guggenheim -- Analyst", "name": "Steve Forbes", "position": "Analyst" }, { "description": "JPMorgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Nomura -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Wells Fargo -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Robert W. Baird -- Analyst", "name": "Peter Benedict", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Kate McShane", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings, and welcome to The Home Depot Third Quarter 2019 Earnings Call. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions]", "It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone.", "Joining us on our call today are Craig Menear, Chairman, CEO and President; Ted Decker, Executive Vice President of Merchandising; and Richard McPhail, Executive Vice President and Chief Financial Officer.", "Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our Investor Relations department at 770-384-2387.", "Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission.", "Today's presentation will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and good morning, everyone.", "First, let me start by welcoming Richard to his first earnings call. Sales for the third quarter were $27.2 billion, an increase of 3.5% versus last year. Comp sales were up 3.6% from last year and our U.S. comps were positive 3.8%. Diluted earnings per share were $2.53 in the third quarter.", "From a geographic perspective, all of our U.S. divisions posted positive comps. Internationally, both Canada and Mexico posted positive comps.", "Overall, we continue to see a strong and engaged customer. As Ted will detail, both ticket and transactions grew in the quarter. With the exception of lumber and electrical, all of our merchandizing departments posted positive comps. We saw a healthy balance of growth between both our Pro and DIY customers, with Pro sales outpacing DIY sales in the U.S.", "While our third quarter results largely demonstrate broad-based growth across geographies and merchandizing departments, our sales performance was below our expectations, driven primarily by the timing of certain benefits associated with our strategic initiatives. At the beginning of the year, we shared with you our expectation that these initiatives would collectively contribute approximately 100 basis points to our comp performance in 2019.", "As the years evolve, we have learned great deal and have shared with you that some of these initiatives have progressed more quickly, while others are taking more time. These investments are significant and long-term in nature, and we expect that the momentum we've seen will continue to build. Our rollout is largely on track and we are realizing benefits. It's just taking a little longer than our original assumptions.", "In a moment, Richard will walk you through the implications this has for our 2019 guidance. But let me first provide more context. We have foundational IT work stream supporting many of our strategic initiatives that will significantly enhance our ability to serve our customers in an interconnected way. Much of this IT work requires unwinding our legacy systems and that has proven to be more complex than originally anticipated.", "Take the B2B website experience for example. Our investments in a personalized B2B website experience is a significant component of the unique value proposition we are creating for our Pros. As you would expect, the most engaged customer cohort is a 135,000 Pros that we on-boarded at the beginning of the year. And we are seeing meaningful lift in spend as these customers become more familiar with the new experience. The rollout of the B2B site experience itself is on track. But underlying IT work must be completed before turning on additional elements of personalization and functionality for our larger Pro customers.", "Other investments are yielding results in line with or in some cases above our expectations. For example, homedepot.com continues to be a source of strength. Online traffic growth was healthy, conversion is up, and third quarter online sales grew approximately 22% from the third quarter of 2018. Customers continue to respond to the ongoing investments enhancements we are making to drive a frictionless interconnected experience, including faster fulfillment options.", "We also continue to leverage our digital platforms to drive incremental growth from adjacent categories like HD Home, pool and workwear, and are seeing good traction across all of these categories. We are seeing healthy growth in our online sales, and online shoppers continue to see the relevance of our stores as more than 50% of our online U.S. orders were picked up in our stores, a testament to the power of our interconnected retail strategy.", "We've continued to rollout automated lockers in our stores to make pickup of an online order easier and more convenient. To date, approximately 1,300 stores have lockers, and we've been very pleased with the customer response, as approximately 95% of customers rating their experience pickup, give us a five out of five stars.", "We fundamentally believe that when a customer comes to one of our stores, it has to be a great experience. Over 60% of our U.S. stores have a new look and feel, and customer response has been very positive. Customer service scores in the category of neat and clean have increase 120 basis points versus last year. Our scores for checkout time satisfaction have increased over 280 basis points versus last year.", "As we approach the end of the second year of our transformative One Home Depot investments, we have even more conviction today that we are making the right long-term investments for the business to extend our competitive advantage in the marketplace. As with any transformation, the work we are doing is complex, and I'm proud with the way our team is consistently off for the challenge.", "Our associates continue to focus on what's most important in our business, our customers, and I want to close by thanking them for their hard work and dedication.", "And with that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. During the third quarter, we saw strength across most of our departments, driven by growth with both our Pro and DIY customers. Comps in appliances, indoor garden, decor and storage, hardware, tools, outdoor garden, paint and plumbing were above the company average. All other departments with the exception of electrical and lumber were positive, but below the company average. Electrical was essentially flat due to light bulbs and deflation in copper. While lumber reported low-single digit negative comp due to continued commodity price deflation, we saw strong unit comp growth.", "During the third quarter, we saw balanced growth with both transactions and ticket. Comp transactions increased 1.8% during the third quarter, an acceleration from what we saw in the first half of 2019. The strength in our comp transactions was driven in part by the strategic store investments geared at improving the customer experience and extended outdoor season and traffic growth in a number of core categories.", "We also saw solid performance in big ticket transactions. During the third quarter, big ticket comp transactions are those over $1,000, which represent approximately 20% of U.S. sales or up 4.8%. Excluding hurricane-related markets, big ticket comp transactions were up 5.5%. In the third quarter, comp average ticket also increased 1.8%. We remain pleased with the performance of our ticket growth, despite significant lumber price deflation. The increase in our comp average ticket continues to be positively impacted by our customers trading up to new and innovative items. During the third quarter, commodity inflation in lumber and copper negatively impacted our average ticket growth by approximately 80 basis points.", "Let me take a moment to comment on tariffs. As expected during the third quarter, we saw increased costs arising from tariffs. Our merchants, finance, and data analytics teams are doing an incredible job mitigating cost impacts and helping us evaluate our elasticities. While still early days, we continue to believe we can effectively manage tariffs. However, we remain cautious on how tariffs could impact the consumer more broadly. Going forward, we will use our tools and analytics to help us continue to focus on being the customer's advocate for value.", "During the third quarter, we saw growth at both our Pro and DIY customers. Sales to our Pro customers, which we estimate represent approximately 45% of all sales continue to outpace DIY sales in the U.S. We are investing in resets, services and a suite of tools to drive a better customer experience, and save our Pro's time and money. In the third quarter, we saw strong growth in Pro heavy categories like fasteners, pneumatics, concrete and installation.", "Turning to our DIY customer, as summer started to wind down, we saw customers take advantage of the extended outdoor season. During the third quarter, categories like patio furniture, exterior stains and paint, soils and live goods, all had cost well above the company average.", "Our digital investments and interconnected strategy are working. As you heard from Craig, we are enhancing features, functionality and category presentations on our website. We continue to see growth in online traffic, conversion and average ticket. In fact, during the third quarter, we saw double-digit online growth in nearly all of our departments. And given the project nature of our business, more than 50% of these online U.S. orders were picked up in our stores.", "Let's look at patio furniture, as an example, the category we know our customers shop both online and in our stores. Recently, we've rolled out a new online category presentation patio that allows our customers to easily see the entire collection, different colors and styles, as well as various fulfillment options, all on one page. These new enhancements help drive our strongest patio comp in the last 10 years.", "Now, let's turn our attention to the fourth quarter. Last quarter, we talked about the incredible response we were seeing from our customers to our industry-leading line up of exclusive cordless outdoor power equipment from RYOBI, Milwaukee, DEWALT and EGO. We are excited to add Makita as new line of 18-volt outdoor tools to our assortment. Makita is 18-volt platform has over 225 tools and over 30 million batteries in the U.S. market.", "During the fourth quarter, we will add a powerful trimmer, lower hedge trimmer and chainsaw to that assortment all compatible with Makita's award winning portable power platform. We are proud to be Makita's exclusive big box partner.", "In addition, we are thrilled about the upcoming holiday season. Our merchants have worked hard to establish The Home Depot, as the holiday shopping destination. We have worked tirelessly with our supplier partners to put together a broad assortment of product offerings, the best value for the holidays. As in previous years, we will have a number of special buys for Black Friday, along with an in-store gift center showcasing great offers from our exclusive brands", "With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ted, and good morning, everyone.", "In the third quarter, total sales were $27.2 billion, an increase of 3.5% or $921 million versus the third quarter of fiscal 2018. Our total company comps were positive 3.6% for the quarter, with positive comps of 4.1% in August, 3.7% in September and 3.1% in October. Comps in the U.S. were positive 3.8% for the quarter with positive comps of 4.4% in August, 3.9% in September and 3.3% in October. Versus last year, a stronger U.S. dollars negatively impacted comp sales growth by approximately $41 million or 0.2%.", "As you will recall, fiscal 2018 had a 53rd week which shifted our fiscal 2019 calendar. As a result of this shift, our comp in October was negatively impacted due to the timing of our Black Friday event last year versus this year. This shift in timing, in event timing, negatively impacted our U.S. October comp by approximately 100 basis points. U.S. comps for the quarter were negatively impacted by approximately 35 basis points.", "As you just heard from Ted, during the third quarter, lumber prices remain depressed. Versus last year, this lumber price deflation negatively impacted our comp sales growth by approximately $175 million or over 65 basis points.", "In the third quarter, our gross margin was 34.5%, a decrease of 31 basis points from last year. The change in our gross margin was primarily driven by higher shrink and the mix of products sold compared to last year.", "In the third quarter, operating expense as a percent of sales decreased by 10 basis points versus last year to 20%. Our operating expense performance reflects strong expense control and continued productivity in the business as well as continued investments in our strategic initiatives.", "Specifically, expenses related to our strategic investment plan of $277 million increased by approximately $44 million from last year, and resulted in approximately 13 basis points of operating expense deleverage. This deleverage was offset by productivity in BAU or business as usual expenses, which drove 23 basis points of operating expense leverage.", "Our operating margin for the third quarter was 14.5%, a decrease of 21 basis points from last year.", "Interest and other expense for the third quarter grew by $56 million to $280 million due primarily to higher long-term debt levels than one year ago.", "In the third quarter, our effective tax rate was 24.5% compared to 21.4% in the third quarter of fiscal 2018. For the year, we now expect our effective tax rate will be slightly lower than 25%.", "Our diluted earnings per share for the third quarter were $2.53, an increase of 0.8% from last year.", "In October, a devastating round of storms and tornadoes impacted the Dallas area. During these storms, a tornado destroyed one of our stores in Dallas, and our thoughts continue to be with that community and our impacted associates.", "At the end of the third quarter, we had an ending store count of 2,290. And total sales per square foot were $449, up 3.5% from last year.", "At the end of the quarter, inventory turns were 5 times down from 5.2 times last year, reflecting loading of inventory in support of our strategic initiatives.", "Moving on to capital allocation. In the third quarter, we repurchased $1.25 billion or approximately 5.2 million shares of outstanding stock. This included repurchases of approximately 2.0 million shares on the open market and approximately 3.2 million shares through an accelerated share repurchase or ASR program. Note that for the shares repurchased during the ASR, it is an initial calculation. Final number of shares repurchased in the third quarter will be determined in the fourth quarter when the ASR terminates.", "Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 45.1%, 290 basis points higher than the third quarter of fiscal 2018.", "Turning to our outlook for the remainder of the year. As we approach the end of the second year of investment geared at achieving our One Home Depot vision, we are confident that we are making the right investments for the business to extend our competitive advantage over the long term. As Craig said, these initiatives are gaining momentum and are contributing to our sales growth, but some of the benefits anticipated for fiscal 2019 will take longer to realize than our initial assumptions.", "As a result, today we are updating our fiscal 2019 sales guidance. Remember that we guide off of GAAP. The fiscal 2019 guidance will launch from our reported results for fiscal 2018, which includes sales and earnings associated with the 53rd week. In fiscal 2019, we now expect comp sales as calculated on a 52-week basis to increase by approximately 3.5% and we now expect sales reflecting the compare of 53 weeks last year to increase by approximately 1.8%. We are also reaffirming our earnings per share guidance for fiscal 2019. We expect fiscal 2019 diluted earnings per share to grow approximately 3.1% to $10.03.", "We look forward to talking with you at our Investor Conference on December 11 in New York, where we'll give you an update on our key strategic initiatives as well as some initial thoughts around fiscal 2020.", "Thank you for your participation in today's call. And Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conduction a question-and-answer session. [Operator Instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning. My first question is what gives you confidence in these initiatives hitting? And then what gives you proof that it's the initiatives that are taking longer to realize and not something slowing in the macro? And then I have one follow-up." ] }, { "name": "Craig Menear", "speech": [ "So, let me start with the initiatives. First of all, we are seeing benefits from the initiatives. It's just not at the rate of our original plan. And when we look at the investment that we're making in this business, as we shared with you back in December of '17, we're doing this for the long-term health of the business, and to position ourselves to win comparatively in the long term. This is such a big opportunity that we're going to do this right and continue to make sure that we're delivering an experience that our customers are accustomed to getting from the Home Depot. And so we think we're getting about half of the investment -- benefit in 2019. And as we continue to add additional features and benefits as we unwind some of the complexities of our legacy systems, we'll see that continue to grow.", "And as it relates to, you know, how do we know, it's not something else. We continue to see broad-based growth in our business. As Ted called out, we had great strength in ticket transactions. We had strength in big ticket. We saw our Pro business accelerate during the quarter. And when we look at what happens in discretionary spend categories, particularly that are high-ticket discretionary spend, we don't see anything there that concerns us at this point." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. And my follow-up is, if you look at the construct of the existing three-year plan, and you start from today where 2019 margins are going to land looks like around 44%. It would call for flattish margins next year to up as much as 60% if you take the original plan. If the macro is not any different than you plan, which it sounds like it's not, what would cause that to change this range of flat to up 60%?" ] }, { "name": "Richard McPhail", "speech": [ "Hi. Hi, there, Simeon. So what I would say is, first of all, we're focused on delivering on the guidance for the year, and we look forward to talking about 2020 at our Investor December conference. Clearly, there has been pressure to our margin from shrink, which was the highest contributor to the decrease year-over-year within that 31 basis points. And so that is an unplanned pressure, and we are taking the steps and have many initiatives in place to address that." ] }, { "name": "Michael Lasser", "speech": [ "Okay. Thanks. I thought I took a swipe at it. I appreciate it." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. You mentioned that you're getting about 50 basis points of lift from the return on investments rather than the anticipated 100 basis points that you previously expected. Is there any reason why we shouldn't just take that delta, the incremental 50 basis points and just tack it on to what we're modeling for next year that speaks to both the nature of the return and the timing associated with the return?" ] }, { "name": "Craig Menear", "speech": [ "Michael, I think as we look at the investments that we're making, we expect that through the balance of '19, as we move into 2020, we will continue to see the momentum build of the investments that we're making. I don't know that we see it as a straight line, but it certainly will continue to ramp. As we shared in my opening comments, for example, on the B2B website experience, the first 135,000 customers that we put on early in the year were seeing very nice results as we on-board more and we on-boarded a number recently at the end of the quarter. As we continue to see them engage, they get more familiar with the experience we see lift. So we are definitely confident that we will continue to see the momentum build through the investments that we're making." ] }, { "name": "Richard McPhail", "speech": [ "And it's also, if you think Michael about the investments we've made in our store environment, and Ted and then you may want to comment a little bit about that. We know that the changes we're making are resonating with our customer and we're seeing positive lift from that." ] }, { "name": "Isabel Janci", "speech": [ "Yeah. No. Thank you, Richard. Couple of things that Craig called out. First of all, when you think about our sales growth, online sales growth, and what we've seen in the stores, the 50% that's picked up in the stores, as we continue to make that easy for our customers, we are seeing just incredible repeat as we think about transactions. So we're going to continue to lean into things that really simplify the experience for more customers. We are also continuing to add delivery capabilities outside of the stores as well with our car and van delivery, which really benefits our Pro customer and we see that accelerated through the quarter.", "And when you think about VOC scores, Craig called it out, as we think about auto lockers. And, but we're also seeing increased VOC scores on our checkout process on the front-end as well. So we think about the investments we're making, and we think about the fourth quarter coming up. We're going to see increased traffic for our customers, another time of introducing all these investments to our customers, which we believe is just going to drive tremendous loyalty." ] }, { "name": "Michael Lasser", "speech": [ "That's helpful. And my follow-up question is you're guiding to a 5% comp, that's implied for the fourth quarter. And that will be higher than what you've done throughout the course of this year. So what's driving your more optimistic expectation? Is it that you're going to see this accelerating return from the investments? Or are there other factors that you can outline that can help bridge to that 5% you're guiding to for the fourth quarter?" ] }, { "name": "Richard McPhail", "speech": [ "Michael, thanks for the question. We're very comfortable with our guide based on the momentum, Ted called out. And while our guidance does imply acceleration that acceleration is mostly caused by the absence or reversal of pressures we saw in Q3 as we walk to Q4, from lumber -- lumber deflation from FX and from an event timing shift that we saw in Q3.", "So you can look at it a couple of ways to normalize Q3. If you take the quarterly comp of 3.6%, and you add back 60 basis points from a much lower level of pressure from lumber we'll see in Q4 versus Q3, and you add back 35 basis points from the impact of event timing to Q3 where basically our Q3 comped over the first week of Black Friday from last year's Q4 due to the calendar shift, and then you add back 30 basis points from favorable FX compares, you'll see Q4 is actually right in line with the normalized Q3.", "You could look at it another way. You could take our October comp of 3.1% as an exit rate, you'd add back 100 basis points from that event timing impact, lumber of 60 basis points and FX of 30 basis points, and again you'll see why we have confidence in the progression from Q3 to Q4." ] }, { "name": "Michael Lasser", "speech": [ "Understood. Thank you very much, and have a good holiday." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Thanks, Michael." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with RBC. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. Two follow-ups. First, so when we think about the impact of both the Black Friday event and lumber pricing, when we are thinking about a net impact kind of negative 25 basis points, is that right, Richard?" ] }, { "name": "Richard McPhail", "speech": [ "From lumber, yes." ] }, { "name": "Scot Ciccarelli", "speech": [ "Okay. Got it. And then also..." ] }, { "name": "Richard McPhail", "speech": [ "[Speech Overlap] answer your question" ] }, { "name": "Isabel Janci", "speech": [ "Can you repeat the question, Scot?" ] }, { "name": "Craig Menear", "speech": [ "Repeat the question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Yes, just the net impact. Right. You had some of the Black Friday event kind of fall into fourth quarter this year versus 3Q last year, plus you had the lumber pricing. I guess I'm trying to figure out what's the net impact, you know, the comments you've made suggests it's about 25% -- 25 basis points on a net basis?" ] }, { "name": "Richard McPhail", "speech": [ "No, they actually both go the same way. So 35 basis points of negative pressure to Q3 and 60 basis points of negative pressure -- sorry, 35 basis points from event timing and 60 basis points from lumber pressure, so they add to about 95 basis points, really sort of alleviation of those pressures as we walk from Q3 to Q4.", "And then, if you're looking at total company comp, where there was a 20 basis point differential between total company and U.S. in the third quarter, then you bring FX into play, and we will have about a 30 basis point favorable compare in the fourth quarter. Does that makes sense?" ] }, { "name": "Scot Ciccarelli", "speech": [ "Okay. I think so. And then a follow-up question on your shrink comment. As the pressure from shrink continue to increase, or/and related to that, do you have any feel for it, if that's being driven more by internal, let's call it, tests or issues or if it's more external? Thanks." ] }, { "name": "Craig Menear", "speech": [ "Yes, Scot, it is continuing to increase. We've seen the pressure. But we have a number of initiatives under way." ] }, { "name": "Isabel Janci", "speech": [ "Yes, I'll add. Certainly, in the departments that we are seeing increased pressure, they are more what we considered kind of malicious, and we have had initiatives under way, and have implemented high, restore some of the things we've done in the past to make sure that we secure our product. But in addition to that we are working through initiatives from a technology perspective as well because we want to make sure that we have a long-term solution to mitigating this risk as well. So while we are doing certain things in the short term to release some of this pressure, we are also working on the initiative in the long term." ] }, { "name": "Scot Ciccarelli", "speech": [ "And so when would you expect that trend, if you will, to start to reverse?" ] }, { "name": "Isabel Janci", "speech": [ "We have an expectation in the stores that we have implemented some of the initiatives that will start to bend the curve. But as I said, we have done that in our high risk stores first, and we want to make sure that as we protect the top line, we are mitigated and really created a good experience for customers. So we are going to continue to monitor, but some of the things we're seeing in the short term has been really positive in these high risk stores that we have implemented." ] }, { "name": "Scot Ciccarelli", "speech": [ "Okay. Thanks a lot, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steve Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steve Forbes", "speech": [ "Good morning." ] }, { "name": "Craig Menear", "speech": [ "Good morning." ] }, { "name": "Steve Forbes", "speech": [ "I wanted to follow up on the investment plan for this year. So I think you called out $44 million -- $44 million of pressure right from higher spend this year. But can you just remind us what the plan is for the whole year relative to 2018, because I thought both -- I guess, both in absolute dollars, because I thought the P&L pressure was going to be similar right same dollar impact '19 versus '18. So should we expect a reversal or a benefit in the fourth quarter?" ] }, { "name": "Craig Menear", "speech": [ "The investment plan actually ramp through..." ] }, { "name": "Richard McPhail", "speech": [ "Yes. Yes, the investment plan ramps actually from a total, and remember I'm calling out capital and expense here. But a total investment plan of about $3.3 billion last year, ramping to an investment plan of about $3.6 billion this year. And so we -- and that's in line with the plan that we set back in 2017. And so the expense year-over-year is really sort of in line with that lift as well because expenses generally lift with the capital." ] }, { "name": "Steve Forbes", "speech": [ "All right. Just a follow-up on that, so can you help us break that down between capital and expenses? Or is it really just the incremental, is the $300 million spread between those two numbers?" ] }, { "name": "Richard McPhail", "speech": [ "It's actually -- so the breakdown for 2019 is about $2.6 billion in capital and about $1 billion and expense, which is higher than last year's levels. But it really is just that increment of ramping up to $1 billion in expense that you see in the P&L and the cadence of those investments quarter-to-quarter over the year, a relatively steady ramping up through the year and peaking in Q4. As you would expect, as we continue to ramp investment up and investment will be higher in 2020 than it was in 2019." ] }, { "name": "Steve Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with JP Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning. Look, the market growth has moderated in '19 relative to the past couple of years. Was that your expectation coming in, and do you think that lower mortgage rates allow the market growth rate to reaccelerate from here? So I think it was like sort of a base case 4% market growth rate was a three-year plan, or do you think that maybe that market growth rate moderates a bit further given where later into the cycle?" ] }, { "name": "Craig Menear", "speech": [ "We shared at the beginning of this year, we did expect that the market growth would be slightly less than it was in the previous year. And so that was -- that was part of our overall expectations. I mean, when we look at the market in total, however, I mean we play in a $600 billion market that we own about 17% of. And if you look at third-party data, it would indicate that we took significant share in Q3. And so we look at this as an opportunity going forward. We always talk to the merchants about the fact that we don't have enough share to worry about of the market growth itself. We just need to stay focused on the customer and continue to drive the business." ] }, { "name": "Richard McPhail", "speech": [ "I think there's another point to that Chris, which is really just looking at the headline of 4% market growth, and what we experienced in 2019 from a lumber deflation perspective. We shared with you earlier in the year that's going to be about $800 million of pressure to us, but it will be pressure in the market in general. And so when you sort of round that out, you're looking at market growth or sort of our base case assumption of 4% lower down to around 3%. And in fact, the fact that we're guiding 3.5% today shows that we think we're getting about 0.5 point from initiatives." ] }, { "name": "Christopher Horvers", "speech": [ "And so do you expect -- so I guess the puts and takes as you look forward to Scot, the benefits from initiatives, which I think back to the three-year plan, you had expected that to ramp, or I guess even over the five-year plan. But then on the other side, you have sort of the rate factor. So do you think that rates allow the underlying market growth rate to reaccelerate, and maybe get some back -- get back some of the deflation. So the underlying growth rate actually could be better as you look forward." ] }, { "name": "Craig Menear", "speech": [ "What I would say is the macro and housing environments have played out right in line with our expectations, and the description we would use is housing is healthy and stable. There is no doubt that recent movements in the rate environment are going to create support for that stability. But as we've said for many years, we expected that we would see that from 2012 a period of moderate housing recovery and a period of sharp housing recovery, and then a period of stability in housing. And that has played out. And so I would say again housing is healthy and stable. The rate environment certainly provide support to that." ] }, { "name": "Christopher Horvers", "speech": [ "That's very helpful. So my follow-up is on the extended season that was an impressive traffic number. Do you think that that extended season with weather -- understand you lapped hurricane last year, but was the just that extended season additive to comp for this quarter?" ] }, { "name": "Ted Decker", "speech": [ "Hey, Chris. It's Ted. Yes and no, I'd say, certainly the extended season, we did well, and things like exterior stains and paint and some garden projects, but then in the Southeast in particular we had heavy drought as well. So there is some give and take with that. I think on the margin we did do better with the extended season. I would say though that the fundamental drivers of the business is the bigger story. When we think about this balance of ticket and transaction growth, we always start the year planning in expecting the balance of ticket and transaction. It really plays out that way, to see 1.8% growth in ticket, 1.8% growth in transactions.", "Real underlying story is also unit growth. We saw our strongest unit, since Craig called out, in a year, and if you adjust for as we've always called it the bathtub effect for spring or if you have a weak Q1, you have a stronger Q2 depending on weather -- when the weather hits, when you normalize for the bathtub effect, this was our strongest units in two years, across the entire business. As Craig said, it's across geographies, and it's actually across the store where we're seeing this unit productivity." ] }, { "name": "Christopher Horvers", "speech": [ "Very helpful. Have a great holiday season." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Baker with Nomura. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "Thanks. A couple of follow-ups on the gross margin. First, what are you seeing competitively in terms of pricing, and if you could touch on the paint category in particular? And then secondly, as it relates to tariffs, you said you are -- you think you can manage tariffs. What does manage tariff mean? Does that mean it has an impact on gross margins, but you can offset it elsewhere? Or basically what are tariffs doing to the gross margins? Thanks." ] }, { "name": "Craig Menear", "speech": [ "So from a competitive standpoint to begin with, we see continued escalated promotional environment in the marketplace that would include the categories of paint that doesn't seem to be abating whatsoever. Ted and merchant team are sticking to our strategy of delivering great everyday value to our customers. We know that that's the long-term right approach for the business and has played well for us over time. And so that is absolutely. Ted, I don't know if you want to comment on the tariffs?" ] }, { "name": "Ted Decker", "speech": [ "Yes. On tariffs, since this started, we said, we believed it's manageable. And when I say that our finance teams, merchants, and data analytics teams have really drilled into the overall impact of the business. We know down to the SKU level, the point of origin, the classification of the tariff, the potential impact, and from there we start working with our supplier partners to mitigate that tariff impact. We all know that on the margin all goods have elasticities, and we ultimately have to put price through, you are going to retard unit productivity.", "So each of Home Depot and our supplier partners are laser focused on maintaining unit growth in this business. So we will work on mitigating the tariff impact to change country of origin, to change makeup of the product itself, to add other features and benefits that can add value to the consumer. With all that being said, we have offset from what would be the -- not theoretical, the actual SKU level buildup of tariff impacts. We have offset well over half. So out of the gate, there is no impact on well over half of the potential tariff impact to our business, again, working closely with our supplier partners.", "And with the balance of the impact that is a manageable set of actions we're taking across the portfolio, not necessarily in the tariffs SKU cells [Phonetic]. We have moved on some retails and that's implied when I said we're measuring the various elasticities, and where we've had to move and where we've acted in a portfolio of fashion. We've maintained unit productivity, as I said, whether effective this is our best units last quarter and over two years. So I would sum all that up to the kind of tariffs that we believe it's manageable." ] }, { "name": "Michael Baker", "speech": [ "Thanks. That's a lot of color, and very helpful. One more, just a follow-up to a previous question, just on the housing in the macro, I get that you're talking about it being stable, but if we just look at the simply -- simple measures of existing home sales, they have picked up as of late, really six months to nine months ago, and historically that does lead to better comps for you guys. So I guess are you surprised that comps aren't accelerating on the back of housing or should we expect that maybe early next year?" ] }, { "name": "Craig Menear", "speech": [ "I go back to the base kind of comp that Richard walked through with you as we look forward. And you know the underlying health of the business is very solid. Great transaction growth, great unit growth, broad-based across the business. If you candidly look at where we thought this year would play out to where we are today, I mean, 70-plus-percent of the variance to the current year-to-date performance is lumber deflation [Indecipherable]." ] }, { "name": "Michael Baker", "speech": [ "Perfect. Thank you." ] }, { "name": "Craig Menear", "speech": [ "So we feel good about the environment." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. Just a question, housekeeping. Last quarter you gave big ticket -- ticket growth by month. So I was wondering if you would be willing to provide that this quarter? And then I had a bigger picture question." ] }, { "name": "Craig Menear", "speech": [ "I don't think we have that with us here right now. We can provide that if you want to call in, in the Investor Relations department." ] }, { "name": "Karen Short", "speech": [ "Okay. And then switching to the 2020 investment comments, so you commented that the 2020 investment would be higher versus '19. So I guess the question is, is that comment applied to both expense and capital? And then within the expense, is that still more skewed to D&A versus SG&A?" ] }, { "name": "Craig Menear", "speech": [ "Look, we've got our Investor Conference in a couple of weeks, and will provide all the color around this at that time. Right now we are laser focused on delivering the balance of this year." ] }, { "name": "Karen Short", "speech": [ "Okay. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey. Good morning. So following up on the SG&A investment question for this year, you spent $277 million in the quarter. That gets me to about $820 million in operating expenses so far this year, if my math is right. So how much of this would you categorize as strategic versus business as usual investment? And then, I just want to confirm, you don't expect the strategic investments to step down in Q4 to get to that $1 billion for the year that you've talked about." ] }, { "name": "Craig Menear", "speech": [ "So all of the investments that we call out is strategic investment of $277 million in Q3. We've guided to a planned number of around $1 billion, and we will be north of $1 billion this year, right in line with expectations as we set them out at the beginning of the year." ] }, { "name": "Zach Fadem", "speech": [ "Okay. And then on the 100 basis point calendar headwind in October, could you expand on that just a little bit more. I just want to confirm that this will be a similar benefit to November? And then when you think about the moving parts lumber deflation in Q4 and then the hurricane headwind perhaps subsiding, why do you think the implied 5%-ish comp in Q4 is the right place to land? And there any other moving parts that we should keep in mind?" ] }, { "name": "Craig Menear", "speech": [ "Yes, I'll speak to the events from a merchandising calendar. It's very heavy at this time of year. So we set our Pro Black Friday. We bring in great values for our Pro. We bring in Appliance Black Friday, which is a very, very large appliance event. And then we've set our gift center, which is a lot of power tools, power tool accessories, hand tools, gifting items. All of those initiatives kicked off on the calendar a week late relative to comp. And that's -- we're quite confident that that's the number of 100 basis points and we see that flowing into Q4. And some of that actually will go into December on the end. So it doesn't all hit in November. This will hit throughout November and December." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Thanks, Ted. Appreciate the time." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Peter Benedict with Baird. Please proceed with your question. Mr. Benedict, your line is live." ] }, { "name": "Peter Benedict", "speech": [ "Sorry, guys. I will take mute off. So my question is just around the Pro B2B sign up cadence. You've talked about 135,000 or so that were signed up early in the year. Are you guys still expecting a $1 million by the end of the year or have you kind of slowed the sign ups because of some of the tech issues that you were talking about?" ] }, { "name": "Craig Menear", "speech": [ "We still expect to on-board about 1 million customers during the year, and we on-boarded a number of them at the tail end of Q3." ] }, { "name": "Ted Decker", "speech": [ "Yes. Peter we finished Q3 just above 780,000 Pros that have been migrated on to the website. And we continue to add new capabilities as we go through the quarter. We now accept the Pro purchase card with our legacy underlying customers so that they can buy on homedepot.com. We've done things like introduce Buy It Again functionality, and we've made new user registration automatic. So as we have new customers signing up on to our Pro Xtra platform, we can get those customers at the time of sign-up and we can automatically migrate them to the B2B website. So we're on track with customer migration and on track with all of the capabilities." ] }, { "name": "Peter Benedict", "speech": [ "Okay. So that $1 target, what -- roughly what percent of your Pros does that represent? I guess, where -- what kind of penetration you guys think you can get longer term?" ] }, { "name": "Craig Menear", "speech": [ "But if you look at it, we think we can get all of our Pros our verified Pro customers migrated on to the website over the long term. So that would represent about 30%." ] }, { "name": "Richard McPhail", "speech": [ "Yes. About 30% of the total." ] }, { "name": "Craig Menear", "speech": [ "The total right now?" ] }, { "name": "Richard McPhail", "speech": [ "And as we continue to build the base of capabilities, then we'll obviously do more as we had originally planned to then make that knowledgable to our Pros and market to them accordingly." ] }, { "name": "Peter Benedict", "speech": [ "Okay. Great. And just my one follow up would be, just getting back to a question a little bit early, just around trade down, I know you mentioned some things around how you're trying to manage elasticities and whatnot, but I'm just even absent of tariffs, have you seen any sign of trade down either within certain categories or whatnot, where maybe some of the Pros are opting for more middle line product as opposed to higher end? I was curious if you're seeing anything there." ] }, { "name": "Craig Menear", "speech": [ "No, we're not. So, couple of points of observation there. Appliances, for example, we continue to see trade up across just great innovation in appliance business. We've introduced Bosch, which is approaching the higher -- highest end of the category, and picking up lots of net new business there. And then the phenomenon with the cordless power tools now going in outdoor power equipment. We're seeing great pick up, and these are all higher price points with the innovation of technology and outdoor power equipment." ] }, { "name": "Peter Benedict", "speech": [ "All right. Terrific. Thanks so much. Good luck, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Hey, guys, good morning. I did want to follow up on that last point. So when we look at your average ticket on a comp basis, up 1.8%, yes, pretty similar to last quarter, where it was 2%. I guess I'm surprised it's not accelerating more. It sounds like you had a little bit less commodity deflation this quarter, big ticket trends seem pretty healthy, maybe had a little bit of inflation on the back of tariff. So I'm just curious, is there something else that's holding back the ticket growth? Maybe is that the shift related to Black Friday where you have a lot of big ticket categories or something else maybe?" ] }, { "name": "Craig Menear", "speech": [ "Yes. Seth, that's exactly it. The big delta would be the events for the holiday promotion. So think of appliances, your average ticket around appliance, gifting portable power tools, combo kits, etc. So that 100 basis point isn't -- that shifted isn't entirely ticket, but much more so the transactions." ] }, { "name": "Richard McPhail", "speech": [ "And I'd just say Seth that again we think about the big ticket in this quarter over $1,000 at 4.8 hurricane adjusted markets at 5.5. That is right in line with our expectations." ] }, { "name": "Seth Sigman", "speech": [ "Yes. Okay. That makes sense. And then just to follow back up on tariffs, it sounds like you guys have manage that really well and have found some offsets. How do we think about the same SKU inflation that is -- that you're seeing in the business and how it may be impacting comps?", "And then just the second part of that. There have been some exclusions announced recently in certain categories that you do play in. I'm just curious if that's meaningful at all for you guys? Thanks." ] }, { "name": "Craig Menear", "speech": [ "Sure. I would say on the contribution of tariff to that ticket growth, it's actually a very nominal amount. It's by far lower than, for example, the introduction of sales of new innovative higher priced AUR items is a far bigger driver of that 1.8% than any price moves we would have made associated with tariffs.", "And on the exclusions, we're working through that. It was last Friday, we had a number of exclusions announced, a number in the flooring category that we're working our way through. Very optimistic about what that is going to mean for vinyl plank. We believe most of our portfolio in the luxury vinyl plank, which has been our fastest growing category and a number of those items are seemingly going to be on the exclusion list. Again we're working through the detail, but we're very encouraged." ] }, { "name": "Seth Sigman", "speech": [ "Okay. Thanks for that." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question will come from the line of Kate McShane with Goldman Sachs. Please proceed with your question." ] }, { "name": "Kate McShane", "speech": [ "Hi. Thanks so much for taking my question. I just wanted to -- you mentioned that the Pro is still outpacing DIY. I just wondered if you had seen any changes in the delta between the Pro and DIY trends?" ] }, { "name": "Craig Menear", "speech": [ "I think if we look at the last few quarters, the delta hasn't changed dramatically, but we did see the Pros strengthened some in this quarter." ] }, { "name": "Richard McPhail", "speech": [ "Saw both strengthen, but -- and then the one comment I would make about the Pro business is we're seeing -- Ted talked a little bit about the unit comps which are very encouraging, but the growth in Pro was primarily through transactions versus ticket. So just good broad-based strength on the business." ] }, { "name": "Kate McShane", "speech": [ "Okay. Thank you for that color. Just had one follow-up question, unrelated, just with regards to the macro environment, if you could talk about any differential between the performance in different areas of affordability from a geographic standpoint?" ] }, { "name": "Craig Menear", "speech": [ "Yes. We actually look at the regional variability every single quarter. And in the third quarter, it was actually the narrowest we've seen in quite some time. And that includes all states, whether they are high salt states or not. So we are very pleased with the narrow variability that existed." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "Craig Menear", "speech": [ "You bet." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you for joining us today. We look forward to seeing many of you at our Investor Conference in December." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
HD	2021-02-23	[ { "description": "Vice President, Investor Relations, and Treasurer", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Craig Menear", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steven Forbes", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to The Home Depot's quarterly earnings call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Welcome to Home Depot's fourth-quarter and fiscal-year 2020 earnings call. Joining us on our call today are Craig Menear, chairman and CEO; Ted Decker, president and chief operating officer; and Richard McPhail, executive vice president and chief financial officer. Following our prepared remarks, the call will be open for questions.", "Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our Investor Relations department at 770-384-2387. Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.", "These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and good morning, everyone. Thanks for joining the call this morning. We hope that you and your loved ones are safe and healthy. Our thoughts are with those that have been impacted by the recent winter storms.", "Fiscal 2020 was a year that we certainly will not forget. It was a year of great hardship and adversity for so many and our thoughts and prayers are with the millions of people who have been directly impacted by the pandemic. It is times like these that I have never been more thankful for the culture that our founders instilled in our business over 40 years ago. We have navigated this crisis by aligning our decisions and actions to some of our most important values: to do the right thing, and to take care of our people.", "At the end of the day, it is our people and culture that make us unique. Our ability to manage unprecedented demand in the business while navigating the global pandemic and supporting our communities through multiple natural disasters and moments of crisis is a direct result of our associates extraordinary efforts. As a result, investing in our associates during this time was one of the easier decisions we made this year. During fiscal 2020, in addition to record-success sharing payouts, we invested a total of approximately $2 billion on enhanced compensation and benefits for our associates.", "As we announced last quarter, we transition from temporary COVID-19 benefits to permanent compensation enhancements for our frontline hourly associates. At the beginning of the year, I would have never thought it possible for the business to grow over $21 billion in 2020. For context, it took us 19 years as a company to achieve the first $20 billion in total sales and we outgrew that in this year alone. This was enabled by investments we've made in the business as well as the team's exceptional execution and cross-functional alignment.", "COVID-19 and its impacts have forced us to change the way we live, work, and interact with one another. And there are some key learnings. The first is that the investments we have made in the business over the past decade were the right ones. And the second is that those investments enabled agility and flexibility to execute on critical business decisions in a changing and dynamic operating environment.", "Investments in technology and infrastructure helped us to extend our in-store focus offering to curbside in a matter of days and convert a newly opened market delivery center facility to a direct fulfillment center in order to reduce online delivery lead times to improve the customer experience. The mechanization of our upstream supply chain helped us to better flow products to our stores, while investment in tools for our store associates and MET teams helped to get that product to the shelves for the customer more quickly and efficiently. Our merchants leveraged data analytics to collaborate with our supplier partners to make real-time adjustments to our assortments as we work to prioritize the highest-demand SKUs for our customers. Despite one of the most difficult operating environments we have ever faced, we continue to make progress with regards to our strategic initiatives.", "Key components of our One Home Depot strategy such as opening of various supply chain facilities, technology investments, and enhancements to the digital experience remain on track. We have also restarted many of the in-store investments that were paused at the outset of the pandemic. As customers engaged with the Home Depot, we see a continued blend of both the physical and digital worlds. As a result, we believe that this distinct competitive advantages and overarching benefits of an interconnected One Home Depot strategy have never been more relevant.", "Now, turning to our financial highlights. Our results for the year clearly indicate that for many customers, the home has never been more important. Fiscal 2020 sales grew $21.9 billion to $132.1 billion, up 19.9% from last year. Comp sales were up 19.7% from last year and our U.S.", "comps were positive 20.6%. Diluted earnings per share increased 16.5% to $11.94 for the year. We finished this year with another exceptional quarter as we saw the continuation outsized demand for home improvement projects. Sales for the fourth quarter grew $6.5 billion to $32.3 billion, up 25.1% from last year.", "Comp sales were up 24.5% from last year with the U.S. comps a positive 25%. Diluted earnings per share were $2.65 for the fourth quarter. Our results this quarter once again were driven by broad-based strength across the business and geographies.", "All of our top 40 markets posted double-digit comps, while Canada posted comps above the company average and Mexico posted double-digit comps in local currency. As Ted will detail, big-ticket comp transactions were up double digits in the quarter and we saw strong double-digit growth from both the Pro and DIY customers. We had a record holiday season as our modified approach to Black Friday and gift center events clearly resonated with our customers. Our interconnected retail strategy and underlying technology infrastructure have continued to support record-level web traffic on a consistent basis throughout the year.", "For the quarter, sales leverage in our digital platforms increased approximately 83% versus the prior year and approximately 55% of online orders were fulfilled through a store. For the year, sales leverage in our digital platforms increased approximately 86% versus last year and approximately 62% of online orders were fulfilled through a store. We continue to invest in our digital assets, introducing new capabilities in different ways to engage with the Home Depot, all with the goal of improving the customer experience. One of the customer-enhancement tools that had to be completely reimagined in COVID in the COVID-19 environment was our in-store workshop program.", "For years, we have offered a number of different in-store workshops including our kids workshops. Until COVID-19, there wasn't an online option for these workshops. But in a few short months, we were able to successfully transition 100% of our workshop content online. The live streaming platform has allowed us to go from an average of five in-store workshops per month to approximately 40 online live streaming workshops per month.", "These online workshops have driven a deeper level of engagement and connectivity with our participating customers. One thing that did not change in fiscal 2020 is our disciplined approach to capital allocation to create value for our shareholders. We remain committed to growing our dividend as earnings grow. As a result, today, we announced our board approved a 10% increase in our quarterly dividend to $1.65 per share which equates to an annual dividend of $6.60 per share.", "As we look to fiscal year 2021, Richard will provide some perspective into the factors that have the potential to impact the company's performance. I'm incredibly proud of all we have accomplished in this unprecedented year and I want to close by thanking our associates for the way they have lived our values by serving our customers, communities, and each other during these challenging times. I also want to thank our supplier partners for their continued support and partnership throughout this year. In addition, I would like to welcome the associates from HD Supply back to the Home Depot family.", "As we close fiscal 2020, we have nearly completed our multi-year accelerated investment program that has positioned us well to serve our customers in this dynamic and changing environment. We have more conviction than ever that we have been investing in the right areas of the business and will continue to invest to extend our competitive advantage and enable market share growth in any environment. We believe that our scale, combined with our low-cost position and continued focus on the customer, will help us win in a highly competitive marketplace and deliver exceptional returns for our shareholders. And with that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. I want to begin by expressing my appreciation to our associates and supplier partners for their unwavering dedication to our customers over the last year. During the fourth quarter, we continue to experience unprecedented levels of demand across our business. For the third quarter in a row, comps in the U.S.", "have been approximately 25%. With remarkable consistency, comps in the U.S. were at or above 20% for 36 of the past 39 weeks. And as you might expect, this level of demand pressured our supply chain.", "But our supply chain teams and supplier partners responded and continue making progress. Over the course of the third and fourth quarters, we made significant improvements to our in-stock positions while supporting massive sales volumes. While there is always room for improvement and there are some current court -- port delays, we believe we are well-positioned as we head into our busy Spring selling season. Moving on to comp performance in the fourth quarter, all of our merchandising departments posted double-digit comps, led by our lumber and indoor garden departments.", "Our comp average ticket increased 10.8% and comp transactions increased 12.6%. Similar to the last two quarters, the growth in our comp average ticket was supported by strong project demand, customers trading up to new and innovative products, as well as continued inflation in certain commodity categories like lumber. During the quarter, we continue to experience significant volatility in lumber prices. As we exited the third quarter, lumber prices were falling sharply off their historic highs seen back in September.", "However, during the fourth quarter, pricing for both framing and panel lumber reversed and set new near-term highs. Despite the elevated prices, unit comps in our lumber department accelerated further from the double-digit levels seen in the third quarter. During the fourth quarter. inflation from core commodity categories positively impacted our average ticket growth by approximately 220 basis points.", "Additionally, our comp transaction growth was supported by the same persistent strength in both online and in-store transactions that we have experienced in the prior two quarters. During the fourth quarter, big-ticket comp transactions or those over $1,000 were up approximately 23%. We saw strong performance across a number of big-ticket categories including appliances, vinyl plank flooring, and vanities. From a customer standpoint, during the quarter, we saw double-digit growth from both our Pro and DIY customers with sales growth from our DIY customers once again outpacing that of our Pro customers.", "DIY sales growth was very consistent with the strong double-digit growth experienced in the second and third quarters. Sales to our Pro customer continued to accelerate posting the best quarter of growth in 2020. As we've mentioned all year, our smaller Pro customers maintained consistent growth and posted strong double-digit growth in every month of the quarter. Growth from our larger Pro customers continued to accelerate, also growing double digits each month of the quarter.", "While the operating environment is still recovering for many of our larger Pro customers, we're encouraged by what we're seeing and hearing as backlogs are growing. Shifting to our DIY customers. We continue to benefit from heightened engagement from both new and existing customers. As our customers continue to spend more time at home, they're telling us their project lists are growing.", "After completing a project, we see many of our DIY customers take on additional, and oftentimes more complex projects with a renewed sense of confidence. During the fourth quarter, our customers exhibited a lot of trends similar to what we saw throughout 2020. For instance, we saw continued strength in outdoor living categories like patio furniture, grills, and outdoor power equipment as customers tried to extend the outdoor living season. We also saw strong performance from popular interior project categories like vanities, faucets, moldings, and interior lighting.", "Customer engagement in our annual Black Friday and gift center events was strong. As I previewed on last quarter's call, we took a different approach to our events this year to prioritize the health and safety of our associates and customers. We made deeper buys on fewer SKUs, we changed the way we use our laydown areas and end camps and we extended our events over several weeks to avoid driving too much traffic on any one single day. And we could not be more thrilled with the results.", "Over the holiday season, our customers said they wanted a sense of normality. They told us they wanted to decorate for the holidays and make the most of the season while spending more time at home with family, so they bought big and they bought early. And we saw a record level of sell-through with our decorative holiday assortment. During the quarter, our interconnected and digital assets continued to perform well.", "Over the last several years, we've rebuilt our website and invested across our platforms to upgrade our infrastructure and improve the shopping experience. These investments allowed us to handle the enormous growth in web traffic and convert more of that traffic into sales. During fiscal 2020, homedepot.com had more than 3.6 billion visits and our conversion rate increased double digits across all platforms including our app, mobile, and desktop. Turning our attention to the upcoming spring season, I could not be more excited about our comprehensive lineup of products including our No.", "1 position in outdoor power equipment. As we've discussed, the cordless outdoor power market continues to outpace growth of the gas market. Cordless tools are easier to use, more environmentally friendly, and have the power and runtime to get most jobs done. Like we have done with our tool department, we are resetting our outdoor power equipment base by branded battery platform.", "Customers can now shop our leading and exclusive lineup by platform including Makita, Milwaukee, Ryobi, Toro, and Dewalt. We are thrilled with the results and expect these resets will be complete in the first quarter. This Spring, we're excited to introduce a new lineup of outdoor power from Ryobi, the No. 1 cordless outdoor power brand.", "The new Ryobi HP high-performance brushless product was introduced in our tool department last year and we are now expanding it into cordless mowers, trimmers, and blowers. The cordless mowers come with 70 minutes of runtime and we are excited about the additional innovation coming in the product pipeline. As we look forward to Spring, we know that now more than ever, the home has never been more important. We feel great about our position as the No.", "1 retailer for home improvement and we look forward to serving our customers in the busy Spring selling season. With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ted, and good morning, everyone. In the face of all was a difficult year for many including for many of our associates, I am proud of the actions we took to take care of our people, our customers, and our communities. In the fourth quarter, total sales were $32.3 billion, an increase of $6.5 billion or 25.1% from last year. Our total company comps were positive 24.5% for the quarter with positive comps of 24.4% in November, 22.4% in December, and 26.5% in January.", "Comps in the U.S. were positive 25% for the quarter with positive comps of 24.3% in November, 21.8% in December, and 28.4% in January. All 19 of our U.S. regions, as well as Canada and Mexico, posted double-digit positive comps in local currency.", "For the year, our sales totaled a record $132.1 billion with sales growth of $21.9 billion versus fiscal 2019. For the year, total company comp sales increased 19.7%, and U.S. comp sales increased 20.6%. In the fourth quarter, our gross margin was 33.6%, a decrease of approximately 30 basis points from last year.", "Gross margin was negatively impacted during the quarter by several factors, including product mix, shrink, and pressure from rising transportation costs. Mix pressure from lumber alone negatively impacted gross margins by approximately 30 basis points in the fourth quarter. For the year, our gross margin was 34%. During the fourth quarter, operating expenses were approximately 20.9% of sales, representing an increase of approximately 25 basis points compared to last year.", "Let me take a moment to comment on a few of our expense items. First, we incurred approximately $110 million of nonrecurring expense related to the completion of the HD Supply acquisition, creating approximately 30 basis points of operating expense deleverage. Second, during the quarter, we continued to support our associates with enhanced benefits in response to COVID-19 and transitioned our temporary support programs to permanent compensation enhancements, which we announced last quarter. These expenses totaled approximately $340 million during the fourth quarter, resulting in approximately 105 basis points of expense deleverage.", "Third, we incurred approximately $55 million of operational COVID-related expenses, including personal protective equipment for our associates and customers and enhanced cleaning of our stores, resulting in approximately 20 basis points of operating expense deleverage. Fourth, we recorded expenses related to our strategic investment plan of approximately $325 million, an increase of approximately $45 million compared to last year. And finally, during the fourth quarter, we showed strong expense control in other areas of the business and drove approximately 130 basis points of expense leverage. Included in this 130 basis points of leverage is approximately 80 basis points of pressure, driven by accrued bonus expense, primarily related to our outperformance for our biannual store Success Sharing program and store and field-based management bonuses for the second half.", "Our operating margin for the fourth quarter was approximately 12.7%. And for the year, it was approximately 13.8%. Excluding the one-time expense associated with the completion of the HD Supply acquisition, our operating margin would have been 13% for the fourth quarter and 13.9% for the year. Interest and other expense for the fourth quarter grew by $35 million to $327 million due primarily to higher long-term debt levels compared to one year ago.", "In the fourth quarter, our effective tax rate was 23.9%, and for fiscal 2020 was 24.2%. Our diluted earnings per share for the fourth quarter were $2.65, an increase of approximately 16% compared to the fourth quarter of 2019. The one-time expenses related to the completion of the HD Supply acquisition of approximately $110 million negatively impacted our fourth quarter diluted earnings per share by approximately $0.09. Diluted earnings per share for fiscal 2020 were $11.94, an increase of 16.5% compared to fiscal 2019.", "During the year, we opened five new stores and ended the year with a store count of 2,296. Retail selling square footage was approximately 239 million square feet. For the fiscal year, total sales per retail square foot were $544, the highest in our company's history. At the end of the quarter, merchandise inventories were $16.6 billion, an increase of $2.1 billion versus last year.", "And inventory turns were 5.8 times, up from 4.9 times from the same period last year. Moving on to capital allocation. Our long-term principles for how we think about deploying capital have not changed. We will continue to invest in the business.", "After investing in the business, it is our intent to return excess cash to shareholders through a balanced approach of paying a healthy dividend and through share repurchases. During fiscal 2020, we invested approximately $2.5 billion back into our business in the form of capital expenditures. We also invested approximately $8 billion in the acquisition of HD Supply to enhance our capabilities and drive accelerated sales growth in a highly fragmented MRO space. We completed this acquisition on December 24.", "During the year, we paid approximately $6.5 billion of dividends to our shareholders. We look to grow our dividend every year as we grow earnings. And as you heard from Craig, today, we announced our board of directors increased our quarterly dividend by 10%. In mid-March, we suspended our share repurchases as part of several steps we took to further enhance our strong liquidity position.", "Prior to that suspension, we repurchased approximately $600 million or 2.5 million shares of outstanding stock in fiscal 2020. We expect to resume share repurchases in the first quarter of fiscal 2021, and we will also maintain an enhanced cash position of at least $4 billion during fiscal 2021. During fiscal 2020, we raised approximately $8 billion of staggered maturity long-term debt to enhance our liquidity position, partially fund the acquisition of HD Supply, and repay approximately $2.75 billion of senior notes. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 40.8%, down from 45% in the fourth quarter of fiscal 2019.", "This decreased primarily reflects our decision to temporarily enhance our liquidity position, including the suspension of our share repurchases back in March. Now, I'll turn to our outlook for 2021. The strong and consistent demand environment we've seen over the past nine months has continued into February. Our customers tell us that their home has never been more important and that they will continue to take on home improvement projects.", "The housing environment remains strong as increased demand for single-family homes has driven housing turnover and home price appreciation. However, significant uncertainty remains with respect to the course of the pandemic, the distribution of vaccines, short-term fiscal policy, and how these developments will impact the broader economy, and ultimately, consumer spending. Given these uncertainties, we're limited in our ability to forecast demand for the year, particularly as it relates to the back half. For this reason, we're not providing guidance for fiscal 2021.", "While we're not able to predict how consumer spending will evolve, if the demand environment during the back half of fiscal 2020 were to persist through fiscal 2021, it would imply flat to slightly positive comparable sales growth. We calculate this by assuming the sales dollar level of demand that we saw in the fourth quarter continues throughout 2021, adjusting for historical seasonality. In this demand environment, we calculate our fiscal 2021 operating margin would be at least 14%. Let me give a little more color around the drivers of our operating margin and investments for fiscal 2021.", "During fiscal 2020, we experienced pressure to gross margin, notably from product mix and shrink. For fiscal 2021, we expect continued pressure to our gross margin from higher transportation costs and shrink. In addition, we will experience some pressure in gross margin as we continue to build out our One Supply Chain network. Remember that the majority of the costs associated with opening and operating our supply chain facilities are accounted for in our cost of goods sold.", "As we transition from 2020 into 2021, our operating expenses will reflect a move away from temporary COVID-related pay and benefits to permanent wage investments, the continuation of strategic investments in the business, and the impact of lapping areas of underspend such as understaffed stores that we realized last year. In fiscal 2020, we incurred approximately $2 billion of expense related to enhanced pay and benefits for our associates. Last quarter, we transitioned away from our temporary support programs in response to COVID and increased permanent compensation for our frontline hourly associates by approximately $1 billion on an annualized basis. In addition, we also incurred approximately $240 million of expense related to COVID operational costs during fiscal 2020, primarily in the form of personal protective equipment for our associates and customers and for enhanced cleaning of our stores.", "As long as the COVID environment persists, we would expect to incur approximately $250 million of COVID-related operating expenses on an annualized basis for fiscal 2021, primarily related to PPE, additional cleaning, as well as extended leave for associates who were directly impacted by COVID-19. During fiscal 2020, we chose to defer some of our in-store strategic investments, both capital and expense, to prioritize the safety of our associates and customers. We expect to complete these investments in fiscal 2021. As we look back on our investments from 2018 to 2020, we believe that we focused on the right areas, improved the customer expense -- experience, and grew significantly faster than our market.", "As we move forward, we are committed to investing in our business to stay ahead of customer expectations and further enhance the customer experience with two main objectives in mind. First, to deliver returns by driving growth faster than the market in any environment. And second, to further strengthen our position as a low-cost provider in home improvement with a relentless focus on productivity and efficiency. This approach will result in a steady -- it is our intent to make those investments on a steadier cadence and to drive operating expense leverage while preserving the ability to adjust our investments as needed.", "We estimate that our fiscal 2021 effective tax rate will be similar to what we reported in fiscal 2020. As we begin 2021, we believe that we've positioned ourselves to meet the needs of our customers in any environment. The investments we've made in our business have enabled flexibility in our operating model, as well as our financial model. As we look forward, we'll continue to invest to strengthen this position and extend our scale and low-cost position to drive growth faster than the market, regardless of what the environment may look like.", "Thank you for your participation in today's call. And Christine, we're now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conducting a question-and-answer session. [Operator instructions] One moment please while we poll for questions. Thank you.", "Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning, everyone. My first question is on the expense line. Richard, if I heard right, I think you -- you said there was about $2 billion of costs that were present in '20.", "I think about a billion of them become permanent. And then I think you said 250 of, I don't know, temporary costs related to equipment, etc. I think -- and then you said we -- we also need to think about expenses that weren't spent in '20 related to I think One HD that will come back into 2021. Is there any way you can quantify that? And then does that mean that at some point, there's, I don't know, $500 million or $750 million of costs that in theory sort of roll off the P&L?" ] }, { "name": "Richard McPhail", "speech": [ "Well, Simeon, thank you for your question. There are a lot of ins and outs since so, that was actually the intent behind the -- the sort of margin case that we put forward. And so, again, just to sort of recap how you get to a 14% margin in that case that we provided, let's start with the operating expense side. You have a few primary drivers and I'll tick through those.", "First, you have the permanent investment in wage for our hourly associates as we transition from temporary support programs in the fourth quarter. You have a continuation of COVID-related operational expenses to keep our stores and our associates safe. You have the overlap of some expense benefit from understaffing in the first half last year as sales ramped up. So the -- the period as we were growing staff to meet the sharp acceleration in sales.", "So that is the year-over-year overlap that you asked about. And then if you look on the -- the cost of goods side, just to cover and come all the way down to 14, we're expecting to see continued pressure from transportation costs, continued pressure from shrink. You'll see pressure reflecting the opening up of our One Supply Chain buildings as we ramp up capacity utilization in that network and a return to more nor -- to a more normal stance with respect to events. And finally, the last comment getting us to the -- the 14, in that case, is that you'll see slightly higher non-cash amortization related to the HD Supply acquisition.", "That's about 10 basis points of an impact to operating margin, but that's non-cash. So that's the bridge to 14." ] }, { "name": "Simeon Gutman", "speech": [ "OK, that's helpful. And then my follow-up maybe for Craig and for you, Richard. If we go back to 2017, realizing that a lot of things have changed. The One HD investments, I think, were slated somewhere of a 20-basis-point hit to margin and a benefit is up to much as 40 basis points.", "If that's still the case and then we do have COVID costs rolling off, it feels like margins are being held back a bit, meaning they could be a good amount higher. Are you -- I don't know if you're -- if you're commitment or your philosophy has changed in -- in -- in some of what you're speaking about regarding continuing a certain level of investment to maintain that growth ahead of the market, or will you allow margin to go up, not gross per se, but more SG&A leverage if you retain a lot of the sales from this period going forward?" ] }, { "name": "Craig Menear", "speech": [ "Simeon, our overall philosophy hasn't changed from the timeframe that we started the accelerated investment. We said that we needed to do that because we had to get ahead of where the customer was taking us, and that's why we made the investment that we did in terms of the $11.1 billion. And -- and the intent behind that was twofold. Number one, we wanted to be able to grow faster than the market, gaining share in the marketplace, and then accelerate our incremental margin dollar growth.", "Since we started the program in fiscal 2017 through '18 to '20, and -- and market share is a little elusive in our -- in our market, but based on the best data we can get, we believe that we've captured about 275 basis points of share growth during that timeframe. And so that has -- during the -- or the whole investment where we're taking share. And so going forward, our -- our approach is to make sure that we are investing on a more steady cadence, what we need to in the business to make sure that we can stay ahead of the customer and we can continue to gain those kind of accelerated share growth opportunities going forward. And our -- our focus is around really optima -- optimizing op margin dollars.", "And if we can do that and drive incremental op margin dollars, we'll let rate fall where it falls." ] }, { "name": "Richard McPhail", "speech": [ "And -- and just to -- to add to Craig's comment about market share capture, if you take that 275 basis points and translate that into dollars, that share gain represents $10 billion of incremental sales annually to our top line versus where we were in 2017. So, you -- you -- as you've heard from Craig, scale matters. Our position is low-cost provider matters and our investments put us in a position to extend both." ] }, { "name": "Simeon Gutman", "speech": [ "OK. Thanks, guys. Take care. Good luck." ] }, { "name": "Craig Menear", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with RBC. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys, hope everyone's well. Can you provide some incremental details regarding HD Supply? Specifically, how do you guys plan to integrate it with interline or your existing MRO business? And then, how are you guys thinking about kind of the market opportunity from here?" ] }, { "name": "Craig Menear", "speech": [ "First of all, you know, we're thrilled with the acquisition of HD Supply. They are clearly a leader in the MRO space and it -- and it really strengthens our position in a $55 billion fragmented market opportunity. And so we're super excited about that. We're going to take our time and, you know, look at how we encompass all the assets that exist between, you know, the -- the formerly airline and now HD Supply and we'll put a plan together that will allow us to use all that asset base to be able to grow and capture share in the MRO market.", "We're super excited about that opportunity." ] }, { "name": "Scot Ciccarelli", "speech": [ "But given the fragmentation of that market now that you have, you know, let's call it two of the bigger operations kind of joining hands if you will, you should have about -- we're estimating about 10% market share in MRO. Does your growth potential actually accelerate just because you -- you can basically answer the bell to so many more customers?" ] }, { "name": "Craig Menear", "speech": [ "I mean that's clearly why we made the acquisition. We want to accelerate growth in that space. And it's a -- it's a great space and allows us to penetrate into a housing segment that was more difficult to penetrate with the orange box. So, we're super excited about the opportunity." ] }, { "name": "Ted Decker", "speech": [ "Yes, Scott, and the -- the capabilities set of those two combined companies, you know, far and away, the strongest distribution network. I mean, this is a distribution business. And in looking at integrating the two supply chains to, you know, by far, the leading national distribution network and then increasingly digital -- transacting digitally and being able to put the -- the capabilities that we have built with our digital assets for the consumer business or B2B assets in HD Supply starts with a -- with a very healthy and -- and -- and well-performing site as well. And then, add the sales force in, you know, thousands of folks on -- on the street with by far the largest distribution sales force in the space.", "So, you put all that together, you have a much stronger calling card when you go to see new and prospective customers." ] }, { "name": "Scot Ciccarelli", "speech": [ "All right. Thanks a lot guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question. Mr. Grom, your line is live.", "Our next question comes from line of Michael Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "Hi. A couple of follow ups. First, on the gross margin, you talked about a lot of pressures. I didn't hear anything necessarily that -- that would improve year over year. So, can we infer from that -- that you expect gross margins to be down next year? And then, I wanted to ask you about inventory.", "I think it is up about 14%, which clearly shows a better in-stock position than it had been but how does that -- how does that compare to where you had planned it to be at the end of the quarter? Thanks." ] }, { "name": "Ted Decker", "speech": [ "So -- so in the inventory position, Michael, as I -- as I made comments in my prepared remarks. We -- we feel great about -- about going into the spring are -- are in stock positions have been -- have been gaining ground while we've supported that $21 billion of comp growth. You just think of the physics of moving that much cube through our network. We were able to do that while continuing to improve our in-stock levels.", "We -- our store inventories are, you know, as you see in our release, about $2 billion over LY, and we -- we have plans to increase that further. As we went into the pandemic last year, we took some very aggressive actions as we've said with a focus on safety for our -- our customers and our associates. We backed off a lot of promotions and when we backed off those promotions we also backed off inventory. We are -- are now preparing for a more normalized spring and we're putting that inventory back into our forecast.", "So, we'll -- we'll have an even stronger inventory position where we sit today as we go into the height of spring. So, we -- we just feel great. The supply chain teams are supplier partners or merchants have worked hand in hand to get that -- that type of flow into our building for the spring season and we'll be in a much better position than we were last year to capture that demand. in our gross margin." ] }, { "name": "Richard McPhail", "speech": [ "In our gross margin, Michael, today, we're not providing guidance. And I can tell you we're focused on driving gross profit dollars and driving operating expense leverage." ] }, { "name": "Michael Baker", "speech": [ "OK. Thanks. Appreciate the color." ] }, { "name": "Operator", "speech": [ "Our next question comes the line of Christopher Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, good morning. I had a follow up on the -- the investment side. You talked about 2% of sales on -- for capex. That's about $2.7 billion, you know, rough math here in '21.", "Do you stay at that 2% level of sales as you go beyond '21? And then, on the opex side related to investments, will investment dollars be in opex be down in '21 and down further in '22? Maybe the best way to frame it is how are you thinking about that, you know, core x COVID, SG&A versus sales growth metric as you look in '21 and '22?" ] }, { "name": "Craig Menear", "speech": [ "Chris, we're -- we're using the capex spend of approximately 2% of sales as kind of a rule of thumb. We clearly have flexibility in that. But the most important thing is we know that in today's world retailers have to continue to invest to be able to stay with customer needs and expectations. And those that haven't done that over the years, unfortunately, the roads are littered with retailers that didn't do that.", "And so, we'll never put a Home Depot in that position and we believe that -- that 2% is a good rule of thumb for us to -- to think about. And then, you know, embedded in our -- our operating margin going forward is the associated expense with capital spend, and that varies depending on what type of expense you have. But our focus is now that we're past our large part, past or accelerated investment period, we're going to get back to operating leverage, fixed funds leverage." ] }, { "name": "Christopher Horvers", "speech": [ "From this point going forward?" ] }, { "name": "Craig Menear", "speech": [ "Yes." ] }, { "name": "Christopher Horvers", "speech": [ "So -- got it. That's very helpful. And then, just a follow-up -- quick follow-up on the gross margin. How are you thinking about the potential impact of -- of lumber? Are you -- are you baking in a headwind there given where pricing is right now? And then, is Home Depot Supply a potential, you know, good guy offset as we think about the puts and takes on gross margin?" ] }, { "name": "Ted Decker", "speech": [ "So, Chris on -- on supply the margin actually isn't a good guy. I mean, it's -- it's -- it's --" ] }, { "name": "Christopher Horvers", "speech": [ "It's on a like-for-like basis. There's -- this is immaterial to the company?" ] }, { "name": "Ted Decker", "speech": [ "It's im -- it's immaterial." ] }, { "name": "Christopher Horvers", "speech": [ "Yeah, yeah." ] }, { "name": "Ted Decker", "speech": [ "They don't -- what they've been reporting, they don't include the supply chain expenses. Well, we'll make that by company but with supply chain for a low distribution in the gross margin not as an operating expense. And then, the other question on lumber. On lumber, we don't -- we don't plan you, know, lumber commodity price moving up or down.", "It's obviously been a huge impact in 2020. It's about $1.7 billion of sales was attributed to lumber price inflation over the course of 2020. But we don't -- we don't even shoot it at what that might do, we just -- we just assume that the levels will stay as -- as they are, as we exit the year. And as you know, we have a very flexible supply chain, particularly in lumber.", "We have our -- our bulk lumber desists, we're -- we're taking product in from our supplier partners and shipping those in real-time daily lumber delivery to the stores. So, we never have huge quantities of inventory to get trapped with a good guy or a bad guy. So, it's pretty -- pretty fluid in -- in mark to market, and again don't make any sort of predictions of whether that's going to go up or down and -- and help or hurt." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. Have a great spring, guys. Thank you." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. Richard, I want -- I want to focus on the outlook for strategic spending. So, maybe both my questions will really be focused here. You mentioned the $3 million and $25 million of quarterly spend and I think that's been consistent for the past two quarters.", "So, any color on -- on how we should be modeling the quarterly investment spend especially given your prior commentary right that I think we should expect the absolute level to be neutral on a year-over-year basis?" ] }, { "name": "Richard McPhail", "speech": [ "I -- I'll go back to Craig's comment on this. You know, now that the investment program is substantially complete, you're going to see us return to a steadier, more consistent investment posture. So, just think about, you know, if you're talking about modeling what that means, we had a three-year period wherein -- in -- in many periods expenses grew faster than sales because of the expense component of the plan and capex obviously was elevated. What we're telling you today is, going forward, we're moving to that steady and consistent cadence.", "And so, as Craig said, capital expenditures will approximate 2% of sales, and then expenses associated with it are -- are assumed within the margin case that we laid out. And from this point going forward, we intend to deliver operating expense leverage on a consistent basis." ] }, { "name": "Steven Forbes", "speech": [ "And -- and maybe just a follow-up on that comment again if you can, right? If we think about what transpired over the past couple of years at the quarterly level of investments then I think ramp from 75 which was considered business as usual to this 325. So, are your commentaries implying that we should expect, maybe not this year but over -- over a multi-year period, to return to those prior levels of investment spend or normal case investment spend or should we anticipate a return to a -- above right that 75 level, given just the incremental needs of the business? Any -- any more detailed commentary would be -- would be helpful." ] }, { "name": "Richard McPhail", "speech": [ "But I think it's important to remember the context that when we kick this investment program off we were $100 billion in sales and now we're over $130 billion in sales. And so, you know, getting -- talking about dollars versus percentages, I think, becomes less relevant and meaningful. So, what -- what we're trying to do is -- is provide you with sort of our stance going forward, which again is going to be steady and consistent. And so, if you -- if you take the case that we laid out which is simply a case where we would expect at least 14% operating margin in a flat to slightly positive comp environment, that would include our view of all operating expenses.", "And going forward, we expect and intend to deliver operating expense leverage on a consistent basis." ] }, { "name": "Steven Forbes", "speech": [ "Thank you. Best of luck. Stay safe." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. Craig, could you talk a bit more about the 220 basis points of share gains you called out as -- 2020 was clearly a big year and -- and you called out the impact of your strategic initiatives. But given that your investments are ongoing and the benefits are still early days. Could you talk about why you think share gains can further accelerate in 2021 and where you think the most opportunity is across your various DIY, Pro, and MRO customer bucket?" ] }, { "name": "Craig Menear", "speech": [ "Sure. So from 18 to 20, it was roughly 275 basis points of share gain that we -- we saw. And again, the intent of the -- of the investments, both the previous three years where we needed to kind of jump start and get ahead of the customer and what we're building out in the capabilities going forward, we believe, will position us well to continue to gain share really in all of the segments that you just called out, DIY, Pro, and in the MRO space. That's our focus, that's what we're trying to get done.", "We are, you know, investing in what we believe the interconnected elements of how the customer is engaging in retail today is hugely important particularly in our space, the project business, where the customer's blending both the physical and digital worlds to be able to complete their project. We're seeing that ongoing. We are excited about the engagement that we've had with new customers into the business with the expansion of the millennial generation in home improvement and homeownership. And we believe that these investments ongoing will allow us to be in a position to continue to capture outsized share.", "That's why we made them. That's what we're focused on and what we see going forward." ] }, { "name": "Zach Fadem", "speech": [ "Got it. That makes sense. And then, for Richard and Ted, can you talk about your base case for inflation this year? Both in terms of pass-through commodity prices and that impact on ticket but also what you anticipate from vendor cost increases and how you think about passing on these increases versus offsetting the portfolio pricing and other productivity initiatives." ] }, { "name": "Richard McPhail", "speech": [ "On -- on general, inflation, again today, we're not providing guidance. Economists' views vary. And so, the case that we laid out to you today is simply a mathematical extrapolation.Ted, maybe you'll talk about from the vendor side." ] }, { "name": "Ted Decker", "speech": [ "Yeah. I'd say that there is no doubt commodity prices are on -- on a tear right now we were just talking about -- about lumber prices and we had all-time record highs over -- over $1,000 a thousand board feet last week, which is up a staggering 140% odd from the prior year. As a stick of lumber that was $2, now over $5. Similarly copper hit $4.11, yesterday, I believe, that's a 12-year high.", "So, those types of products, you know, copper and wire lumber obviously in all -- all stick goods. Those -- those are priced to market by virtually everyone in the marketplace. So we -- we don't have a lot of anxiety around managing the commodity flows as it comes to, you know, transportation and which are real transportation costs and in suppliers who are obviously seeing some cost pressures.You know, we've managed that for 41 years. There have been periods of hyperinflation there've been -- been periods of muted inflation.", "We've run this as a portfolio. We work closely with our supplier partners to be the advocate for value for the customer. And as I think about all that -- that's going on now, I reflect back to the tariffs and I guess I -- I want for that was our biggest issue when we're -- when we were managing tariffs. But you know, tariffs and now the commodity environment is just one more in a string of market dynamics that our merchant teams have worked through for 41 years." ] }, { "name": "Zach Fadem", "speech": [ "Appreciate --" ] }, { "name": "Craig Menear", "speech": [ "I don't know if it's helpful but in the context of kind of the market to market moves, that represents roughly 18% to 20% of our volume that moves as commodities move on an ongoing basis." ] }, { "name": "Zach Fadem", "speech": [ "Thanks. That's really helpful guys. Appreciate it." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. So, can you calibrate the scenario that you laid out for your big year ahead, if your comp is flat to slightly up you would have at least a 14% operating margin? What happens if your comp is down 5%, can you still have a 14% operating margin?" ] }, { "name": "Richard McPhail", "speech": [ "We're not going to speculate, Michael. You know, we do retain a -- a good degree of financial flexibility. But our actions will truly depend on the circumstances that -- that are present at the moment." ] }, { "name": "Craig Menear", "speech": [ "And just remember, our largest costs in the business are our costs associated with payroll and that is driven on a transactional basis that flexes with buying." ] }, { "name": "Michael Lasser", "speech": [ "OK. A more longer-term question. Prior to 2018, Home Depot typically had 20% to 30% incremental margin on additional sales. In the last few years, owing to the tariffs, owing to the strategic investment plan, and on to COVID, the contribution margin has been in the single-digit maybe low teens range.", "Looking past 2021, do you think you can get back to an incremental margin that's in line with your historical experience, or for whatever reason is the ability to gain share in home improvement just more expensive today than it's been in the past and why would that be the case?" ] }, { "name": "Richard McPhail", "speech": [ "I -- I would -- I would disagree with your last statement but I can tell you that our focus is driving incremental operating profit dollar growth and earnings growth. And we do that, you know, everything we do eventually directs itself toward driving sales productivity or cost productivity. And so, that's what we're focused on. At the end of the day, it's about operating profit growth and that's what we're focused on." ] }, { "name": "Michael Lasser", "speech": [ "OK. Thank you very much and good luck with the spring." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question will come from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi, thanks for squeezing me in. A big -- a big picture kind of question and just a follow-up and some of the components of guidance. But, I guess is there any way to quantify the pro backlog, and then is there any way you could frame how you think about the DIY versus the Pro comp in 2021? And then, on your guidance with respect to shrink lingering in 2021, I guess I was under the impression that -- that would be something that we -- you would cycle as we got to the end of this year, so any color and that would be great?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. Karen, it's -- it's really difficult to try to quantify a Pro backlog. The only thing we can share with you is what our Pros tell us and that their -- their jobs are building. We've seen a -- an acceleration of the Pro business from quarter to quarter.", "And as it was called out in the fourth quarter, we actually had our best quarter of the rolling 12 with the Pro. I think the thing that is really interesting is the fact that on the DIY side we've seen the acceleration of the millennial generation engagement with home improvement and homeownership and in the -- over time the thing that will be interesting to watch is -- has that in fact expanded the market. That -- that's the interesting question that we don't know the answer to but we're watching carefully. So we think there's a lot of opportunity as we go forward." ] }, { "name": "Karen Short", "speech": [ "Great. Thanks." ] }, { "name": "Richard McPhail", "speech": [ "Yeah. And on --on shrink, you know, we -- we saw pressure on a year-over-year basis in 2020 and that pressure is pretty consistent across the quarters. At this level, at this elevated level of sales though it's harder to tell the degree of the impact we've made. So, we're gonna keep watching it and work on the problem right." ] }, { "name": "Karen Short", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and thank you all for joining us today. We look forward to speaking with you on our first-quarter earnings call in May." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2019-05-21	[ { "description": "Vice President of Investor Relations and Treasurer", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, Chief Executive Officer and President", "name": "Craig Menear", "position": "Executive" }, { "description": "Chief Financial Officer and Executive Vice President-Corporate Services", "name": "Carol B. Tome", "position": "Executive" }, { "description": "Executive Vice President of Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President-Outside Sales & Service", "name": "William Lennie", "position": "Executive" }, { "description": "Executive Vice President-Supply Chain & Product Development", "name": "Mark Holifield", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Robert W. Baird -- Analyst", "name": "Peter Benedict", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Gordon Haskett -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zachary Fadem", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Elizabeth Suzuki", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to the Home Depot First Quarter 2019 Earnings Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. (Operator Instructions).", "It is now my pleasure to introduce your host Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, and good morning everyone. Joining us on our call today are Craig Menear, Chairman, CEO and President; Ted Decker, Executive Vice President of Merchandising; and Carol Tome, Chief Financial Officer and Executive Vice President, Corporate Services. Following our prepared remarks, the call will be opened for questions. Questions will be limited to analysts and investors.", "And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get your question during the call, please call our Investor Relations Department at 770-384-2387.", "Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission.", "Today's presentation will also include certain non-GAAP measures, reconciliation of these measures is provided on our website.", "Now let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and good morning everyone. Before I begin, let me take a moment if you would, personal privilege. As you've read at the end of April, we announced that Carol has decided to retire as our Chief Financial Officer and EVP of Corporate Services, effective August 31. After 24 years of service to the Home Depot. This month in fact marks for 18th anniversary as our CFO, making her one of the longest tenured CFOs in the Fortune 100.", "And while I have more to say about Carol's numerous contributions to the Home Depot, as we get closer to her actual retirement. I did want to note on today's call, Carol's extraordinary financial stewardship of our Company. Richard McPhail who will become our CFO in September will indeed have big shoes to fill, and Carol I can't thank you enough for your service to our Company and to our shareholders." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you, Craig." ] }, { "name": "Craig Menear", "speech": [ "Sales for the first quarter were $26.4 billion, up 5.7% from last year. Comp sales were up 2.5% from last year with U.S. comps of positive 3%. Diluted earnings per share were $2.27 in the first quarter. Our sales performance came in below our expectations in the quarter as a result of two factors. First, the month of February was the second wettest on record for the U.S. Second, lumber prices continue to decline in the quarter, resulting in a negative impact to sales growth of approximately $200 million.", "Looking at our results geographically, all of our U.S. divisions posted positive comps. Two of our 19 U.S. regions posted mid-single digit negative comps as they faced difficult compares due to hurricane-related sales a year ago. Internationally, Mexico posted another quarter of positive comps in local currency, while Canada's comps were slightly negative. There is no doubt, it's was a noisy quarter, but when you look through the noise to the core business, we are pleased with the underlying performance. We saw growth in both ticket and transactions in the quarter and 10 of our 14 merchandizing departments posted positive comps.", "Ted will provide additional details around departments that were negative in the quarter as Hurricane comparison price deflation impacted several categories. What we remain excited about, is the progress we're making with regards to our strategic investment priorities. These investments enable us to continue to grow share in a highly fragmented $600 billion (ph) addressable market. We are making these investments from a position of strength, as the number one retailer in home improvement.", "Every investment was formed using the customer back approach to create a truly seamless, frictionless customer experience that will drive results, not just over the next several years but for the long-term. Our strategic efforts to drive an enhanced interconnected customer experience through investments in both the physical and digital worlds are yielding solid returns.", "Online traffic growth was healthy, and first quarter online sales grew 23% from the first quarter of 2018. We continue to use our digital platforms to lean into adjacent categories like HD Home, pool and even workwear where the customers told us that we have the right to compete for an additional share of their wallet. For the consumer, we are investing in new category experiences that make it easier for a customer to shop their full project needs online. If a customer is redoing a bathroom and decides on a particular type and finish of faucets, chances are, they probably want to see the full suite of matching bath faucets for vanity, shower and tub.", "In order to take friction out of this process, we are now rolling the ability to shop a collection using minimal clicks. But we are investing to address the unique demands of the digital customer experience. We know that our customers continue to value the relevancy of our stores, as seen an increased number of customer transactions in the quarter. Additionally, approximately 54% of our online U.S. orders were picked up in our stores during the quarter, a testament to our interconnected strategy.", "During the quarter, we continued to make progress, enhancing this interconnected customer experience by investing in our stores, to improve our front-end checkout experience, continuing to roll out automated lockers, streamlining our customer service desk and simplifying tools for our associates. This is translated to reduce wait times and increase customer satisfaction, as our customer service scores and checkout time satisfaction have increased over 500 basis points versus last year.", "Not only do these front-end investments have customer service and productivity benefits, they're also helping us to optimize store layouts to maximize merchandising space productivity and high traffic event, in laid out areas. Another key focus area from an investment standpoint is our pro-customer, which once again outpace the DIY customer in the quarter. Pros tell us that they are busier than ever. This is why investing in our portfolio of offerings to help them manage their businesses efficiently and remove friction from their shopping experience, are critical.", "Having the brands that Pros care about in-stock with job-like quantities is table stakes. You have to have that, to serve them. But the value proposition that we are creating for the Pro, through various investments over the next several years, as is, as we believe unique to the marketplace. We continue to onboard Pro customers through our new B2B website experience. Adding 35,000 customers in the quarter for a total of 135,000 customers that have been migrated to this experience so far. Our plan is to on-board over 1 million customers by the end of this year.", "Though it is early days we are seeing increased engagement, which translates in the increased spend. We also continue to make traction with the investments in other capabilities like Terrell (ph) for example. We know that 90% of Pros, rent tools. But several years ago, only about 1 out of 10 Pros rented from us. Today that number has improved to 1 out of 4. Yet there remains opportunity for further growth as we continue to invest in our tool rental experience.", "We know that when Pros rent tools from us, their spend increases. Again the theme here is about driving engagement. The more dimension of the relationship is with our Pro customers, the more they spend. This is a time of transformational change in the business as we execute our One Home Depot strategy. Our team continues to focus on what is most important, our customers. We hired 80,000 new associates for spring and thanks to our new in-aisle mobile training solution pocket guide. They had product knowledge at their fingertips, to help them get up to speed quickly. Our merchants store MET teams, supplier partners and supply chain teams did an outstanding job of delivering value and service to our customers throughout the quarter. I'd like to close by thanking them for their dedication, hard work and commitment to our customers.", "And with that, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning everyone. As Craig mentioned, when we worked through the noise of the first quarter, we were pleased with how the business performed. Looking at our departments, constant appliances, indoor garden, core tools, outdoor garden, building materials, plumbing and hardware, were about the Company average. Paint and kitchen and bath were positive, but below the company average, no work in flooring were slightly negative, in large part due to hurricane overlaps.", "Our electrical lighting department reported a low-single digit negative comp due primarily to light bulbs. Commodity deflation grow high-single digit negative comps (technical difficulty). In the first quarter, comp average ticket increased 2% and comp transactions increased 5.5%. During the first quarter, we continue to see significant deflationary trends in lumber that began last year. Let me give you an example, the lumber prices peaked last year, we were selling a 4x8 sheet of OSB for approximately $17, and our units were negative.", "At the end of the first quarter, the price for that same sheet of OSB had fallen over 58% to about $8. While we have seen nice unit productivities, prices have fallen, we have not overcome the top line headwind from this significant deflation. Without lumber price deflation, our average ticket growth would have been closer to 3%.", "During the first quarter, big ticket comp transactions are those over $1,000, which represent approximately 20% of U.S. sales, were up 3.9%, reflecting in part the impact of last year's hurricane-related sales. Excluding hurricane-related markets, big ticket comps were up approximately 5.1%. Wet weather in February, also had a significant impact to our big ticket performance in the quarter. The big ticket comps were flat in the month of February. And finally, lumber price deflation also had a negative impact.", "We continue to see strong performance in the big ticket categories like vinyl plank flooring, water heaters and appliances. And just to comment on appliances, as a result of our supply chain initiatives and working more closely with our partners, we are seeing improved customer satisfaction scores in appliance delivery. During the first quarter, we saw growth with both our Pro and Do-It-Yourself customers. Pros are complex customers. We are investing in a number of different initiatives and services to help our Pros get their jobs done. One of these services is our tool rental business. We have the largest number of tool rental centers in North America with approximately of 1,100 locations inside our conveniently located stores.", "As Craig mentioned, we know that approximately 90% of Pros rent tools, and only one in four of our Pros rent tools from us. We also know that when Pros start running tools (technical difficulty) see a significant uptick in their overall Home Depot spend. As part of our multi-year investment plan, we are investing in more space, more tools and better technology to improve the customer experience, and continuing to grow this differentiated service offering.", "In addition to our Pro investments, we continue to invest across our interconnected platforms. During the first quarter, we had record quarterly online visits that helped drive 23% growth in our online business. As we continue to invest in the online experience and reduce friction, we see higher traffic and improved conversion rates. In addition to enhanced site functionality, we are also expanding certain online assortments.", "At our Investor Conference in 2017, we talked to you about HD Home, our expansion in home decor categories. We continue to lean into this category by offering a wide assortment and great values, and we are seeing strong growth. We are also expanding our online assortments in categories like auto, cool workwear, natural extensions to our in-store assortments. We are excited about the growth we are seeing from brands like Weather Guard, Hayward and Carhartt.", "Now, let's turn our attention to the second quarter. We are thrilled to announce the launch of the DEWALT ATOMIC 20-volt compact series, exclusive to the Home Depot. These compact tools offer the same 20-volt cordless power as traditional 20-volt tools, in a smaller, more versatile platform. The DEWALT ATOMIC series complements our already successful lineup of compact and sub-compact power tools from Milwaukee and Makita. The Milwaukee 12-volt program is a favorite for mechanical trades, while the sub-compact Makita 18-volt line up offers the most power and torque in its class. In the big box channel, these DEWALT, Milwaukee and Makita tools can only be found at the Home Depot.", "We are excited about new product offerings across all of our categories in our upcoming events. During the second quarter, we will host our Memorial Day, Father's Day, and Fourth of July events, where we will be offering more of great values and special buys for our customers.", "With that, I'd like to turn the call over to Carol." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you, Ted and good morning everyone. Before we discuss our first quarter results, I want to mention that at the beginning of fiscal 2019, we adopted ASU number 2016-02, which pertains to how we account for leases. The adoption of this standard impacted our balance sheet, but it did not materially impact our income statement or statement of cash flows. Under this new standard, operating lease right of use assets and liabilities are now reflected on our balance sheet.", "With that, let's move on to our first quarter results. In the first quarter, total sales were $26.4 billion, a 5.7% increase from last year, versus last year, a stronger U.S. dollar negatively impacted total sales growth by approximately $76 million or 0.3%. Recall that for our first quarter comp calculation, we are comparing weeks one through 13 of fiscal 2019 against weeks two through 14 of fiscal 2018. Our total company comps were positive 2.5% for the quarter with negative comps of 2% in February, positive comps of 5.6% in March, and positive comps of 3.2% in April.", "Comps in the U.S. were positive 3% for the quarter, with negative comps of 1.9% in February, positive comps of 6.1% in March, and positive comps of 4% in April. The cadence of our monthly comps was a bit distorted by the Easter shift this year. Adjusting for the timing of Easter, our U.S. comps were 4.5% in March and 5.3% in April. As you heard from Craig, our first quarter sales growth missed our expectations, driven primarily by two notable factors. First, weather had a negative impact on our February performance.", "To put the February weather impact in two perspective, 17 of our 19 U.S. regions reported negative comps in February. By the end of the quarter, however, only two regions reported negative comps, and that was due to hurricane related overlaps. Second, versus last year, lumber price deflation hurt our sales growth by approximately $200 million. If you ignore the weather impact of February across our business and lumber price deflation, our total company comp would have been closer to 4.5%.", "In the first quarter, our gross margin was 34.2%, a decrease of 36 basis points from last year. The year-over-year change in our gross margin reflects the following factors. First, the change in mix of products sold caused approximately 17 basis points of gross margin contraction. Second, higher shrink than one year ago resulted in 13 basis points of contraction. And finally, higher supply chain and fulfillment expense cost approximately 6 basis points of gross margin contraction.", "In the first quarter, operating expense as a percent of sales decreased by 44 basis points to 20.5%. Our operating expense performance reflects the impact of our strategic investment plan and ongoing expense control. Specifically, expenses related to our strategic investment plan of $229 million, reflect a $50 million increase over last year, and approximately 15 basis points of operating expense deleverage. This deleverage was offset by productivity in BAU, or Business As Usual expenses, which drove 59 basis points of operating expense leverage.", "Our operating margin for the first quarter was 13.6%, an increase of 8 basis points from last year. Interest and other expense for the first quarter grew by $34 million to $273 million, due primarily to higher long-term debt levels, than one year ago. In the first quarter, our effective tax rate was 24.4% compared to 23.5% in the first quarter of fiscal 2018. Our first quarter tax rate was higher than last year due to certain state tax settlements that did not repeat. For the year, we expect our effective tax rate to be approximately 25.5% in line with our guidance. Our diluted earnings per share for the first quarter was $2.27, an increase of 9.1% from last year.", "Now, moving onto some additional highlights, during the quarter we opened two net new stores for an ending store count of 2,289. Selling square footage at the end of the quarter was 238 million square feet. Total sales per square foot for the first quarter were $435, up 5.6% from last year. At the end of the quarter, inventory turns were 4.7 times, down from 4.9 times last year, reflecting growth in inventory to accelerate merchandising resets, as well as an early load-in for spring sales. For the year, we expect our inventory turns to be flat to what we reported in fiscal 2018.", "Moving on to capital allocation. In the first quarter, we repurchased $1.25 billion or approximately 6.5 million shares of outstanding stock. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 45.4%, 940 basis points higher than the first quarter of fiscal 2018.", "Turning to the remainder of the year, our view on the U.S. economy and the drivers of home improvement spend are not fundamentally different from what we shared with you back in February. First quarter U.S. GDP growth was strong. Unemployment is the lowest, it has been in nearly six decades and wages are rising. The relevant housing metrics that drive home improvement spending, notably home price appreciation, existing home turnover, household formation and the age of the housing stock continue to be supportive of our outlook.", "And as you've heard from Craig, as expected, we are seeing benefit from our strategic investments. The building blocks of our 2019 plan are in place. Nonetheless, two factors have changed, since we put our plan together. First, there was a recent announcements that certain tariffs are increasing to 25%. We are working through the impact of these tariffs, and as a result have not included them in today's guidance. Second, and more immediate, is the significant deflation we are seeing in lumber prices. You'll recall that our sales forecasting model does not include commodity price inflation or deflation.", "If lumber prices remain at today's level, this could hamper our fiscal 2019 sales growth plan by as much as $800 million. But because we cannot predict what will happen to lumber prices, and because we are just one quarter into the year. At this point, we are not changing our sales or earnings per share guidance for fiscal 2019. With that in mind, today we are reaffirming the sales and earnings-per-share growth guidance that we laid out on our fourth quarter earnings call.", "Remember that we guide off GAAP, so fiscal 2019 guidance will launch from our reported results for fiscal 2018, which includes sales and earnings associated with the 53rd week. When we report our quarterly comp sales results, we will compare weeks one through 52 in fiscal 2019, against weeks two through 53, in fiscal 2018. For fiscal 2019, we expect comp sales is calculated on a 52-week basis to increase by approximately 5%.", "We expect sales to increase by approximately 3.3%, reflecting the compare of 53 weeks last year. For earnings per share, we expect fiscal 2019 diluted earnings per share to grow approximately 3.1% to $10.03. Our earnings per share guidance includes our plan to repurchase approximately $5 billion of outstanding shares during the year.", "So we thank you for your participation in today's call, and we are now ready to take questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now begin conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks, good morning. Can you hear me?" ] }, { "name": "Craig Menear", "speech": [ "Good morning. Yes." ] }, { "name": "Carol B. Tome", "speech": [ "Yes, good morning." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. Good morning. Sorry about that. Carol, congratulations and good luck. My first question is, I have it's two parts. So don't count this as my follow-up." ] }, { "name": "Carol B. Tome", "speech": [ "We will." ] }, { "name": "Simeon Gutman", "speech": [ "I realized you don't give quarterly guidance. But for this context, I think it's helpful if you can share with us what the internal expectation for Q1 was, and how much it underperformed and I appreciate you made the 4.5% comment ex-weather, ex-lumber. Because, are you making up 50, 100 basis points for the year and I get, it sounds like lumber could end up being around a 70 basis point headwind. And then the second part of that is, if it is mostly weather, do we think about you making most of it up in the second quarter and a little in the third, but we leave the fourth quarter alone?" ] }, { "name": "Carol B. Tome", "speech": [ "Well, thank you for your question, Simeon. As you point out, we normally don't provide our quarterly plan, but I will tell you that our plan for the first quarter of 2019 with a comp of 4.5%. So if you look through the weather noise in February, as well as the lumber deflation, we were very pleased with our results. The other thing that I will remind you all of, is that we are comping this year $800 million of hurricane-related sales, $500 million of those hurricane-related sales took place in the first quarter of last year. So our compares get much easier as we look to the back half of the year." ] }, { "name": "Simeon Gutman", "speech": [ "Right. I guess (multiple speakers)" ] }, { "name": "Carol B. Tome", "speech": [ "(multiple speakers) about weather and we'll recover it. This is very different than what we saw a year ago in the first quarter, which was very much in April story that impacted our garden department. The weather in February impacted our business, 17 of 19 regions were negative. The majority of our selling departments were negative. Our transactions were negative 2.5% for the month of February alone.", "Our big ticket was flat in the month of February, those sales are coming back as the weather improves. Part of those sales are related to our Pro customer and we understand from our pros, that they have backlogs that are in excess of 90 days. So those sales will come into the second quarter and continue into the third quarter, that's what gives us confidence to reaffirm the guidance of a 5% comp for the year, albeit there is lumber price deflation, and it continues into May, actually. If we look through lumber price deflation, our May results are performing as we expected, but we thought it was important to get that lumber price deflation number out there for you because we can't predict. Too early in the year to know what's going to happen to lumber prices, but we thought we should give you the number." ] }, { "name": "Simeon Gutman", "speech": [ "Great, that's helpful. And then maybe just to clarify and this will be the follow up, it -- so you've initially guided the back half, I think it was about 250 basis points stronger than the first half. And you've made the case right hurricane, I think you just said $800 million at least in the first half of this year, and then we have lumber. And so that doesn't I think if we do the math, that doesn't leave as much of a spike as far as other initiatives go, as far as the pickup that's required in the back half. Is that fair and maybe can you just quantify what is outside, what needs to happen from the business to get stronger outside from the lapping of weather and now unfortunately I guess lumber deflation?" ] }, { "name": "Carol B. Tome", "speech": [ "So, just as a point of clarification on the hurricanes, it's $800 million for the year, 500 million in the first half, 300 in the back half. So clearly the hurricane comparison is much easier in the back half. As we look at the shape of the year today, we would expect that the back half comps to be more than two times the first half comps, principally because of those hurricane compares. But more importantly, because of the initiatives that we are investing into, one of those initiatives being the B2B website that we've talked to about. Greg, maybe you want to talk about what we're seeing or (inaudible) with the B2B website." ] }, { "name": "Craig Menear", "speech": [ "Yeah, we're actually very pleased. I'll let Bill jump in here, we added 35,000 customers in the quarter and we expect to have 1 million customers up by the end of the year." ] }, { "name": "William Lennie", "speech": [ "Yeah. Simeon we're migrating customers as new website capabilities come on-board. I'll give you just a few examples of it, keep build capabilities we added in Q1. We added in administrator and user hierarchy which allows administrators or account owners to add purchasers or users. We also now allow customers to easily link their purchases of QuickBooks and upload their purchase history. Then we also made localization much easier, our Pro customers shop across multiple cities, multiple stores. This allows them to save their stores they shop and easily localize their purchases.", "And then in Q2 next up, we'll enable the perch for the Pro purchase card, which is our legacy Interline customer shopping in Home Depot stores, be maybe to use that Pro purchase card online and they have their purchases attributed back to their account, will make it buy it again easier for them, it will be an auto-populated page based on their recent purchase history, both in-store and online. And then we have a redesigned homepage coming up, that's going to be based on our feedback from test and target on 1,500 customers, that just more personalized that experience, makes it easier for them to transact.", "So, it is early days, it's too early to comment on sales lift. But the experience that we're delivering is all about engagement like Craig said. And we know the more that we take friction out of the ability to transact more as customers engage. So, early days, but pleased with the capabilities, pleased with the results we're seeing from the customers that are active." ] }, { "name": "Simeon Gutman", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning, thanks a lot for taking my questions. And Carol congratulations and best wishes. There is -- nice things we can say. Thank you, for everything. With sales coming in below your expectations in 1Q and some of the challenges lingering into 2Q, at what point in the year do you start to see downside risk to the full-year guidance, if sales do not improve? Is that window as soon as June or July or do you think, even if 2Q is softer than you expect you can maintain that full-year 5% comp expectation?" ] }, { "name": "Craig Menear", "speech": [ "Michael, we'll have to see how the second quarter actually plays out, as it relates to lumber. Clearly, when you look at the first quarter, the two big impacts were the situation in February, were really, it was pretty horrible across the country. And then lumber -- and if you think about lumber for a minute, I'll let Ted get into some of the feedback that we're hearing from our suppliers. But lumber has a lot of factors. And when you think about -- we won't know until we see what the environment is and what the storm situation may look like this year. It's predicted to be another potentially active year that could change a lot of things, but we're also hearing some information from our suppliers." ] }, { "name": "Ted Decker", "speech": [ "Yeah, so on lumber the situation this year is really the exact opposite of last years growth. Last year the mills had a shortage of logs and we had some early housing activities, so lumber prices went to all-time highs. Those peaked at toward the end of May of 2018. This year the mills were able to harvest their logs, they had tremendous amount of inventory on the log decks. And at the same time with the wet February, we have the slowest start to housing. So this would be exact opposite year. And so, prices have fallen in some categories, I said OSB, as much as 50%. So what we're hearing now is, the mills are working through their backlog of logs.", "The mills had not been able to curtail earlier in this year, because you've got to process the logs, as it get wet and soggy and start to roll. It worked through a lot of that backlog and we're starting to see some of the first curtailments. But again, it's very early days, we're going to need to see rebound in spring, in housing, construction, that's where lumber prices are set on the margin, in the distributor channel, not the retail channel. Our units are terrific, given our units, we'd be expecting to see lumber prices going up." ] }, { "name": "Carol B. Tome", "speech": [ "Yes, exactly." ] }, { "name": "Ted Decker", "speech": [ "But unfortunately the price is set at the margin through the wholesale distribution, which has a lot more to do with housing starts. So as weather clears up, mills curtail logs get worked. There is promise for the back of the year, so that's why again we -- we laid out the risk, but haven't called it." ] }, { "name": "Michael Lasser", "speech": [ "Okay. In recognizing and putting aside the lumber deflation and recognizing that your model is heavily influenced by overall GDP growth in the home price appreciation. If you look at any of your sales by category, are any of them showing a correlation to housing turnover? There is evidence that some of your specialty competitors in areas like flooring are exhibiting weakness in a pretty tight correlation to housing turnover. So if you're not seeing that, why do you think that is the case?" ] }, { "name": "Craig Menear", "speech": [ "If we look -- on a continual basis, we look at discretionary categories. And we don't see a direct correlation to any movement in discretionary categories. and matter of fact you think -- look at things like clause or organization, which is purely discretionary, and we feel good about those kind of businesses. There has clearly been a shift in the flooring business to vinyl, which has had some impact on some other categories. But we don't see anything right now, that would indicate the change." ] }, { "name": "Michael Lasser", "speech": [ "So Craig, even though housing turnover has been under a considerable amount of pressure over the last several months, it's not having an impact on any real category within your portfolio, despite the fact that in the past it's been a pretty influential driver of the overall business?" ] }, { "name": "Carol B. Tome", "speech": [ "Yes. Michael, you've just written a report on this, which was really helpful, that there is been a disconnect between housing turnover and sales performance. And we went back and try to correlate turnover to our departments, to see if there was any correlation and we couldn't see it. Now, our flooring department was one of our slower growing departments in the quarter, but that isn't correlated to housing turnover. We think we have some opportunities within the mix." ] }, { "name": "Ted Decker", "speech": [ "Yeah. The dynamic in flooring and these things are trends and trends will reverse themselves. We saw a meaningful shift to hard surface flooring over the past several years, that went into tile, that then went into wood look tile with not rectangular or not square but more rectangular shape. And then in the last couple of years, luxury vinyl plank arrived on the scene.", "And it's an incredibly innovative product, because you can put it below sub-floors, it's waterproof, it's unbelievably easy to lay, you don't obviously have to get tile set material, you don't have to level floors, it's so much faster for our Pros. So we've had unbelievable growth in the last three years, and it just continues. That all in is a lower price point, lower all-in basket, because you are not getting sub-materials growth et cetera. It's certainly less expensive for the Pro to lay. So that's part of the mix shift that Carol was talking about. That's not to say that there isn't still plenty of demand for soft surface in tile, in wood and laminate. And we need to do a better job responding on our mix in those categories, as you know, we put a lot of emphasis on the plank and we've got some work to do on mix in the other categories." ] }, { "name": "Michael Lasser", "speech": [ "That's very helpful, and Carol, congrats again." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks and good morning. And my congratulations to you as well, Carol. I think you're -- I started following your company in '03 and I think you're the last remaining C-suite person. So, congratulations and obviously just a tremendous career. My question -- my first question is, at the start of the year you mentioned that the first half would be 250 bps below on a comp basis. But the second half -- versus the second half -- on a stack basis relatively flat. You do lap a big May, a year ago on the seasonal shift. Should we think about 2Q on a two-year stack basis? Or do we do a little better considering that, the shift of the Pro that you talked about, out of February into later than year, presumably you had plan, May down given the compare?" ] }, { "name": "Carol B. Tome", "speech": [ "I think the easiest way to think about Q2, is that the comp rate should be higher than what we reported in the first quarter. If the stacking gets a little confusing because of the calendar shift. And if I could change the calendar shift, trust me, I would. Wish I could have done that before because it just confuses that kind of thing, but I would just think that's the easiest way to think about your model." ] }, { "name": "Christopher Horvers", "speech": [ "Okay. And do you have a sense of like shifting that two weeks -- two to 14 last year, obviously you flow that through the top line impact, but presumably the compare -- the comparison itself was harder than what you would -- what you reported last year. So is there -- have you been able to quantify or you looked at that in terms of what 1Q would have looked like a year ago, if you had to two to 14 in the comp base -- in the comp calendar?" ] }, { "name": "Carol B. Tome", "speech": [ "Yeah. If we hadn't shifted the calendar, our unshifted comps would have been 5.8%. And I can give that to you by month if you'd like. The unshifted comp for February, 2.6%, for March 5.5%, and for April, 8.1%." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And then as a follow-up on lumber deflation, that obviously impact sales, but do you maintain gross margin? This is margin rate sort of work in the opposite direction such that while you lose sales, our gross profit dollar is roughly the same. So in other words, if there is risk around deflation, it seems like, is that more of a top line risk, but not necessarily a bottom line risk?" ] }, { "name": "Carol B. Tome", "speech": [ "It's a top line risk, because margin is one of our lowest of lumber -- is one of our lowest margin category, a lower penetration of lower margin category is good for the gross margin. So while we called out the risk to the top line if lumber prices stay where they are today, we didn't call any risk to the bottom line, because there really isn't much risk to the bottom line." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. Best of luck. Thank you." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Peter Benedict with Baird. Please proceed with your question." ] }, { "name": "Peter Benedict", "speech": [ "Hey, guys. Carol, my congratulations as well, it's been great to work with you. So my first question is just looking back into the garden sales category, I think it was called out as being above. I think last year it was 200 plus basis point headwind. Can you maybe give us a sense of just how impactful garden was at least here in the first quarter and shifted or unshifted how we'd like to do it? That's my first question." ] }, { "name": "Ted Decker", "speech": [ "Well, I would say in garden we've planned for, if there is such a thing, a more normal spring, it turned out, it wasn't as normal as we've liked. But what you saw and when we called out about the company comp, particularly in indoor garden., that was all driven by a consumer response to just fantastic innovative product. And we've talked about product innovation, so finding the value, and the store, (inaudible) the tool to help them save time and save money on their jobs. And we have just such terrific product in outdoor power equipment, particularly as worthless technology moves into that space with our new grills, with pellet grills led by Traeger, which is an exclusive to us by far the dominant player in pellet grills, new patio collections. So despite the not so great weather, the customer responded to the product in the values and that's what really drove the business, live goods for example how has some room to make up, which we're looking forward to in Q2, and that's obviously weather driven and when we get great weather, our live goods are selling double digits and obviously when it's cold and rainy on a weekend, not so much. But really pleased with the garden business, again you wouldn't -- you wouldn't think it would be as strong, given the weather we've been talking about, it's really product and value." ] }, { "name": "Peter Benedict", "speech": [ "Okay, that's helpful. Thanks. And then just, I think you called it earlier, something around appliances that the customer service scores were up, I'm just curious if you guys can give us an update of where you guys are in terms of delivery, the DTC delivery capabilities same day, one day and just anything to call out there in terms of progress you're making on being more convenient for your customers? Thank you." ] }, { "name": "Craig Menear", "speech": [ "Peter, I'll make a comment and I'll turn over to Mark. So 2018 was really the year that we put pilots in place and 2019 moving forward through to 2022 will be the rollout of those. So, Mark, if you want to provide an update?" ] }, { "name": "Mark Holifield", "speech": [ "Sure. Thanks, Craig and good morning, Peter. Yeah, we, first-off, in terms of next day or one day delivery coverage from our Home Depot Pro distribution centers, formerly Interline, we already have coverage today, via privately trucks for all our Home Depot Pro customers in all major metropolitan areas. When you look at parcel shipping capability from our direct fulfillment centers, with second day or faster delivery for over 90% of the population, were at next day for 36% of the population.", "We've begun to retrofit our Hagerstown, Maryland direct fulfillment center for further parcel shipping. And because of its proximity to the population centers of the Northeast, that'll get us to the next day delivery, a parcel for 50% of the U.S. population by the end of this quarter. Will further improve our next day delivery capability with our new direct fulfillment centers under development in both Dallas and up in the Pacific Northwest near Seattle.", "And then when it comes to stores, we delivered from stores everyday, as well, and we've talked in the past about our delivery partnerships with Deliv and Roadie for crowd sourced delivery via car and van and that's now available to 40% of the U.S. population for car, 70% for van. And what that means for customers is we've got same-day delivery available for orders placed by 2:00 PM and next day after that time. And by the end of Q2, we'll have the same day and next day capabilities for small parcel items from stores, moving from 40% to 50% of the population. So our delivery keeps getting faster and that's very important because our data shows that every time we take time out of the delivery lead time, we increased conversion.", "We've got new data tools that are helping us to know what products to stock (ph) where and what delivery options to enable. Those tools can help us with understanding, hey, if we take a day out of power tools versus a day out of power tool accessories, which creates more value to our customers in terms of conversion. And we can tell that, across the departments and classes in the company." ] }, { "name": "Peter Benedict", "speech": [ "That's great color. Thanks, Mark, and good luck." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with RBC. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning guys, Scot Ciccarelli. Actually another delivery question, I appreciate all the color there. But when you look specifically at your pro sales. I'm sure it depends on category, what percent of your pro sales today are delivered to a Pros job site? And then how do you think that evolves as you build out your supply chain and the delivery capabilities, you're just talking about?" ] }, { "name": "Craig Menear", "speech": [ "Yeah, Scott, for competitive reasons obviously, we're not sure the specific data on that, but we believe that delivery is important for the Pro and particular segments of the Pro customers. It's important to be able to get them what they need, when they need it. So they can depend on that service. And that's what we're working to do." ] }, { "name": "Mark Holifield", "speech": [ "Yeah. And Craig, a little bit more color on that, we are definitely designing our delivery offerings around key Pro use cases. For instance we'll be opening our new flat-bed delivery center out of Dallas later this year. That's really a pro-oriented delivery with the flatbed trucks with the Moffitt on the back able to put it on the job site. Also we've implemented those two and four hour delivery windows that give our Pro reliability in terms of when a delivery will be there, so that they can count on their crews being kept busy by having very timely delivery." ] }, { "name": "Scot Ciccarelli", "speech": [ "So let me assess presumably as you build out that capability, more and more people will windup taking advantage of it presumably, that's why you're making it. But what, how should we think about the margin implications as delivery to job site mix growth?" ] }, { "name": "Craig Menear", "speech": [ "It's an all-in calculation that we use obviously. And as you grow with the Pro that actually uses delivery, it gives us an opportunity to much more effectively compete against the distribution houses and the lumber and building material yards that provide the service. And we look at as an all-in cost of operation considering what we get on the trucks and what kind of gross margin dollars that actually provides." ] }, { "name": "Mark Holifield", "speech": [ "Yeah, Craig. We've managed this as a portfolio, as you said and we have seen that when our Pros engaged with us in delivery they buy more across the portfolio. So it's an important portfolio management tool for us." ] }, { "name": "Ted Decker", "speech": [ "When you get that blend with the Pro, the overall margin with the Pro on a blended basis is very comparable to the DIY customer." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. All right. Thanks a lot guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Seth Sigman with Credit Suisse. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Hey guys, thanks for taking the question and Carol again congrats to you. A couple of points I wanted to follow-up on. First on the deflation, you talked about lumber being an 80 basis point headwind. Can you just give us a sense of the total commodity deflation impact comparable to sort of how you guys have disclosed it in the past? And then the second part of the question is around just sort of broader inflation that you're seeing across the store outside of the commodity categories sort of any trends that you're seeing, what you guys seeing from vendors and how are you trying to sort of manage through that from a retail price perspective? Thanks." ] }, { "name": "Carol B. Tome", "speech": [ "Sure. If you look at the commodity business excluding lumber, we'd look at building materials and copper and there was actually slight inflation in the quarter, about 30 basis points of growth came from commodity inflation that was offset, obviously by the stronger U.S. dollar, because that was deflating. So it kind of worked its way out. And then in terms of just general inflation across the store..." ] }, { "name": "Ted Decker", "speech": [ "Yeah, I would say that has abated, so we track, working with our finance partners very closely, all request for cost changes from our supplier base, our own costs with our direct import product label, supporting private label products, that has ramped up meaningfully over 2018. And as we went into '19, I wouldn't say it's reversed, that we have tighter way of cost out opportunity. But the pressure has subsided. So this is all putting aside the new tariff, I would say we're in a neutral to slightly positive cost position, even excluding the lumber deflation. On the tariffs, so we increased the Phase 3 tariffs on all products shipped out of China, on from May 10, so nothing has landed yet, think of three odd weeks to cross the Pacific Ocean. So we're looking at the end of this month, the increase on the tariffs of $200 billion of product going from 10% to 25%. For us that's about, call it $1 billion so the tariffs we've already received through 2018. We've said it's manageable and it's of roughly $1 billion impact. Should these new tariffs hold, it would be an incremental $1 billion, so call it less than 1% of our total sales. So it will certainly be more acute in certain categories. But as we repeatedly say we run the businesses of portfolio and 1% in aggregate of sales little harder, but to manage, but still I would call the manageable category." ] }, { "name": "Carol B. Tome", "speech": [ "So that just the math of it. That's just the math of it, we haven't gone vendor-by-vendor, product-by-product, we actually determine what the actions will be." ] }, { "name": "Craig Menear", "speech": [ "Yeah, Seth, I would say there is one interesting thing to look at when we talk about the tariffs. So when you look at kind of what happened in laundry, because that's one where it went into play, it was pushed throughout the market and candidly moved forward into retail. In the initial stage of that, we saw no impact for the first several months, then we actually saw negative unit declines come into play. And now we've seen double-digit positive growth in last quarter in laundry. So it's, it will be interesting to see how this all plays through, both in terms of how we can -- we'll work our portfolio approach as Ted said, but then how that actually plays out of the market. So more to come on that." ] }, { "name": "Mark Holifield", "speech": [ "Yeah, it's a great -- the laundry say it's been completely digested, and it was our strongest comping appliance category. As Craig said, in double digits, and that those tariffs have held and those go up to 50%." ] }, { "name": "Seth Sigman", "speech": [ "Okay, great. Thanks everybody for the color. I'll leave it there." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey, thanks, good morning and Carol congrats. Just on the macro front here, just wondering how sales are trending in some of the markets where we're starting to see some of the home prices start to slow down or in some cases compressed?" ] }, { "name": "Carol B. Tome", "speech": [ "Now let's take a market like L.A., there is been a lot of conversation about what's happening in home prices in L.A. Our comp in L.A. was considerably ahead of our Company for the first quarter. Let's take a market like New Jersey where people were very concerned about what would happen to sales, given the high -- state. And when we see New Jersey, it's actually outperforming the company average, too. So trust me, we're spending a lot of attention and looking at performance by markets, but we just can't see anything at this point in a negative way, pardon me, we see lots of things in a negative way." ] }, { "name": "Chuck Grom", "speech": [ "Okay. Good. I just wanted to see if you guys could clarify on that. And then just on the guide, I know you're keeping the sales and the earnings. Just wondering if you're still comfortable with the 34% gross margin and the -- I believe the 53% expense growth factor and overall operating margin of about 14.4%?" ] }, { "name": "Carol B. Tome", "speech": [ "Yes. Nothing has changed within the top and the bottom line of the P&L guide." ] }, { "name": "Chuck Grom", "speech": [ "Okay, great. Congrats again." ] }, { "name": "Carol B. Tome", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zachary Fadem", "speech": [ "Hey, good morning. First of all, Carol, also Richard congrats. First question from me, on the SG&A line, Q1 had the benefit of the calendar shift on the top line. Curious how that impacted margins here? And as we think about the cadence in the Q2 with the calendar shift reversing, should we anticipate incremental deleverage with comps presumably above total sales, could you just walk us through the moving parts here a little bit?" ] }, { "name": "Carol B. Tome", "speech": [ "Yeah, so first as it relates to the gross margin, the calendar shift doesn't impact the gross margin, because you have 13 weeks of sales against 13 weeks of sales, from an expense perspective, because we do have a difference in our comp rate and our total sales growth rate. It will have a more meaningful impact on our expenses, either as a percent of sales or from an expense growth factor perspective. So we are expecting in the second quarter that our comp will be higher than our sales growth, again, because of the calendar shift. So you would expect our expense growth factor to be higher in the second quarter than it was in the first quarter. Does that make sense? Hopefully, that makes sense for you." ] }, { "name": "Zachary Fadem", "speech": [ "Yeah, yeah, that makes sense. Appreciate that. And then second, just to follow-up again on the (inaudible) tariff bigger inflation at the 10% level has abated a little bit. But perhaps you could comment on just the elasticity of demand in your categories, based on the data that you have as further price increases look a little bit more inevitable here?" ] }, { "name": "Ted Decker", "speech": [ "You broke up a little, but I think I got that, we look at the elasticity very carefully and that supports when we always say, we take a portfolio approach. We don't necessarily put dollar cost, it received into like dollar increase in retail. That's a super elastic item, we may hold if not even drop price in that category for trying to spur demand and manage the cost increases somewhere else in the portfolio. And yeah, we are very, very robust data and great again support with our finance partners and internal assortment planning and pricing teams that are working all those elasticities by category, by product, by market." ] }, { "name": "Carol B. Tome", "speech": [ "These are sophisticated tools that we've built up over a number of years, that allows us to have this kind of responsiveness." ] }, { "name": "Ted Decker", "speech": [ "Yeah, its going on 8 years." ] }, { "name": "Carol B. Tome", "speech": [ "Yeah." ] }, { "name": "Zachary Fadem", "speech": [ "Got it. Appreciate the color." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question will come from the line of Elizabeth Suzuki with Bank of America Merrill Lynch. Please proceed with your question." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Thank you. And maybe this was touched on already and I missed it. But just curious if you could comment on current petition from U.S. tile manufacturers or anti-dumping and countervailing duties against Chinese tile manufacturers. Do you source a meaningful percentage of your tile from China and what's the -- your current strategy as it pertains to duties, tariffs, et cetera on those imported products?" ] }, { "name": "Craig Menear", "speech": [ "We don't have a huge fight in the China tile import, fortunately, we're sourcing largely domestically in Mexico." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Thank you. That's helpful." ] }, { "name": "Operator", "speech": [ "Thank you. We have reached the end of the question-and-answer session. I would now like to turn the floor back over to Ms. Janci for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you for joining us today. We look forward to speaking with you on our second quarter earnings call in August." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day." ] } ]
HD	2018-02-20	[ { "description": "VP, Investor Relations", "name": "Diane Dayhoff", "position": "Executive" }, { "description": "Chairman, CEO, and President", "name": "Craig A. Menear", "position": "Executive" }, { "description": "EVP of Merchandising", "name": "Edward P. Decker", "position": "Executive" }, { "description": "CFO, EVP of Corporate Services", "name": "Carol Tom", "position": "Executive" }, { "description": "EVP of Supply Chain and Product Development", "name": "Mark Holifield", "position": "Executive" }, { "description": "William G -- . -- Lennie -- EVP of Outside Sales and Service", "name": "William G", "position": "Executive" }, { "description": "Kevin -- President, CMO of Online Business", "name": "Kevin", "position": "Executive" }, { "description": "UBS Securities, LLC -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Jefferies, LLC -- Analyst", "name": "Daniel Binder", "position": "Analyst" }, { "description": "Morgan Stanley & Co., LLC -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "JPMorgan Securities, LLC -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Credit Suisse Securities (USA), LLC -- Analyst", "name": "Seth I. Sigman", "position": "Analyst" }, { "description": "Oppenheimer & Co., Inc. -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "BTIG, LLC -- Analyst", "name": "Alan Rifkin", "position": "Analyst" }, { "description": "Zelman & Associates -- Analyst", "name": "Dennis McGill", "position": "Analyst" }, { "description": "Goldman Sachs & Co., LLC -- Analyst", "name": "Matthew J. Fassler", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Deutsche Bank -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- -- Analyst", "name": "Elizabeth Suzuki", "position": "Analyst" }, { "description": "Eric -- Cleveland Research Company -- Analyst", "name": "Eric", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Good day, and welcome to The Home Depot Q4 2017 Earnings Conference Call. Today's conference is being recorded. [Operator Instructions]", "At this time, I'd like to turn the conference over to Ms. Diane Dayhoff, Vice President, Investor Relations. Please go ahead, ma'am." ] }, { "name": "Diane Dayhoff", "speech": [ "Thank you, Abby, and good morning to everyone. Joining us on our call today are Craig Menear, Chairman, CEO and President; Ted Decker, EVP of Merchandising; and Carol Tomé, Chief Financial Officer and Executive Vice President, Corporate Services.", "Following our prepared remarks, the call will be opened for analysts' questions. Questions will be limited to analysts and investors. And, as a reminder, we would appreciate it if the participants would limit themselves to one question with one follow-up, please. If we are unable to get to your question during the call, please call our Investor Relations Department at 770-384-2387.", "Now, before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig A. Menear", "speech": [ "Thank you, Diane, and good morning, everyone. Before I start, I'd like to recognize Diane Dayhoff. This is Diane's last earnings call. I want to thank Diane for all of her amazing contributions to the company in her nearly 15 years. Diane, we wish you all the best in retirement." ] }, { "name": "Diane Dayhoff", "speech": [ "Thank you." ] }, { "name": "Craig A. Menear", "speech": [ "Fiscal 2017 was another record year for our business and we achieved the highest sales and net earnings in company history. Fiscal 2017 sales grew $6.3 billion to $100.9 billion and an increase of 6.7% from Fiscal 2016, while diluted earnings per share grew 13% to $7.29. Sales for the fourth quarter were $23.9 billion, up 7.5% from last year. Comp sales were also up 7.5% from last year, and our US stores had a positive comp of 7.2%. Diluted earnings per share were $1.52 in the fourth quarter.", "We continue to see broad based growth across the stores in our geographies. All three of our US divisions posted positive comps in the fourth quarter, but we did see more variability in regional performance than we have in several quarters due to weather. Internationally, both Mexico and Canada posted another quarter of positive comps in local currency.", "While sales did benefit from hurricane recovery efforts, we also had hurricane related expenses. Our merchants, store teams, supplier partners, and supply chain teams did an outstanding job delivery value and service to our customers throughout the quarter, both in stores and online.", "As Ted will detail, both ticket and transactions grew in the quarter, and we saw growth in both pro and DIY categories. Pro sales, once again, outpaced DIY sales in the quarter as the work that we're doing to enhance service capabilities for our pros continue to resonate. We are pleased with the growth of sales to our DIY customers, who also gave us a likelihood to shop again score of 86%, up almost 150 basis points from last year.", "Our interconnected business made great strides in 2017 as the team continued to enhance our digital assets to enable a more seamless experience for our customers no matter how they choose to shop with us. We implemented a new e-commerce platform, enhanced our search and mobile functionality, increased checkout speed, and expanded chat functionality to improve the customer experience with our online contact centers.", "We continue to invest in our digital properties and it has increased traffic and conversion. Versus prior year, our online sales grew 21% in the fourth quarter and 21.5% in Fiscal 2017, now representing 6.7% of our total sales. While we're seeing significant growth in our online sales, these online shoppers see the relevance of our stores as approximately 46% of our online US orders are picked up in our stores, a testament to the power of our interconnected retail strategy.", "We have talked a lot about the progress we have made in building our upstream supply chain network over the past several years. We've also told you about the $1.2 billion investment we plan to make over the next five years to leverage the capabilities and competitive advantages we have in our upstream network while significantly improving our downstream proficiencies to leverage our scale and convenient locations.", "This year, we will pilot the local flatbed DFCs and market delivery operations. But, I want to remind you that this investment in One Home Depot's supply chain is a five-year journey where the financial benefits won't be realized until the initiative is complete. These investments are critical to meet the evolving needs of our customers, and we are committed to creating the fastest, most efficient delivery network for home improvement products.", "We are not an organization that rests on our laurels of previous accomplishments. I don't want to miss this opportunity to applaud each and every one of our associates for the incredible work that has brought us to this point in our company's history. As I mentioned, Fiscal 2017 was a record sales and earnings year on the heels of a record Fiscal 2016.", "In 2017, our associates and suppliers served our customers during their time of need as we navigated the disruptions caused by various natural disasters. We also welcomed two new teams to the Home Depot family through the acquisitions of Compact Power and The Company Store. All of this was accomplished during a time marked by a high degree of change in our business as we respond to the rapidly evolving retail environment. As they always do, our associates continued to adapt to these changes while consistently delivering outstanding customer service.", "Today, our board announced a 15.7% increase in our quarterly dividend to $1.03 per share. We remain committed to maintaining disciplined capital allocation to create value for our shareholders.", "Turning to 2018 and beyond, I'm very excited about the opportunities that are ahead of us. Carol will take you through the details, but we expect 2018 to be another year of growth, with expected sales growth of approximately 6.5% and diluted earnings per share of approximately $9.31.", "At our investor conference in December, we outlined our three-year financial targets and an accelerated investment plan to create the One Home Depot experience for our customers. Today, we are reaffirming our investment strategy and our 2020 targets to grow sales as high as $120 billion with operating margin as high as 15%. We are updating our return on invested capital target to now more than 40%.", "One of the areas that we're investing in is our associates. In the fourth quarter, we did just that. We recognized associates through success sharing, our profit sharing program for our ROE associates. For the second half of the year, 99% of our stores qualified for success sharing. Beyond success sharing, we were pleased to be able to pay out an incremental one-time bonus to our hourly associates in light of tax reform. Together, this was an investment in our associates of more than $240 million in the back half of the year.", "I want to close by thanking all of our associates for their hard work and dedication to our customers in the fourth quarter and throughout the year. We look forward to continuing this momentum in 2018. And with that, let me turn the call over to Ted." ] }, { "name": "Edward P. Decker", "speech": [ "Thanks, Craig, and good morning, everyone. We had a strong fourth quarter as sales exceeded our expectations. We saw strength across the store, led by our pro customer, and our online sales continued their double-digit growth.", "Looking at our departments, lumber, electrical, and tools had double-digit comps in the quarter. Appliances, plumbing, and building materials were also above the company's average comp. Décor, flooring, millwork, paint, indoor garden, hardware, outdoor garden, and kitchen and bath were positive, but below the company average. Lighting recorded a low single-digit negative comp primarily due to LED price deflation.", "In the fourth quarter, we saw growth in both ticket and transactions. Comp average ticket increased 5.5% and comp transactions increased 1.9%. Commodity price inflation in lumber, building materials, and copper positively impacted average ticket growth by approximately 105 basis points.", "Foreign exchange rates also positively impacted average ticket growth by approximately 42 basis points. Big ticket sales in the fourth quarter were transactions over $900.00, which represent approximately 22% of our US sales, were up 9.8%. The increase in big ticket sales was driven in part by strength in vinyl plank flooring, fencing, and appliances. Transactions for tickets under $50.00, which make up approximately 16% of our US sales, grew by 0.8% in the quarter.", "In the fourth quarter, we saw strong sales with both our DIY and pro customers. Sales to our professional customers were double digits in the quarter. Pro heavy categories such as lumber, pressure treated decking, insulation, and gypsum, all had double-digit growth during the quarter with solid unit productivity. Our paint initiatives continue to gain traction as we saw strong sales to both our pro and DIY customers throughout the quarter.", "Turning toward DIY customers, we saw a terrific response to our events throughout the quarter. Traffic was strong, both in store and online during our black Friday gift center and Holiday events. During the quarter, our DIY customers drove strong comps in power tools, hand tools, rugs, appliances, and decorative Holiday.", "We also continue to see strength in storm related categories in the quarter with double-digit comps in generators, wet/dry vacs, and portable heating. As part of our focus on balancing the art and science of retail, we continue to refine and localize our assortments. A recent example is with our Artscape category, which includes pavers, wall block, and landscape rock. We are leveraging the power of our clustering and space optimization tools to assign assortments and facings at a local store level.", "As a result, we have been able to optimize on-shelf inventory levels to provide job life quantities for our customers, minimize shelf maintenance for our store associates, and maintain a meaningful and innovative assortment. Initial results in warm weather markets have been strong.", "Now let me turn our attention to the first quarter. Product innovation and speed to market allow The Home Depot to maintain its position as the number one retailer in product authority in home improvement. To that end, our merchants are constantly collaborating with our suppliers to deliver new products exclusively to The Home Depot.", "For example, we recently updated our assortment of Klein tools for professional electricians. This includes the new 9-inch Journeyman diagonal cutting pliers that provide 57% more cutting surface, and a new magnetizer tool that is great when needing to magnetize a screwdriver or bit. The addition of these new products to our existing assortment of big-box exclusive client tools keeps us winning with the electrician.", "With spring quickly approaching, we are gearing up to fulfill the needs of our customers as they complete their outdoor projects and get ready to enjoy the warm weather. In addition to our annual spring Black Friday event, we are excited about our new patio set offerings, which provide customers great value across a wide selection to fit their specific style and needs.", "New this year, as part of our exclusive Hampton Bay collection, we are offering cushion guard technology, which guarantees water repellency as well as protection from fading and stains. This gives our customers peace of mind and reassurance that they are purchasing quality material at an everyday low price.", "With that, I'd like to turn the call over to Carol." ] }, { "name": "Carol Tom", "speech": [ "Thank you, Ted, and good morning, everyone. In the fourth quarter, total sales were $23.9 billion, an increase of 7.5%. Through last year, a weaker US dollar positively impacted total sales growth by approximately $100 million, or 0.5%. Additionally, we estimate that hurricane related sales positively impacted total company sales growth in the quarter by 1.7%, or $380 million.", "Our total company comps, or same-store sales, were positive 7.5% for the quarter, with positive comps of 8.3% in November, 11.5% in December, and 3.1% in January. Comps for US stores were positive 7.2% for the quarter, with positive comps of 8.2% in November, 11.4% in December, and 2.5% in January.", "Our monthly comps were distorted by the timing of Christmas. This year, the Christmas holiday fell in our fiscal January rather than December. Adjusting for this timing shift, our total company comps would have bee 8.3% in November, 8.5% in December, and 5.8% in January.", "For Fiscal 2017, our sales increased 6.7% to $100.9 billion, and total company comp sales were positive 6.8%. Comps for US stores were positive 6.9%. During the year, foreign exchange rates positively impacted total sales growth by approximately $67 million, or 0.1%. In the fourth quarter, our gross margin was 33.9%, a decline of 12 basis points from last year. We attribute the modest decline in our gross margin primarily to lower margin hurricane related sales. For the year, we experienced 11 basis points of gross margin contractions in line with our plan.", "In the fourth quarter, operating expense as a percent of sales decreased by 30 basis points to 20.5%. Our expense leverage was driven primarily by our strong sales performance. During the quarter, we had a few expenses that we did not plan. First, as a result of the one-time cash bonus stemming from tax reform, we incurred approximately $117 million of incremental expense. And, we incurred approximately $66 million of hurricane related expenses.", "Fiscal 2017 operating expense as a percent of sales was 19.5%, a decrease of 47 basis points from last year. For the year, our expenses grew at approximately 63% of our sales growth rate. Ignoring hurricane related sales and expense and backing out the one-time bonus, our expenses grew at approximately 45% of our sales growth rate in Fiscal 2017.", "Our operating margin for the fourth quarter was 13.4%, and for the year was 14.6%. Interest and other expense for the fourth quarter grew by $11 million to $246 million, reflecting for the most part, a higher long-term debt balance versus last year.", "In the fourth quarter, our effective tax rate was 39.6%, compared to 35.2% in the fourth quarter of Fiscal 2016. In the fourth quarter, we recorded a net tax expense of approximately $127 million, resulting from tax reform. While this is a provisional charge, it was slightly better than our initial estimates.", "Our diluted earnings per share for the fourth quarter were $1.52, an increase of 5.6% from last year. For the year, diluted earnings per share were $7.29, an increase of 13% compared to Fiscal 2016. Our fourth quarter and Fiscal 2017 diluted earnings per share were negatively impacted by approximately $0.17 due to the one-time bonus and net tax expense previously mentioned.", "Moving on to some additional highlights, during the fiscal year, we opened six new stores, including three in the US and three in Mexico, for an ending store count of 2,284. Selling square footage at the end of the year was 237 million square feet. For the fiscal year, total sales per square foot increased 6.7% to $417.00, the highest level since Fiscal 1999. At the end of the quarter, merchandise inventories were $12.7 billion, up $199 million from last year. Inventory turns were 5.1 times, up from 4.9 times last year.", "Moving on to capital allocation, in Fiscal 2017, we generated approximately $12.3 billion of cash from the business and used that cash, as well as proceeds from $3.3 billion of both short- and long-term debt issuances, to invest in the business. We purchased our shares and paid dividends to our shareholders. During the year, we invested approximately $2.3 billion back into the business through capital expenditures and acquisitions.", "Further, we repurchased approximately $8 billion, or about 49.5 million, of our outstanding shares, including roughly $2.1 billion, or 11.5 million shares, in the fourth quarter. Finally, during the year, we paid $4.2 billion in dividends.", "Computing on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 34.2%, 280 basis points higher than the end of Fiscal 2016.", "Today's press release includes our guidance for Fiscal 2018. I want to take a few moments to comment on the highlights. Remember that we guide off of GAAP, so Fiscal 2018 guidance will launch from our reported results from Fiscal 2017. There are a few things to keep in mind when thinking about our Fiscal 2018. First, Fiscal 2018 will include a 53rd week. So, the fourth quarter of Fiscal 2018 will consist of 14 weeks. We will continue to report comps on a 52-week basis, but we will base our overall guidance on 53 weeks.", "Second, beginning in the first quarter of Fiscal 2018, we will adopt ASU 2014-09, which addresses revenue recognition. This accounting standard will not have a material impact on our sales or our operating margin guidance. But, it will change the geography of certain items on our income statements. Our guidance today does not incorporate this new standard. We will give you a more detailed update during our first quarter conference call in May.", "Finally, our guidance incorporates investment plans we laid out in December and the impact of tax reform. So, with that, let's zoom out and look at the macro environments. The US economy is strong and tax reform is net positive for the housing industry. We expect higher job growth, higher income growth, and yes, higher mortgage rates. But, with that, comes higher home price appreciation and rising housing demand, which should drive home improvement spending.", "For Fiscal 2018, we expect sales to grow approximately 6.5% with the extra week adding approximately $1.6 billion in sales. During Fiscal 2018, we expect total company comp sales of approximately 5% and we're planning to open three new stores. For Fiscal 2018, we are projecting our gross margin rate to be about the same as it was in Fiscal 2017, reflecting for the most part, the benefit of the extra week.", "As we discussed during our December investor conference, we have a number of investments planned, which will cause our expense growth factor to be higher than what it's been in the past. Further, with tax reform we have elected to pull some of the investments forward into Fiscal 2018. We expect our 2018 operating expenses to grow a little more than 100% of our sales growth rate.", "For the year, we expect that our operating margin will be approximately 14.5%, with the extra week adding approximately $300 million in operating profit. For Fiscal 2018, incorporating tax reform, we estimate our effective tax rate to be approximately 26%. We expect Fiscal 2018 diluted earnings per share to grow approximately 28% to $9.31, with the 53rd week contributing approximately $0.19. Our earnings per share guidance includes our plan to repurchase approximately $4 billion of outstanding shares during the year.", "For the year, we project cash flow from the business of roughly $14.1 billion, which includes about $1.8 billion of cash resulting from tax reform. We will invest $2.5 billion of this cash back into the business in support of the strategic initiatives we outlined at our investor conference. We will also use this cash to pay $4.8 billion of dividends.", "As Craig mentioned, we just announced a 15.7% increase in our quarterly dividend, which equates to an annual dividend of $4.12, in line with our targeting dividend payout ratio of 55% of earnings.", "Finally, we will repurchase $4 billion of outstanding shares. Note that this is a preliminary share repurchase target and may be adjusted throughout the year. At our investor conference in December, we shared with you our long-term financial targets and our strategy to create One Home Depot. Over the next three years, we will nearly double our investments into the business to enhance the customer experience, invest for the future, and create value.", "Today, we are reaffirming and updating our long-term targets. By Fiscal 2020, we are aiming to grow our sales to a range of $115-120 billion with an operating margin of 14.4-15%. Reflecting the impact of tax reform and a resulting higher net operating profit after tax, we now believe our return on invested capital in Fiscal 2020 will be more than 40%.", "...", "So, we thank you for your participation in today's call. Abby, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator instructions] We will take our first question from Simeon Gutman with Morgan Stanley. Please go ahead." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning, everyone. Congratulations, Diane. My first question is on the top line, the fourth quarter. You're cycling two warm winters. I realize the hurricane was some benefit in the quarter, but if you look at the underlying run rate of the business, is there anything to glean? Like the fact that some of these categories are still hanging in despite you've had more normalized weather? Does that mean we should see an even stronger spring when we get there?" ] }, { "name": "Craig A. Menear", "speech": [ "We're first of all very pleased with the performance in the quarter, both across categories as well as geographies. To your point, we definitely had benefit from hurricane recovery sales, particularly offset by a real winter in January this year. Carol, you might want to share how we made up the fourth quarter." ] }, { "name": "Carol Tom", "speech": [ "Yeah. We were really pleased with the results in the fourth quarter. Clearly, the hurricane sales were higher than what we had included in our guidance at the end of the third quarter, so we were pleased with that. But, just the underlying business was very strong. We had winter. If you look at the month of January alone and the comps across our divisions, the comp in the Western division and Southern division in the month of January was higher than the comp for the company for the quarter.", "Now, in the North, where we had real winter, our comp was low single-digit, as you expected. So that means we should have a pretty good spring, I would think, when you have a normal winter." ] }, { "name": "Simeon Gutman", "speech": [ "Looking at the housing market in total, and looing at the market color you guys have, in more mature markets, where the housing market has already recovered, can you talk about any trends, good or bad, and then alternatively, in less mature recovery markets, anything that you're seeing that's encouraging about the pace of sales in those markets?" ] }, { "name": "Carol Tom", "speech": [ "If you look at the variability in our regions, the spread was a bit wider than we've seen in the past several quarters, but that's because of the hurricane related sales, where we had high high double-digit comps. But, if you ignore the hurricane related sales, you actually see the variability tightening. That's because the economic environment in the cities that have recovered is robust and there is a housing shortage." ] }, { "name": "Craig A. Menear", "speech": [ "If you look at a market like Dallas, which has had tremendous growth in home value appreciations, the affordability index is still terrific. So, we're looking at housing continuing to be a tailwind for us." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "We will take our next question from Brian Nagel with Oppenheimer. Please go ahead." ] }, { "name": "Brian Nagel", "speech": [ "Hi. Good morning. Nice quarter. Congratulations, Diane. I wanted to follow-up on Simeon's question on hurricanes. If we look at the cadence of business in the last couple of quarters, it seems like you actually got a bigger benefit from hurricanes here in the fourth quarter, which was a surprise to us. Any new insights in watching these sales come through, as to how long these benefits could persist into 2018?" ] }, { "name": "Craig A. Menear", "speech": [ "Overall, the fourth quarter was almost comparable to the third quarter in terms of total benefit. Fourth quarter was slightly stronger than what we had anticipated. When we look at the go forward in the business for 2018, we expect the sales from hurricanes to be somewhat comparable to what we experienced in 2017 overall, and most of that coming in the first half of the year." ] }, { "name": "Carol Tom", "speech": [ "Just to put some numbers behind that, we believe we had $662 million of hurricane related sales in the back half of 2017, and we expect to have that same number of sales in 2018. The difference is that the 2018 sales will be a little bit more profitable than what we experienced in 2017. In fact, when you add it all up, we lost money on those sales. We lost about $11 million on those sales in 2017 and we expect to lose a little bit of money on those sales in 2018." ] }, { "name": "Brian Nagel", "speech": [ "Got it. Carol, you mentioned in your prepared comments the pull forward a bit in the cadence of the investments that you laid out and how the tax legislation was just passed. Do you have any color on specifically what investments you're pulling forward earlier? How should we think about the potential of return on those investments?" ] }, { "name": "Carol Tom", "speech": [ "Let me just give you a breakdown of our expense growth factor guidance for 2018. Our core expenses will grow at about 45% of our sales growth next year. We add to that, then, about 10% related to acquisitions. As we've talked in the past, our acquisitions have more variable expenses than our core. So, when you add up core and acquisitions, expenses growing at 55% of our sales growth. Then the investments that we're making -- add another 46-plus, so that our expenses will be a little more than 100% of our sales growth in 2018.", "What are we pulling forward? Well, if you remember the pie chart that we shared with you at our investor day and we showed buckets of expense, one of the buckets of expense was a bucket called other. In that bucket called other, were people expenses. We are pulling forward some of those people expenses because those are easy things to do. Some of the other investments we're making takes time. We talked to you about supply chain as an example. Our supply chain initiative is actually a five-year initiative. But, the people investments are things that we can pull forward and we think that's the right thing to do." ] }, { "name": "Brian Nagel", "speech": [ "Thank you very much. Congrats again." ] }, { "name": "Operator", "speech": [ "Our next question comes from Mike Baker with Deutsche Bank. Please go ahead." ] }, { "name": "Michael Baker", "speech": [ "Hi. Thanks. Can you explain the calendar shift in a little bit more detail, December versus January? How does Christmas end up in January? Even when that make that adjustment, January does seem to have been a little bit softer, but is that just the winter weather?" ] }, { "name": "Carol Tom", "speech": [ "Michael, it's just our accounting convention. We have a 445 close, and it's just when Christmas Day falls. Christmas this year was a Sunday more Monday and, anyway, it just fell into another month. It's just calendar. That's all it is.", "In terms of our January comp, even on an adjusted basis, it was lower than the previous two months. But, we had a winter in January. Our Western and Southern divisions, in the month of January, comps were higher than the company average for the quarter. But, in the North, where we had winter, it was low single digits." ] }, { "name": "Michael Baker", "speech": [ "Right. Okay. That makes sense. Rates -- it doesn't seem like it's an issue yet, but I think in the past, you've given some color on where's that breakpoint where we start to become worried about rates, either measured on a 10-year bond or a 30-year fixed mortgage or however you look at it?" ] }, { "name": "Carol Tom", "speech": [ "30-year rates today are 4.2%. The consensus estimate for 2018 is 4.3%. I've seen a high estimate out there of 4.6%. But, to put into perspective, our math suggests that for every 25 basis points of a mortgage rate increase, it's $40.00 of additional mortgage interest per month. So, we don't see any concern with a rising interest rate over the next several years actually. Remember that historical 30-year mortgage is 5.6%. The affordability index, broadly speaking, is still very good at over 155%." ] }, { "name": "Michael Baker", "speech": [ "Okay. Appreciate the color. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Michael Lasser with UBS. Please go ahead." ] }, { "name": "Edward P. Decker", "speech": [ "We still look at it on a split of roughly 50/50 over time, coming from ticket and traffic overall. From departments, we still have opportunity in larger ticket building material, special order kitchens, lumber -- while lumber has certainly run up in price, the project business is still growing, and we still have significant opportunities. So, from a department perspective, we see more continued growth in those departments." ] }, { "name": "Michael Lasser", "speech": [ "And, Ted, is there anything to read into about the performance of the lighting category? A price deflation in LED has been happening for a long time. Could it be now that the category's just reached either a maturity point or is now starting to shift more online?" ] }, { "name": "Edward P. Decker", "speech": [ "We see the price deflation continuing into 2018 and we plan for meaningful deflation to continue throughout 2018." ] }, { "name": "Carol Tom", "speech": [ "There is some good news with price deflation, though, because we are relamping our stores with LED light. It was a good thing that we waited for this investment because the cost is coming down. Glass half full here." ] }, { "name": "Michael Lasser", "speech": [ "Thank you so much." ] }, { "name": "Operator", "speech": [ "Our next question comes from Seth Sigman with Credit Suisse. Please go ahead." ] }, { "name": "Seth I. Sigman", "speech": [ "Thanks a lot, and good morning. Nice quarter. Diane, congrats. I wanted to follow-up on the gross margin outlook for flattish in 2018. I'm wondering if you can reconcile that with the longer-term guidance that calls for a decline of 40 basis points over the next three years. And, related to that, presumably frayed and mixed could still be headwinds as you look into '18. What are you assuming as other offsets in there? Thank you." ] }, { "name": "Carol Tom", "speech": [ "We've guided gross margin flattish for the year. That includes the 53rd week. The margin in that 53rd week will be higher because it doesn't have as much fixed cost allocated to it. So, if you ignored the 53rd week, the gross margin for the business would be down call it seven-ish basis points. We have factored into our outlook a tightening transportation market, higher fuel costs -- although, that has gotten better recently. We're going to have to stay close to this. We have lots of cost out opportunities that we will certainly drive. But, the transportation market is tightening. We might have a little pressure there, but we'll manage through it." ] }, { "name": "Seth I. Sigman", "speech": [ "On the delivery from store initiative, I think it's been in stores for over a year now. Can you speak about the performance, the types of pros that are utilizing it and if you're seeing actually new customer come in, or is it just driving share of existing pros wallet? Thank you." ] }, { "name": "Edward P. Decker", "speech": [ "We're very pleased with growth overall in delivery, and we're seeing that happen both with our pro and with our consumer. Mark's here. I'll let him comment." ] }, { "name": "Mark Holifield", "speech": [ "We're seeing the same kind of mix of pro and consumer that we see across the business. We're very pleased that that store based delivery continues to grow. One highlight there -- we're continuing to roll out the car and van lower cost delivery options to more markets as we go, including our home market of Atlanta now. Expect to have that rolled out by spring to all of the major markets." ] }, { "name": "Carol Tom", "speech": [ "And the question always is incrementality. And, based on our analysis, we're driving incremental growth here." ] }, { "name": "Seth I. Sigman", "speech": [ "Very helpful. Thank you. Good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from Matt Fassler with Goldman Sachs. Please go ahead." ] }, { "name": "Matthew J. Fassler", "speech": [ "Thanks a lot. Good morning. Diane, thanks so much for all of your years. Isabel, welcome back to you. Carol, you gave the adjusted comps on a monthly basis for the total company. Do you have the December and January numbers for the US stores alone?" ] }, { "name": "Carol Tom", "speech": [ "It's a 300 basis point shift, so you can just do that math." ] }, { "name": "Matthew J. Fassler", "speech": [ "Great. If you talk about the transactions under $50.00, we're used to at this point the bigger ticket transactions growing at or close to double-digit and the smaller ticket transactions growing low singles. Are those transactions being subsumed under visits, i.e. the visits are coming down and that's just reflected in a bigger ticket? Is it a question of market shares and a question of that business being done online? How should we think about that trend in the small ticket business?" ] }, { "name": "Craig A. Menear", "speech": [ "Matt, we've actually done some work in this area. I would start with a comment that this has been impacted by both innovation and inflation. I'll let Carol walk through the details of this, but we're pleased with what we're seeing." ] }, { "name": "Carol Tom", "speech": [ "We are. We took our ticket and broke it into quintals. If you look at the bottom quintal, we see the price has jumped through innovation and inflation 11% over the past couple of years. So, it's moving out of that less than $50.00 bucket into a higher bucket. The other contributor is price inflation in LED light bulbs. LED light bulbs would be in that $50.00 bucket. It's just a change in the business model and we're reacting to that change." ] }, { "name": "Matthew J. Fassler", "speech": [ "Thank you so much, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from Chuck Grom with Gordon Haskett. Please go ahead." ] }, { "name": "Chuck Grom", "speech": [ "Hi. Thanks. Just a quick modeling question. On the expense growth factor of slightly north of 100%, should we expect that to be pretty even throughout the year by quarter or are you expecting any lumpiness throughout the year?" ] }, { "name": "Carol Tom", "speech": [ "It will be lumpy. It will be higher in the first half of the year than in the back half of the year. In the back of the year of '17, we had hurricane related expenses that will not repeat." ] }, { "name": "Chuck Grom", "speech": [ "Helpful. Historically, when you have the type of winter that you guys are going through this year -- and us as well -- can you remind us how the business tends to pick back up in the spring, based on your historical experience?" ] }, { "name": "Craig A. Menear", "speech": [ "It totally is dependent on when spring actually breaks. That can happen early or late. Mother nature will control that. But, what we do see from that type of activity is generally, when you have a harsh winter, you have a lot of garden opportunity with replacement of shrubs. You have ice damage and roofing. So, there are different types of elements within the business that will actually see a benefit from a hard winter." ] }, { "name": "Chuck Grom", "speech": [ "Okay. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Elizabeth Suzuki with Bank of America Merrill Lynch. Please go ahead." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Hi. Good morning. Generally, when costs are rising -- transportation, labor, general inflation, etc. -- how much of these cost increases are you able to pass through to the consumer?" ] }, { "name": "Craig A. Menear", "speech": [ "First of all, in each situation, with cost in our first cost of goods, we look at that on a case-by-case basis and work with our suppliers to help them try to minimize as many impacts as we possibly can. Candidly, we look at a portfolio approach to how we actually deal with that. Cost may not necessarily go into a category where we may absorb some costs. It could go somewhere else. We obviously look to offset that within our own business to try to hold value for the customer." ] }, { "name": "Elizabeth Suzuki", "speech": [ "Great. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from Dennis McGill with Zelman & Associates. Please go ahead." ] }, { "name": "Dennis McGill", "speech": [ "Good morning. Thank you, everybody. Carol, on investor day, I think you talked about investments adding somewhere in the neighborhood of 50-200 basis points to same store sales growth. How did you think about the benefit in '18 when you formed the plan?" ] }, { "name": "Carol Tom", "speech": [ "Not a lot of benefit in '18. We have to first make the investments. If you think about it, we talked about a lump of $1 billion investment over the next three years. We're going to ramp up. You'll see more of the return in the back half of the three-year planning than you do in the initial part of the three-year plan." ] }, { "name": "Dennis McGill", "speech": [ "Okay. Thank you. When you talk about the cash flow from the business and look at the guidance for share repurchases, can you talk about how you thought about getting to that $4 billion number, especially with repatriation being an opportunity? Also, maybe just update us on where that stands as far as getting that cash back?" ] }, { "name": "Carol Tom", "speech": [ "Yeah. Based on the cash flow guidance that we've given you and the use of cash, you're like, \"Wow, you're going to have some leftover cash.\" That's right. We are. We're exploring what to do with that cash. It could be additional share repurchases, dividends, pay back debt, build cash for the future, and so on. We're going to take our time to think through this and, as we determine what to do with the cash, we will let you know. The $4 billion specifically is what we had on our investor day, so we just kept that for the year and we'll update you as the year continues." ] }, { "name": "Operator", "speech": [ "Our next question comes from Scot Ciccarelli with RBC Capital Markets. Please go ahead." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, everyone. Carol, what is the mortgage rate that you think starts to adversely impact home pricing trends? Related to that, real estate is a very localized industry. Do you have thoughts regarding the potential impact on home prices in affected areas?" ] }, { "name": "Carol Tom", "speech": [ "Let's look at the latter part of your question first. 80% of American households are going to have more money this year because of tax reform, given the increase in the standard deduction. Further, many corporations are enjoying lower taxes and we see many corporations taking that cash and investing it in the people, like Home Depot is. We think those two things by themselves offset any negative that could arise with the change in the mortgage interest deduction or the cap on state and local tax deduction.", "Just a few other things. On the cap on mortgage interest deduction of $750,000, only 5% of houses that are sold in a year are $750,000 or above. So, it's a small subset of what happens in the housing market. As we've talked bout, only about 30% of tax filers itemize, and only about 22% of them itemize for mortgage deductions.", "On the state and local tax front, if you live in California or New York, it's not going to feel very good. But then, there's a housing shortage. I commented on San Francisco with 0.8 months of supply. New York City has 2.2 months of supply. We don't actually think there's going to be an impact on housing as a result. Although, if you live in New York or California, you may feel it.", "On mortgage rates, you can't just look at mortgage rates alone. You have to look at where home prices are going to look at affordability. But, if you just kept home prices where they are today, it's our view that mortgage rates could go to 7% before there's any issue on the affordability end of it. The other way to look at it is just averages. The average mortgage rate over the past 30 years is 5.6%. So, that might be a good number for us all to land on." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from Alan Rifkin with BTIG. Please go ahead." ] }, { "name": "Alan Rifkin", "speech": [ "Thank you. Congratulations, Diane, and welcome back, Isabel. Shortly before the tax reform was passed, you laid out your three-year goals. Presumably, they're going to be incremental investments from the tax savings. That will result in increased returns. Why is there no change to the three-year 2020 guidance if the returns by that point should be realized?" ] }, { "name": "Craig A. Menear", "speech": [ "We're actually not looking to do incremental investment beyond what we shared. $11.1 billion over three years is what we believe that we need to do. There is an, if you will, do-ability factor to making that all happen. There is not the opportunity to add a whole bunch of new investment on top. We are pulling some investments forward to make it happen faster, but don't look for us to add a whole new layer of investment on top of the $11.1 billion." ] }, { "name": "Alan Rifkin", "speech": [ "Okay. Thank you. I believe you said that the flooring category, while comping positive, was below the corporate average. It seems like, for the first time in many quarters, that is the case. Can you provide some color as to what is going on in that category, in your opinion?" ] }, { "name": "Edward P. Decker", "speech": [ "We're very pleased with the performance. You have to remember, Alan, the average is 7.5%. It's very healthy across the flooring portfolio." ] }, { "name": "Alan Rifkin", "speech": [ "Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from Christopher Horvers with JP Morgan. Please go ahead." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks, and good morning. Following up on the SG&A to sales growth rate, you guided over the three years 75-90%. Is the pull forward mainly from 2019 into 2018 and how should we think about the cadence of that 75-90% as we look past this year? Is '19 thus lower as a result?" ] }, { "name": "Carol Tom", "speech": [ "We pull forward both from '19 and '20. We'll update you on 2019 and 2020 guidance when we get to those two years. But, nothing changes from the overall expense growth factor guidance that we gave you back in December." ] }, { "name": "Christopher Horvers", "speech": [ "Understood. As you think about how robust the backdrop here is in home improvement, have there been any changes in terms of the promotional environment? It seems like some prices are being passed through here. Is it becoming less promotional? Any change at all sequentially?" ] }, { "name": "Edward P. Decker", "speech": [ "I don't think there's been a significant change in the promotional activity. If anything, we were less promotional in Q4. But, the overall market was very similar to prior year." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks very much. Have a great spring." ] }, { "name": "Operator", "speech": [ "Our next question comes from Eric Bosshard with Cleveland Research Company. Please go ahead." ] }, { "name": "Eric", "speech": [ "Good morning. In terms of pro and online, what have you learned? Any big learnings from those two areas in '17? How do you think about the growth rate in '18 relative to '17 in those areas?" ] }, { "name": "Craig A. Menear", "speech": [ "Overall, we were very pleased with our pro business in '17. We continue to see growth there. As customers continue to take on bigger projects as a result of feeling good about their home values, we see that continuing as we move into 2018. Bill, do you have any other comments on that?" ] }, { "name": "William G", "speech": [ "I'd say the other learning is the more dimensional our relationship with our pro is, the stronger our share of wallet becomes. I think that was exemplified by the pros that are managed by our POSs, which was one of our fastest growing areas for our pro business. So, it's that pro engagement and that one-on-one recognition that seems to be resonating with the customer. We'll carry that into next year." ] }, { "name": "Craig A. Menear", "speech": [ "As it relates to online, very pleased with what the team was able to accomplish in our online business, setting in a whole new platform we operate on, enhancing our capabilities around search and mobile. Kevin's here. I'll let him speak how to we're thinking about '18." ] }, { "name": "Kevin", "speech": [ "From a learning perspective, it just reinforced what we've been chasing -- chasing the customer. Wherever they lead us, we invest in significantly to eliminate a lot of friction between the different channels as we pursue our One Home Depot strategy. Investing in expertise and knowledge in the online property, you'll see more of that in 2018, with similar growth aspirations. We have a consistent track record of over $1 billion of growth in each of the last few years in our online property. We'll look to do that again in '18." ] }, { "name": "Eric", "speech": [ "The inventory leverage was solid in 2017. The two points within that? What contributed to that and how should we think about the path of that moving forward?" ] }, { "name": "Craig A. Menear", "speech": [ "We were very pleased with our overall inventory position as we came through the fourth quarter and finished the fiscal year. Our primary focus, when it comes to inventory, is to maintain in stock. That is first and foremost, so that we have what the customer needs on the shelf when they come in. Mark, do you want to make any additional comments?" ] }, { "name": "Mark Holifield", "speech": [ "Customer service begins with in stock, so that's always the top initiative. But, we expect to continue to leverage inventory as our business continues to grow in the quarter. We'll be making some investments as we open new distribution facilities for online, but we continue to expect to leverage our inventory." ] }, { "name": "Carol Tom", "speech": [ "If you just want a model, model inventory turnaround at 5.35." ] }, { "name": "Eric", "speech": [ "Great. Thank you." ] }, { "name": "Diane Dayhoff", "speech": [ "Abby, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Okay. Our last question will come from Daniel Binder with Jefferies. Please go ahead." ] }, { "name": "Daniel Binder", "speech": [ "Thank you. On the pro, would you talk a little bit about that gap between DIY and pro? I know it's been consistently growing faster than DIY. Is that accelerating? Can you also talk a little bit about the online trends?" ] }, { "name": "Craig A. Menear", "speech": [ "The one thing we're seeing is that there is a little cloudiness in where the actual purchases are coming from. In some cases, you're seeing people that had DIY projects that are now electing their pros to go and do both the purchase and the work. But, we're very pleased with the DIY growth and seeing strength with our consumer business as well as the pros. There is a good balance there.", "As far as online, we're pleased with the progress and results. We saw strong sales growth in all three end markets -- institutional, multifamily, and trades. We continue to see traction in pro purchase in the MRO initiative. So, we're pleased with the progress." ] }, { "name": "Carol Tom", "speech": [ "And maybe one difference that we are seeing is the rate of growth for the high spend pro is the same as the rate of growth of the low spend pro. That's where we are in terms of recovery. They are busy, which is good news." ] }, { "name": "Daniel Binder", "speech": [ "One merchandising, one of the merging trends we've seen out there is the connected home. Just wondering when we'll see more from Home Depot on that. It seems like you're pretty well positioned to capitalize on it, but maybe a little bit further behind some other players in the electronics space in that area of the business." ] }, { "name": "Edward P. Decker", "speech": [ "Yes, we're roiling out some more dedicated end caps and one-, two-, and three-bay sets as the connected home products come into the store. We're super excited. There is new product coming from Ring, from Nest, and on light and fan controls by Lutron. So, across the board, all of our major suppliers are coming up with great innovative product and we're growing the space in the store to merchandise it appropriately." ] }, { "name": "Craig A. Menear", "speech": [ "The other thing that you'll see is, in general, in every bay in the store where there's an opportunity to have product that is enabled through technology, you'll see that happen over the next five years. It will continue to evolve. And, it won't be so much a section over the next five years. It will be in every bay in the store. That will happen because the manufacturers are finding ways to enhance their product for the customer." ] }, { "name": "Daniel Binder", "speech": [ "Great. Thanks." ] }, { "name": "Diane Dayhoff", "speech": [ "Thank you, everyone, for joining us today. We look forward to talking to you on our first quarter call in May.", "..." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, this does conclude today's call. We thank you for your participation. You may now disconnect." ] }, { "name": "Eric", "speech": [ "More HD analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
HD	2023-08-15	[ { "description": "Vice President, Investor Relations and Treasurer", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, President, and Chief Executive Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Billy Bastek", "position": "Executive" }, { "description": "-- Executive Vice President, U.S. Stores and International Operations", "name": "Ann-Marie Campbell", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Executive Vice President, Outside Sales and Service", "name": "Hector Padilla", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Jackie Sussman", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Mike Baker", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steve Forbes", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to The Home Depot second-quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded.", "It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Welcome to Home Depot's second-quarter 2023 earnings call. Joining us on our call today are Ted Decker, chair, president, and CEO; Billy Bastek, executive vice president of merchandising; Ann-Marie Campbell, executive vice president of U.S. stores and international operations; and Richard McPhail, executive vice president and chief financial officer.", "Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our Investor Relations Department at 770-384-2387.", "Before I turn the call over to Ted, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentation will also include certain non-GAAP measures.", "Reconciliation of these measures is provided on our website. Now, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thank you, Isabel, and good morning, everyone. Sales for the second quarter were $42.9 billion, down 2% from the same period last year. Comp sales for the total company, as well as our U.S. stores, also declined 2% from the same period last year.", "Dilutedearnings per sharewere $4.65 in the second quarter, compared to $5.05 in the second quarter last year. All three of our U.S. divisions posted low single-digit negative comps in the quarter. Our geographic variability narrowed significantly on a sequential basis as weather normalized, particularly in our Western division, and spring-related categories rebounded relative to the first quarter.", "While there was strength in project-related categories like building materials, hardware, and plumbing, we continue to see pressure in certain big-ticket discretionary categories. Pro sales performance was slightly negative in the second quarter and outperformed the DIY customer. While surveys suggest that Pro backlogs are lower than they were a year ago, they are still healthy and elevated relative to historical norms. Additionally, projects in these backlogs are generally smaller in scale and scope.", "In the second quarter, we were pleased with the consumers' engagement with the home improvement, particularly across small projects, which Billy will discuss in greater detail. Going forward, as we continue to navigate a unique and uncertain environment, our focus continues to be on operating with agility as we respond to evolving customer dynamics while also driving productivity and efficiency throughout the business. In addition and as we mentioned at our investor conference in June, we operate in a large and fragmented $950 billion-plus addressable market. We remain committed to growing the business and believe we are well positioned to continue capturing market share.", "To that end, I'm pleased to announce HD Supply's acquisition of Redi Carpet, a national MRO flooring provider with a proven track record. This acquisition, which closed at the beginning of the third quarter, extends our current product offering in the multifamily customer vertical with 34 locations strategically located throughout the U.S. Our team will continue to focus on what is most important, our associates and customers. Our merchants, store MET teams, supplier partners, and supply chain teams did an outstanding job delivering value and service to our customers throughout the quarter, and I'd like to thank them for their dedication and hard work.", "Before I close, I would like to send our thoughts and prayers to the people of Maui. While we are thankful that our people on the island are all accounted for, we are heartbroken by the loss of life and extreme devastation that the community must now navigate, and we stand ready to help in the days, months, and years ahead. And with that, I'd like to turn the call over to Billy." ] }, { "name": "Billy Bastek", "speech": [ "Thank you, Ted, and good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their ongoing commitment to serving our customers and communities. In the second quarter, as we saw weather improve across the country, most notably in our Western division, we saw an increase in spring sales and strength in smaller-ticket projects. In addition, we saw a continuation of the trend we observed starting in the fourth quarter of fiscal 2022 with softness in certain big-ticket, discretionary-type purchases.", "Turning to our department comp performance for the second quarter. Six of our 14 merchandising departments posted positive comps, including building materials, outdoor garden, hardware, plumbing, tools, and millwork. During the second quarter, our comp average ticket was slightly positive and comp transactions decreased 2%. Excluding core commodities, comp average ticket was primarily impacted by inflation across several product categories, as well as demand for new and innovative products.", "Deflation from core commodity categories negatively impacted our average ticket growth by approximately 160 basis points during the second quarter driven by deflation in lumber. During the second quarter, we saw a significant decline in lumber prices relative to a year ago. As an example, on average, framing lumber was approximately $420 per thousand board feet, compared to approximately $715 in the second quarter of 2022, representing a decrease of over 40%. Turning to total company online sales.", "Sales leveraging our digital platforms increased approximately 1% compared to the second quarter of last year. We're excited about our customer engagement across our interconnected platforms as we continue to remove friction from the experience. We know the vast majority of our customers engage with us in an interconnected manner. Whether it be through project inspiration and research, transacting, fulfillment, or support, our customers blend the physical and digital world.", "For those customers that chose to transact with us online during the second quarter, nearly half of our online orders were fulfilled through our stores. During the second quarter, Pro sales were slightly negative and outpaced the DIY customer. While surveys suggest that Pro backlogs are lower than they were a year ago, they are still healthy and elevated relative to historical norms. And in the second quarter, we saw strength across many Pro-heavy categories like gypsum, fasteners, and insulation.", "In addition, we continue to see strength across smaller projects with positive comp performance in a number of categories, including live goods, hardscapes, and landscapes. Big-ticket comp transactions or those over $1,000 were down 5.5% compared to the second quarter of last year. After three years of unprecedented demand in the home improvement market, we continue to see softer engagement in big-ticket discretionary categories, like patio and appliances, that likely reflects both pull-forward of these single item purchases and deferrals. Our merchandising organization remains focused on being our customers advocate for value.", "This means continuing to provide a broad assortment of best-in-class products that are in-stock and available for our customers when they need it. We will also continue to lean into products that simplify the project, saving our customers time and money. That's why I'm so excited about the innovation we continue to bring to the market. This quarter, we are excited to announce the addition of the Milwaukee brand to our assortment of electrical hand tools.", "Within this assortment, we will be introducing a brand-new line of innovative Milwaukee hand tools that provide a high degree of precision with lasting results for our Pro customers. We've already seen positive results with our Pro customers and feel confident that the addition of these Milwaukee tools will strengthen our position as the No. 1 destination for the electrical trade in the big-box retail channel. Additionally, in kitchen and bath, we continue to bring innovation to the market with Glacier Bay.", "Glacier Bay is one of The Home Depot's top proprietary brands known for performance and style. This fall, we are excited to grow our faucet lineup to include innovative functionalities, such as touchless and spring neck designs, add to our assortment of sinks and shower heads, while also expanding into new categories like disposals. We are also extremely excited about our lineup for Halloween. Our merchants have worked with our supplier partners to put together an expanded assortment of product offerings for this Halloween season, including the return of many fan favorites, as well as new collections for the Halloween enthusiasts.", "These products bring excitement to our stores and help drive traffic, and our sneak preview of our Halloween lineup was a tremendous success. We are thrilled for the full rollout in the coming weeks. With that, I'd like to turn the call over to Ann." ] }, { "name": "Ann-Marie Campbell", "speech": [ "Thanks, Billy, and good morning, everyone. Our store teams have a relentless focus on cultivating the best customer experience in home improvement. We know that our associates are a key differentiator, and they are essential in helping us sustain the customer experience we strive for. In order to provide the best customer experience in home improvement, we must focus on cultivating the best associate experience in retail.", "This means not only investing in competitive wages and benefits but also providing tools, training, and development opportunities that make working at The Home Depot an endurable and rewarding experience. I am happy to share that our approximately $1 billion of annualized compensation investment that we announced earlier this year is having the intended effects. This quarter, we continued to see meaningful improvement in our attrition rates, particularly among our most tenured associates. More consistent staffing levels are resulting in improved customer service, productivity, and safety.", "These improvements are exactly what we set out to achieve with this wage investment. In addition to investing in our associates, we must also leverage technology to further simplify both the associate and customer experience. As you heard at our investor and analyst conference in June, our customers journeys differ. Depending on the project they are working on, they shop with us in different ways.", "There is the unassisted cash-and-carry purchase, which represents a significant majority of our in-store sales. And the remaining sales are assisted purchases, where customers need help in purchasing a product, a service, or installation. It is critical that we have the right products in-stock in the right quantity and on the shelf available for purchase, particularly for unassisted sales. That's why you hear us talk about our focus on improving our on-shelf availability, or OSA, positions.", "We are working to narrow the gap between what is considered in-stock, meaning our systems indicate it is in-store, versus on the shelf and available for sale for the customer. We are doing this by starting to leverage new technology such as computer vision. Computer vision enables technology to do what we previously relied on associate eyes to do and provide specific locations of depalletized product that is stored in our overhead. To start, associates will take a picture of bays using their HD phones.", "These images then feeds into our systems and provide a single real-time view of inventory that can then seamlessly integrate into applications like Sidekick. Powered by machine learning, Sidekick directs associates to key bays where OSA is low or out exists. This helps our teams prioritize the highest-value task inside their respective stores. The beauty of the machine learning model is that the algorithm is continuously learning as computer vision images are captured and Sidekick tasks are completed, so it will get better and better at directing our associates to the right bay at the right time.", "While it's early days, as we have begun implementing this technology, we have seen meaningful improvements in OSA, increased associate engagement and productivity, and higher customer service scores. In terms of our assisted sales experience, we have worked to improve this experience by enhancing our systems and processes and have made significant strides. Historically, our associates had to navigate dozens of different systems. Over the last several years, we have invested to simplify the order management system in our stores with the introduction of Order Up.", "We have created a more robust, intuitive system that is easy for the first-day associate to use. This system enables any associate to more easily serve customers across a number of different applications, whether that's picking up an order, placing an order, changing an order, or scheduling a service or installation. Not only does Order Up make it easier to fulfill a customer's needs, but it also frees up more time for associates to spend serving customers that needs assistance while in our stores. These enhancements have made the average Order Up experience over 40% faster for the customer, which has led to improved customer service scores.", "These initiatives are just a few examples of the many different types of projects that can drive significant impact for customers, our associates, and shareholders. I am so excited about all that our store teams are doing to focus on both the customer and associate experience. None of this would be possible without our amazing associates, and I want to thank them for all they do to take care of our customers. With that, let me turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ann, and good morning, everyone. In the second quarter, total sales were $42.9 billion, a decrease of approximately $900 million or 2% from last year. During the second quarter, our total company comps were negative 2% with comps of negative 2.6% in May, negative 3.3% in June, and negative 0.2% in July. Comps in the U.S.", "were negative 2% for the quarter with comps of negative 2.6% in May, negative 3.3% in June, and negative 0.4% in July. As you heard from Billy, during the second quarter, we continued to experience lumber deflation compared to the prior year. While lumber prices were down, we saw an improvement in unit productivity, resulting in a net negative comp impact of approximately 85 basis points versus the second quarter of 2022. In the second quarter, our gross margin was 33%, a decrease of 8 basis points from the second quarter last year, primarily driven by pressure from shrink.", "During the second quarter, operating expense as a percent of sales increased approximately 100 basis points to 17.6% compared to the second quarter of 2022. Our operating expense performance during the second quarter reflects our previously executed compensation increases for hourly associates, as well as deleverage from our top-line results. Our operating margin for the second quarter was 15.4%, compared to 16.5% in the second quarter of 2022. Interest and other expense for the second quarter increased by $49 million to $428 million due primarily to interest on our floating rate debt, as well as higher debt balances than a year ago.", "In the second quarter, our effective tax rate was 24.4%, up from 24.3% in the second quarter of fiscal 2022. Our diluted earnings per share for the second quarter were $4.65, a decrease of 7.9% compared to the second quarter of 2022. During the second quarter, we opened two new stores bringing our total store count to 2,326. Retail selling square footage was approximately 241 million square feet.", "At the end of the quarter, merchandise inventories were $23.3 billion, down $2.8 billion compared to the second quarter of 2022. And inventory turns were 4.4 times, down from 4.5 times last year. Turning to capital allocation. After investing in our business and paying our dividend, it is our intent to return excess cash to shareholders in the form of share repurchases.", "During the second quarter, we invested approximately $800 million back into our business in the form of capital expenditures. And during the quarter, we paid approximately $2.1 billion in dividends to our shareholders, and we returned approximately $2 billion to shareholders in the form of share repurchases. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 41.5%, down from 45.6% in the second quarter of fiscal 2022. Now, I'll comment on our guidance for fiscal 2023.", "Today, we are reaffirming our guidance for 2023. We expect fiscal 2023 sales and comp sales to decline between 2% and 5%. We are targeting an operating margin between 14.3% and 14% for the year. Our effective tax rate is targeted at approximately 24.5%.", "We expect interest expense of approximately $1.8 billion, and we are anticipating between a 7% and 13% decline in diluted earnings per share compared to fiscal 2022. In addition, we continue to focus on driving productivity in the business and feel confident that we will realize the previously announced $500 million in annualized cost savings in 2024. We also remain focused on meeting the needs of our customers with our leading product authority in home improvement, strong in-stock levels, and knowledgeable associates. We will continue to prudently invest to strengthen our competitive position and leverage our scale and low-cost position to outperform our market and deliver shareholder value.Thank you for your participation in today's call.", "And Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conducting a question-and-answer session. [Operator instructions] One moment please while we poll for questions. Thank you.", "Our first question comes from the line of Christopher Horvers with JPMorgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, everybody. So, I think the big question is for the industry, have we seen the bottom? You did a down 4.5% in the first quarter. You needed the down 2% in the second quarter.", "July was flat. So, how are you thinking about the trends going forward? Was there anything in the second quarter that we shouldn't extrapolate on a go-forward basis, whether that was weather shift? Or was there something about July that benefited that month in particular?" ] }, { "name": "Ted Decker", "speech": [ "Good morning, Chris. It's Ted. The quick answer is, yes, July really was a weather shift. We had a particularly wet in cold June.", "And with that weather shift, the months of the second quarter were all sequentially about that same minus 2%. But to answer your question from a more macro perspective on where we see the industry and the demand, just start by saying, as you all know, we looked at 2023 as a year of moderation after the explosive growth we had the prior few years. And as we called out, consumers would be shifting their spending from goods to services. And while that shift is happening, the overall economy and the consumer, in particular, have remained incredibly resilient.", "As we all know, the economy continues to grow with a number -- another great GDP print for the second quarter. And fears of a recession or at least a severe recession have largely subsided, and the consumer is generally healthy. There's PCE spending, continues to grow, albeit at a slower rate. And if you look at the home improvement customer, our core customer, the homeowner, they've seen continued growth in home equity over the last several years, strong job growth, and increases in wages.", "So, the core customer remains strong. And if you look at Home Depot, you look at our operations, what we can specifically control, we feel great about where we are halfway through this year. As you saw, the meaningful reduction in inventory, we think our inventory positions are better placed than they've been in the past few years. Our in-stock rates have continued to improve.", "Our value proposition remains strong. And as Ann called out, the wage investments are really paying off. But given all those positives and -- that we were pleased in the second quarter, uncertainties remain, Chris. We don't know how quickly or further the share shift in PCE will occur and where spending in home improvement in particular will ultimately settle.", "And we don't know how the monetary policy actions which are specifically intended to dampen consumer demand, what that impact will ultimately have on consumer sentiment in the overall economy. And as I said, while we did see the sequential improvement in our comp sales, a lot of that was a seasonal recovery in the second quarter. And as I said, specifically in July, as well as the impact of lumber, is beginning to abate. And as Billy called out, we do continue to see pressure in certain big-ticket, discretionary categories.", "So, while there's a lot of positives in the macro and with the consumer, we still see enough uncertainty really largely driven by this PCE shift and where that ultimately lands, that we -- well, again, we feel good. We just thought there was too much uncertainty to take, for example, revise our guidance from earlier in the year. But having said all of that, long answer, when we do get through this period of moderation, we remain incredibly bullish on the sector. We couldn't feel better about the macro for housing and home improvement and our prospects and ability to keep taking share in this huge and still largely fragmented market." ] }, { "name": "Chris Horvers", "speech": [ "Thank you for that. My follow-up question is on the ticket side. I mean, you are -- if you run stacks or CAGRs on your average ticket, it did deteriorate in the second quarter relative to the first. So, can you talk about the drivers of that? And how much of that is this shift to smaller-ticket projects accelerating because you are going to start to lap through that ticket pressure in the fourth quarter.", "So, is what you're seeing now indicative of that shift from large to small is accelerating, so we can't just assume that we sort of annualize that out in the fourth quarter?" ] }, { "name": "Richard McPhail", "speech": [ "Well, Chris, this is Richard. First, just with respect to stacks and progression, what we're encouraged by is we're seeing -- as cost pressures in our industry sort of abate, we're seeing ticket and transactions actually begin to converge. And we think that that's actually a healthy signal in the business. So, I think that's the most macro comment that we could make about ticket progression.", "With respect to large versus small projects, certainly, our customers and our contractors tell us that there is some stance of deferral when it comes to large projects. Customers are opting for -- they are more likely to opt for smaller versus larger, and that may have some impact on ticket. But we're also seeing the impacts of what we call softness in certain large-ticket discretionary item purchases like patio and appliances. So, there's a lot going on there, but I think that the -- maybe the most important dynamic is just kind of that nice recovery in transactions as both ticket and transactions begin to converge and normalize." ] }, { "name": "Chris Horvers", "speech": [ "Understood. Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thank you so much for taking my question. Given this trend of small transactions coming in and maybe even replacing large transactions, is it more likely that you can take the low end of your guidance off the table of a down 5% comp for the year outside of some macroeconomic shock at this point?" ] }, { "name": "Ted Decker", "speech": [ "Well, Michael, I don't want to go through the answer I just went through with Chris but --" ] }, { "name": "Michael Lasser", "speech": [ "I hear you." ] }, { "name": "Ted Decker", "speech": [ "That's pretty -- that's pretty much laid out the view. I mean, again, we feel really good about the second quarter. Clearly, we like the sequential improvement. And as Richard said, the normalization in settling, if you will, of a much healthier balance of ticket and transactions.", "But there's still just a lot of uncertainty. Is the Fed going to raise? Are we going to get a budget deal passed? I mean, there's so many things out there swirling that -- we just updated or reaffirmed in June that we're just more comfortable standing pat right now." ] }, { "name": "Richard McPhail", "speech": [ "And the other thing just to at least know that we're watching is our share of PCE. We've watched this since our sales spiked in 2020 as, not a perfect measurement, but certainly a way to think contextually about what we saw during the three years of unprecedented growth. As predicted, we've seen our share of PCE. As Ted mentioned, as we've seen share shift from goods into services, we have also seen our share of PCE steadily revert back toward 2019 levels.", "When you think about the bottom end of our sales guidance, that actually corresponds with the math that would say if our share of PCE reverted all the way back to 2019 levels, that would imply the low end of the guidance. We don't see anything in our business today that tells us that that's the trajectory, but that is the math of our PCE share shift. And I'd also just repeat, Ted, we're not sure where that share ultimately settles. The home is so much more important from a financial perspective for -- you'd say all homeowners than it was three years ago that perhaps there's an elevated level of home improvement spend in PCE versus prior years.", "We just don't know. But that low end of the range does correspond to the PCE share shift math." ] }, { "name": "Michael Lasser", "speech": [ "Understood. My follow-up question is Home Depot's operating expenses this year are being impacted by the $1 billion wage investment. But SG&A growth over the last few years has been anything but normal. So, the key debate here is, has the company entered a period where the cost of doing business has just gone up such that even if the cycle recovers in 2024, the company won't see a significant improvement in its profitability because so much will need to be reinvested back in operating expenses based on what's happening right now?" ] }, { "name": "Ted Decker", "speech": [ "Well, I wouldn't paint that picture, Michael. Clearly, too early to talk about 2024. But we made a significant investment in wage, as Ann said, and we're in a much more comfortable position on a national minimum level and where we are in competitive markets. So, again, as Ann mentioned, we couldn't feel better about the returns on that investment.", "We don't expect that we're going to need to make that outsize of an investment in the near-term planning horizon. Wage rates are still up, but we're seeing those come down. Annual increases that we track month to month, as I'm sure you do, are moderating. So, we don't see another big wage investment.", "And then this business, as it always does, will leverage with volume in those dynamics of this P&L leveraging with modest comps. That investment thesis remains intact." ] }, { "name": "Michael Lasser", "speech": [ "Gotcha. Thank you so much." ] }, { "name": "Richard McPhail", "speech": [ "It might just do to remind, as we laid out in the investor conference, in a market-normalized case with 3% to 4% top-line growth, in a normalized case, we expect margin expansion based on operating expense leverage that would lead to mid to high single-digit EPS growth. So, nothing's really structurally changed that much, but it is worth just pointing back to our comments in June." ] }, { "name": "Michael Lasser", "speech": [ "Understood. Thank you so much. And good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. Can you help us unpack the cadence of DIY versus Pro from Q1 to Q2 as last quarter saw DIY outperform Pro for, I think, the first time in two years? And with that reversing out in Q2, curious how you think about the moving parts between the two, and if we should expect the spread to widen or contract going forward." ] }, { "name": "Ted Decker", "speech": [ "Zach, I wouldn't read too much into that. There was so much noise in Q1 that I'd just say that was an outlier. And the theme of the Pro responding to the investments we're making in outperforming the consumer that we just saw in Q2 is consistent with what we've seen. But for an outlier, very noisy Q1." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And, Richard, you had talked about the $500 million in cost savings next year coming out of the base. But I believe there's also about 10 bps to 20 bps of productivity benefit this year. And I'm hoping you could speak to, first of all, the differences between the two and the buckets of savings and then whether that 10 bps to 20 bps for this year is in the base today or if it builds through the year." ] }, { "name": "Richard McPhail", "speech": [ "Sure. Zack, thanks. Yes, that 10 to 20 is something we called out at the very beginning of the year when we -- or -- and actually Q -- when we talked about the progression of margin. And so -- or rather the range of operating margin outcomes.", "That -- you can think of that as really productivity that we anticipate in ordinary course. It certainly offset expenses such as the wage investment, but it was part of our original guidance and consistent with revised guidance in Q1 and consistent with guidance today. The 500 million cost-out that we anticipate for 2024 is separate. And it really reflects our -- the rationalization in most part of a cost structure that we had to build up as we saw product volume skyrocket in 2020 and 2021.", "So, we built a cost structure that isn't necessary today in today's volumes. And so, we will rationalize some of that cost structure. A good example would be a warehouse that we took a lease on to hold product during 2020 and 2021. We are looking at our real estate footprint, and some of that may well be rationalized.", "Those are the -- and with that comes cost savings. That's the nature of the 500 million. Think about it as a permanent reduction in our fixed cost base." ] }, { "name": "Zach Fadem", "speech": [ "And all these are SG&A, right? Just to confirm." ] }, { "name": "Richard McPhail", "speech": [ "There's probably some -- there could be some geography in COGS and in operating expense, but we haven't settled in that yet. To your question, let me just make sure that we're clear. That initial 10 basis points to 20 basis points of productivity is included in our operating margin guidance for 2023. No part of the 500 million is included in 2023.", "That is assumed full-year benefit annualized in 2024." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Appreciate the time. Thanks, Richard." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. You talked about relative strength in the smaller project spending, but in an environment with negative Pro sales and smaller Pro backlogs, how are you guys benchmarking your efforts to gain traction in the large and complex Pro business you've spent a lot of time talking about?" ] }, { "name": "Hector Padilla", "speech": [ "Hey, Scot. This is Hector. Good morning. As we mentioned in the investors' conference, what we are building as far as the ecosystem for the Pro, it is hard and it will take some time.", "Now, the good news is that it will also be very hard to replicate, as you know. And today, we're very encouraged by the signals that we are getting from our Pro customers as they engage with different pieces of the ecosystem. We are in many markets today with the expanded ecosystem. There are pieces of the ecosystem that we don't have fully deployed.", "Think of our order management system or a trade credit. But we continue to gauge our performance with our Pros. Those Pros continue to engage, not only in the supply chain assets that we have built and with our outside sales resources as we expanded that team, but they are visiting our stores in a more frequent basis. So, we continue to be very encouraged by what that cohort is always performing, and we'll continue to invest in the efforts." ] }, { "name": "Scot Ciccarelli", "speech": [ "OK. Got it. Thank you, Hector. And then just a second question.", "Inventory was down quite a bit even with the negative comp. Would you guys expect that to mark the bottom of your destocking process? Or should we expect inventory levels to continue to drop? Thanks." ] }, { "name": "Billy Bastek", "speech": [ "Well, we're pleased with the progress we've made relative to our inventory position. And you think about everything that's happened in the supply chain and lead times associated with that has helped. Listen, we still have work to do to improve productivity. But we feel good about our inventory, and we have low obsolescence risk and super experienced merchant teams.", "So, a lot of the dynamics in the supply chain helped us really. And at the same time, I might add, our in-stocks are better than they've been since before the pandemic. So, we're really pleased about the inventory productivity, but at the same time, our in-stocks, our ability to be in-stock below a feed as Ann called out or OSA. And so, really pleased with both of those pieces." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thanks, Bill." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Jackie Sussman", "speech": [ "Hey, there. This is Jackie Sussman on for Simeon. Thanks so much for taking our question. You were speaking earlier on small projects replacing large projects.", "Can you drill into the backlog a bit more? How much have they come off off-peak? How far above normal levels are they? And is there any evidence you're seeing that consumers are fully pushing off or canceling projects rather than just trading down? Thanks." ] }, { "name": "Richard McPhail", "speech": [ "Well, I'll start on that one. And if we rely on publicly published surveys. The one that we watch is the National Association of Homebuilders Index. We have seen backlogs declined sequentially.", "But yeah, they are well above the historical average. And so you would really say the professional customer has been oversubscribed for so many years that they still have a full book of business, just not maybe oversubscribed. They may be taking phone calls again, but they are very healthy. Again, if you think about the historical average -- and you can look this up.", "But historical average being a score for 50, the index is still at 61, so down from peak but higher than average." ] }, { "name": "Ted Decker", "speech": [ "In addition to the publicly available indexes, obviously, we have millions of Pros and the field sales force that Hector mentioned. So, anecdotally, we are getting loads of feedback from our customer base. They are still busy and engaged with those backlogs, but it's their commentary to our sales force that they are smaller. So, that's where we get the color on that dynamic." ] }, { "name": "Jackie Sussman", "speech": [ "Got it. That's helpful color. And just one quick follow-up. Shrink was the only real call-out on the gross margin line, can you talk about how that trended in the quarter? Did it get worse or any better? And are there any actions that you are taking to kind of mitigate that impact going forward?" ] }, { "name": "Richard McPhail", "speech": [ "From a financial perspective, shrink has been a consistent pressure over the last several quarters and even the last few years, and it's something we are tackling every day. And, Ann, maybe talk a little bit --" ] }, { "name": "Ann-Marie Campbell", "speech": [ "No, we are certainly in the battle in retail as we kind of think about shrink. But we have always continued to lean into initiatives that we have seen that can have impact to mitigate overall. And I know it's early as we think about the Inform Act, but the Inform Act is one of the key components as we think about organized retail crime that I think will help give us a little bit more visibility in some of the things that are happening out there. But certainly, it's been largely in line with what we have seen in the last several quarters.", "We certainly have key initiatives to help mitigate that. And we need our kind of government partners to help on their end as well to help us in retail to really mitigate what we have seen out there." ] }, { "name": "Jackie Sussman", "speech": [ "Got it. Thanks so much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Zaccone with Citi. Please proceed with your question." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Good morning. Thanks very much for taking my question. I was hoping you could comment a bit more about the homeowner engagement that you talked about.", "It sounds like it was a bit of a sequential improvement. Was that largely weather-driven, or are you actually seeing some elasticity of demand as inflation eases in some categories?" ] }, { "name": "Billy Bastek", "speech": [ "Yes. Thanks, Steven. No, I think we articulated earlier about the weather patterns. We actually talked in Q1 about the impact that the West had.", "The West was our best-performing region, best-performing division for Q2. So, we saw a lot of that engagement back into those spring categories. We pushed a little bit around from June to July with some of the weather and the heat, as you saw more in ACs and fans. So, a much more normalized balance to the quarter outside of just some shifting of some of those smaller seasonal pieces." ] }, { "name": "Steven Zaccone", "speech": [ "OK. Great. And then just a clarification on second-half expectations, is there any difference in how you are thinking about the business in the third quarter versus the fourth quarter comps? And then maybe a more near-term question, if July benefited a bit from weather, how has August to-date trended? Is it fair to say you are kind of back within that full-year guidance range?" ] }, { "name": "Richard McPhail", "speech": [ "Right. So, the first two weeks of the third quarter have been a little better than our first-half comp. But we have 24 weeks left in the year. So, we think the guidance range is appropriate." ] }, { "name": "Steven Zaccone", "speech": [ "OK. And then just third quarter versus fourth quarter, should we just kind of look at the one-year comparisons?" ] }, { "name": "Richard McPhail", "speech": [ "We are not going to provide quarterly guidance. And again, we have got 24 weeks left in the year. So, we think the range is appropriate." ] }, { "name": "Steven Zaccone", "speech": [ "OK. Thanks. Best of luck in the back half." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your questions." ] }, { "name": "Chuck Grom", "speech": [ "Thanks very much. Great quarter. You committed to investing 1 billion in wages this year. But as comps and transactions have remained negative and the flexibility that you have with the transaction-based labor model, is there the potential for that full amount not to be realized or will you reinvest it in other parts of the business?" ] }, { "name": "Richard McPhail", "speech": [ "Well, from a financial perspective, of course, there is an assumption around how many hours would be utilized during the year. There is something that has to be multiplied against the wage. But I wouldn't say this is a material. You are not going to see a material change in our financial profile.", "And again, our guidance is the best guideline for you to look out with respect to our annual -- likely annual performance." ] }, { "name": "Chuck Grom", "speech": [ "OK. Great. Thank you. And then for Ann, just can you elaborate a little bit more on the computer vision technology? How quickly is that going to be rolled out across the chain? And maybe elaborate on some of the benefits you think you could see in the near-term." ] }, { "name": "Ann-Marie Campbell", "speech": [ "Sure. So, first of all, we started with Sidekick application, which direct associates to pass down product from the overhead. And so Sidekick is a task to computer vision to help that associate see where the product in the overhead, so which is a complementary component to drive overall productivity. So, we are certainly bullish.", "We have that in our -- a region that's fully rolled out already. We have that in what we consider pilot stores across every single region. And we expect that to be rolled out later this year. We are seeing some really, really good output finding product that takes a ton of time in our stores.", "So, I have been around for a long time, my neck looking up in the overhead trying to find product for customers, and we have thousands of associates that's doing that every day. So, complementing, directing the task, and then finding exactly where the product is in the overhead drives a ton of productivity for us, and we expect to roll that out later this year." ] }, { "name": "Chuck Grom", "speech": [ "OK. Thanks, Ann." ] }, { "name": "Ann-Marie Campbell", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hi. Good morning. Thanks for taking my question. So, at the risk of being maybe a bit repetitive, I just -- with regard to inflation, I guess maybe now disinflation, so we are starting to see -- and I know you mentioned in your prepared comments the lumber price dynamic there where you have seen improved unit demand.", "But the question I have is as we are seeing or we are moving past maybe peak-ish inflation and getting more disinflation. How are you seeing the overall business flex here, both from a -- I guess from what you are doing as well as how your consumers are reacting generally?" ] }, { "name": "Ted Decker", "speech": [ "I mean, broadly on the inflation piece, well, we still expect that the overall year will have a net inflationary impact on our costs in retails. But as we go into the second half, it is moderating. And when you look at just the activity of cost increase requests, I mean they are negligible. I mean, there are a couple.", "And we were in the billions of dollars at one point of cost in. And so, net new requests for cost and certainly cost increases in the supply chain, that's all completely abated. As we go into the second half, when you think of product cost, transportation, overall transportation costs, and then what would ultimately do in retails, inflation has certainly abated. Commodity is certainly down meaningfully from the peak, as well as year over year, as well as even shorter term.", "But beyond commodity and the fact that we don't have increased inflation, we are not expecting a deflationary environment. I think Richard used the term settling. We are kind of settling into these noncommodity price levels. And as the Pro and consumer customer has gotten used to those over the last few years, you are seeing the normalization in transactions as Richard called out.", "So, we are encouraged that the cycle of inflation is essentially behind us. And, Richard, I don't know if you -- or, Billy, if you have anything else to add to that." ] }, { "name": "Billy Bastek", "speech": [ "No. I would say we are encouraged by the improvement in transactions and as we see the normalized pieces that Richard spoke about earlier, but we don't see a deflationary environment as we go forward." ] }, { "name": "Brian Nagel", "speech": [ "That's very helpful. And then the second question I have, and I know it's going to be a bit nuanced, but just to understand how your consumers really reacted here. So, as you look at the West Coast, you called out, I think is a point of strength in the quarter as weather maybe normalized a bit. But the question I have is as you are watching that consumer reengage with Home Depot amid more normal weather conditions, is there anything there surprising, or is the consumer coming back like you would normally expect with the weather shift like we have seen?" ] }, { "name": "Billy Bastek", "speech": [ "Yes. I would say, Brian, that we commented out in Q1 because of the impact that we saw, and it played out precisely kind of how we thought in the West. As I mentioned, that was our best-performing division. Customers engaged heavily in our seasonal businesses that were so pressured into Q1.", "And so it really did play out precisely how we had thought." ] }, { "name": "Brian Nagel", "speech": [ "OK. I appreciate it. Thank you." ] }, { "name": "Billy Bastek", "speech": [ "Thanks." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Mike Baker", "speech": [ "OK. Thanks. Two, please, if I could. One, bigger-picture.", "I think last quarter, maybe it was in the June Analyst Day, you said that you thought the housing market would be down mid to high-single digits in 2023. That was sort of the industry baseline. There has been some indicators of housing being a little bit better. Is that still the way you are thinking about the industry right now, down in that mid to high-single digit range?" ] }, { "name": "Richard McPhail", "speech": [ "Well, we have said there are some economists who might call for that. We were uncertain, and that's really because when you look at supply and demand imbalances in the market, we have worked our way into a structural deficit of housing in North America. And what's interesting to us is you have actually seen sequential improvement month over month in home prices for the last four months. So, I think if you just look at observed data, home prices have, for the most part, remained steady versus last year, and so better than many economists' predictions at the beginning of the year." ] }, { "name": "Mike Baker", "speech": [ "OK. So, -- but has your view changed at all or too much uncertainty?" ] }, { "name": "Richard McPhail", "speech": [ "We didn't ascribe any housing benefit to our guidance for 2023. And we think long term, those supports for home improvement demand are there. And we do think that supply demand imbalance is an important part of that, along with the aging of the housing stock. So, again, we are bullish on the future of this market." ] }, { "name": "Ted Decker", "speech": [ "Yes. I think the big story with housing now as it's playing out is values have held up. And Case-Shiller just came out with some data and Redfern just -- Redfern just came out with some data that that drop-off in values has been erased and that we are now back to record highs of home values in the United States and sequential improvement as Richard just said. The near-term story in housing is that with so many people locked in to the incredibly low mortgage rates that there just isn't a lot of inventory available for sale.", "So, transactions are at certainly near-term lows in terms of nominal number of houses that are turning over in a percentage of the housing stock. So, many people are below 5%, even at 3% mortgage rates. So, values are holding if not now back increasing fundamental imbalance again of 2 million to 3 million to 4 million homes. And the issue is inventory.", "And people are getting used to it. We understand new buyers have sort of digested the increase in mortgage rates to the 7%-ish, but there is just not that much available to purchase." ] }, { "name": "Mike Baker", "speech": [ "Yeah. OK. It makes sense. Sorry, that was one question.", "The follow-up is this, if I could. You had said -- I hate to be so short-term-focused, but August was better than the first half comps. But any comment on August versus the second quarter comps?" ] }, { "name": "Richard McPhail", "speech": [ "Again, the first two weeks of the quarter were a little better than our first half comp. We have 24 weeks left. And so, we just -- we would point you back to our guidance." ] }, { "name": "Mike Baker", "speech": [ "OK. Fair enough. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Credit Suisse. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. So, two questions. The first is when you think about the dynamics on DIY versus the Pro in terms of the impact to your second half comp and then into '24, how are you thinking about DIY in terms of recovery? I think it's pretty clear where you stand on the backlog with the Pro.", "But I think DIY is a big question in terms of how that customer will feel and is going to feel in the second half." ] }, { "name": "Richard McPhail", "speech": [ "We don't -- I think at the end of the day, it's all the same demand. And whether the Pro is fulfilling that demand or not, it's sort of all the same. So, I wouldn't -- I actually would view it as saying we feel good about where our Pro business is. We feel good about the entirety of it, really.", "We don't know where those trends will go. But again, we know our Pros say their backlogs are healthy." ] }, { "name": "Karen Short", "speech": [ "And then the second question is --" ] }, { "name": "Ted Decker", "speech": [ "No, I was just going to say that the consumer -- the nearest term view of consumer is the engagement in seasonal is led by the consumer, certainly, the garden business, but also things like exterior painting and stain. And when the weather improved, consumer responded. And it was really steady, constructive demand. So, what we expect going forward, I think you look at all those macro comments we mentioned earlier that our consumer is a homeowner, 80%-odd of them on their homes, up tremendous equity value in that home, great jobs, great income.", "And it's a very healthy consumer segment in the overall economy. So, seeing their engagement in Q2 as weather improved, seeing their engagement in something like Halloween -- I mean, it's not an enormous business for us. But to say unbelievable engagement, Billy, in that product category, which is 100% discretionary, is a pretty decent telltale of engagement in the sector." ] }, { "name": "Karen Short", "speech": [ "OK. That's really helpful. Thank you. And then my second question is, Richard, you always discussed your ability to flex SG&A with respect to labor but then also inventory rapidly based on the comp in order to maintain stability with operating margins.", "So, I guess my question is, with the recent wage investments, do you still have the same flexibility within the same timeline in general to -- with that rule of thumb in mind?" ] }, { "name": "Richard McPhail", "speech": [ "Absolutely. I mean, you would say that the jumping-off point would be post-wage investment. But post-wage investment, we have the same degree of flexibility we all -- we have always had." ] }, { "name": "Karen Short", "speech": [ "OK. Thanks very much." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steve Forbes", "speech": [ "Good morning everyone. So, just two quick follow-ups. The first on ticket, curious if you could expand on DIY ticket versus Pro ticket trends as we think about sort of second-half complexion. And then maybe if you could just speak to what the full-year comp implies in terms of ticket, if it's still positive as you see it today." ] }, { "name": "Richard McPhail", "speech": [ "We have -- I will answer the second part first, and then I will turn it to Billy. Again, we have got 24 weeks to go. We are not going to break out ticket and transaction within our guidance, other than just to repeat, we are encouraged by what we have seen with respect to settling of ticket and recovery in transactions. Billy?" ] }, { "name": "Billy Bastek", "speech": [ "Yes. And as we called out just on the lumber piece alone, we will see that abate as we get to the back half of the year, and there will be much less of an impact than we saw in the first half overall." ] }, { "name": "Steve Forbes", "speech": [ "And then just lastly, as we think about the Dallas market, the 350 basis points you guys noted as of 2022 at the Analyst Day presentation, any update on how that market is trending year-to-date 2023 versus the company average?" ] }, { "name": "Hector Padilla", "speech": [ "Yeah. No, Steve. This is Hector, again. We continue to be very encouraged by the results in Dallas, and we have scaled a lot of the capabilities that we first implemented in Dallas to all the markets.", "And we are seeing very similar and encouraging results as we see the customers engage, not just with the delivery sales, but also again, back in our stores and through our online digital platform. So, continue to be very encouraged about the performance. For us, Dallas has been a success so far. And we will continue to deploy capabilities to round out the ecosystem in Dallas and again in other markets as we test and learn and deploy capabilities at scale." ] }, { "name": "Steve Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "There are no further questions at this time. I would like to turn the floor back over to Ms. Janci for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and thank you for joining us today, everyone. We look forward to speaking with you on our third-quarter earnings call in November." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2020-11-17	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman and Chief Executive Officer", "name": "Craig Menear", "position": "Executive" }, { "description": "President and Chief Operating Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President and Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "J.P. Morgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Goldman Sachs -- Analyst", "name": "Kate McShane", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Gordon Haskett Research Advisors -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "Executive Vice President", "name": "Mark Holifield", "position": "Executive" }, { "description": "D.A. Davidson -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Guggenheim Securities -- Analyst", "name": "Steven Forbes", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings, and welcome to The Home Depot third-quarter 2020 earnings call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Joining us on our call today are Craig Menear, chairman and CEO; Ted Decker, president and chief operating officer; and Richard McPhail, executive vice president and chief financial officer. Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors.", "And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our Investor Relations department at (770) 384-2387. Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.", "These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and thanks for joining our call this morning. We hope that you and your loved ones are safe and healthy. As we announced yesterday, we entered into a definitive agreement to acquire HD Supply, a leading national distributor of maintenance, repair, and operations products in the multifamily and hospitality end markets. Before moving to the results of the quarter, I want to take a moment to discuss how HD Supply fits into our strategic framework.", "As you know, the MRO customer is an important pro customer for the Home Depot. We are committed to better serving the MRO customer and growing in this space. The success we've had with our existing MRO business makes us confident in our ability to accelerate sales growth in a highly fragmented $55 billion MRO marketplace. While the transaction is subject to customary regulatory approvals, I look forward to welcoming the HD Supply associates to The Home Depot.", "Richard will take you through the financial details shortly. Now, let's discuss our third-quarter results. Sales for the third quarter grew $6.3 billion to $33.5 billion, up 23.2% from last year. Comp sales were up 24.1% from last year, with U.S.", "comps a positive 24.6%. Diluted earnings per share were $3.18 in the third quarter. The third quarter was another exceptional quarter for The Home Depot as we saw the continuation of outsized demand for home improvement projects. Our results were driven by broad-based strength across the store and geographies.", "All of our top 40 markets posted double-digit comps, while Canada posted comps above the company average, and Mexico posted its best performance since the onset of the pandemic with double-digit comps in local currency. As Ted will detail, both tickets and transactions were up double-digit in the quarter, and we saw strong double-digit growth from both the pro and DIY customers. As we mentioned last quarter, the step change in volume of business that we have witnessed over the last six months is not without its challenges, but our strategic investments, coupled with our near-term actions taken, have allowed us to better serve our customers. Our third-quarter performance is a reflection of this.", "And as we continue to learn and adapt to meet the unprecedented level of demand we are seeing in the market, actions we have taken across our supply chain, in our stores, and in partnership with our suppliers have helped us to improve in-stock levels, reduce lead times, better manage in-store replenishment and improve fulfillment options and delivery times. All of this has ultimately translated to over 300 basis points of sequential improvement in customer satisfaction scores for the third quarter. Our interconnected retail strategy and underlying technology infrastructure have continued to support record-level web traffic on a consistent basis for over six months. Sales leveraging our digital platforms increased approximately 80% versus the third quarter last year, and approximately 60% of online orders were fulfilled through a store.", "We continue to invest in our digital assets, introducing new capabilities and different ways to engage with The Home Depot. Over the past several months, we have refreshed the digital experience in key categories and are extremely pleased with the customer response. In decorative lighting, for example, we enhanced the category experience to offer improved visual imaging and more lifestyle photos of our on-trend lighting assortment. As a result of these changes and increased marketing effort to better highlight our offering, we have seen significantly higher customer engagement with the category online, which helped to drive sales growth above the company average in the quarter.", "We also found new ways to leverage our online platform to better showcase our assortment for events. For our Halloween event, we increased our digital offering and enhanced our presentation, which resonated with our customers, resulting in the strongest customer response we've had to these events. We are focused on continuing the momentum of our strategic investments to enhance the interconnected shopping experience and position ourselves for continued share capture over the long term. Key components of our One Home Depot strategy, such as opening various supply chain facilities, technology investments, and enhancements to the digital experience, remain on track.", "And we have now restarted many of the store investments that were paused at the onset of the pandemic. Our results through the first nine months of the year clearly indicate that for many customers, the home has never been more important. And we hear from them that they will continue to invest in home improvement through a multitude of different projects and plan to embrace the upcoming holiday season. As customers engage with The Home Depot, we see a continued blend of both the physical and digital worlds.", "As a result, the distinct competitive advantages and overarching benefits of an interconnected One Home Depot strategy have never been more relevant. I'm incredibly proud of our associates for the many ways that they have lived our values by serving our customers, communities and each other during these unquestionably challenging times. Our ability to grow the business by more than $15 billion through the first nine months of the year while navigating the global pandemic and supporting our communities through multiple natural disasters is a direct result of our associates' extraordinary efforts. Given the ongoing demands and complexity of the current environment, we continue to focus on taking care of our people, in part by extending weekly bonuses for hourly associates in our stores and distribution centers for the duration of the third quarter.", "Through the end of the third quarter, we have spent approximately $1.7 billion on temporary pay and benefits in response to COVID-19. As Richard will discuss, we have now made the decision to transition from our temporary weekly bonus program to invest in permanent compensation enhancements for our frontline hourly associates. This will result in approximately $1 billion of incremental compensation expense on an annualized basis. Our orange-aproned associates are the heartbeat of The Home Depot and supporting them through this time of uncertainty and beyond continues to be a key priority.", "We know that we must remain agile and flexible to execute against the demands of the current environment. And our third-quarter performance highlights key progress that we have made as we continue to learn and adapt. I could not be more proud of the resilience and strength that our associates have continued to demonstrate, and I want to thank them and our supplier partners for their hard work and dedication to serving our customers and communities. And finally, I want to take a quick moment to congratulate Ted, Ann-Marie, and Jeff, who are on the call with me today, on their recent promotions and expanded responsibilities.", "Their new roles are among a number of leadership development moves that we have made as we continue to invest and grow the deep bench of talent that we are fortunate to have here at The Home Depot. And with that, I'd like to turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. I want to thank all of our associates and supplier partners for their incredible effort to serve our customers in this unprecedented environment. The consistently strong demand we've seen over the last six months has been remarkable. For the last two quarters, we have seen comps north of 20% for 25 of the 26 weeks.", "The strong demand has pressured supply chains, and we partnered with our supplier partners to make various improvements. As we mentioned last quarter, the actions we took include adjusting our assortments and planograms, introducing alternative products, and, in some cases, reducing the number of SKUs in certain categories to focus on the highest demand products. In addition, we are further recognizing our rapid deployment center network that now implemented mechanized floor loading in two-thirds of our facilities, meaningfully improving our productivity in those buildings. As a result of all these actions, we have seen reduced product lead times and continued improvement in our in-stock positions.", "The in-stock level in our U.S. stores has improved for 12 straight weeks. While we are pleased with these results, we are not at pre-pandemic levels. We have also revisited customer fulfillment choices, some of which we paused earlier in the year.", "As a result, we are starting to reestablish premium delivery windows and expressed car and van delivery service that covers over 70% of the U.S. population. During the third quarter, each of our merchandising departments posted double-digit comps led by our lumber and decor and storage departments. Our comp average ticket increased 10% and comp transactions increased 13%.", "The growth in our comp average ticket was driven primarily by the continuation of project demand we saw in the second quarter, customers trading up to new and innovative items, as well as inflation in certain commodity categories like lumber. Over the last four months, we've seen significant volatility in the pricing of lumber as the industry works to balance supply and demand. During the third quarter, the average price of framing lumber was approximately 130% higher than the same period last year. As we exited the quarter, pricing for certain lumber categories had fallen from the peaks we saw mid-quarter but still sit well above the levels we saw this time last year.", "Despite this significant inflation, we saw strong double-digit comps in lumber in the third quarter. During the third quarter, inflation from core commodity categories positively impacted our average ticket growth by approximately 260 basis points. Additionally, the strength of our comp transaction growth was driven by consistently strong in-store and online transactions, continuing the same trends we saw in the second quarter. During the third quarter, big-ticket comp transactions or those over $1,000 were up approximately 23%.", "We saw strong performance across a number of big-ticket categories like appliances, vinyl plank flooring, and lumber. During the third quarter, we saw double-digit growth with both our pro and DIY customers. And while DIY sales grew faster than pro sales, our pro business posted the strongest growth we've seen all year. As we look at our different pro cohorts, growth with our smaller pro customers has been consistent with strong double-digit growth every month of the year.", "Growth with our larger pro customers is healthy and accelerated from the second quarter. However, some large pros still face headwinds related to the current operating environment, including some customers being hesitant to invite pros into their homes. Turning to our DIY customers. We continue to see unprecedented levels of engagement from both new and existing customers across a variety of home improvement projects.", "And importantly, as these customers complete a project, they are gaining the confidence to tackle their next project and reengage with The Home Depot. During the third quarter, we saw customers take advantage of an extended selling season for our garden seasonal categories, resulting in significant growth in categories like hardscapes, soils, riding mowers, and outdoor power equipment. However, garden seasonal were not the only projects our customers were working on. If we exclude our garden departments from our third-quarter results, our comp was still north of 20%.", "We saw customers working on a variety of projects across their home, with categories like garage organization, ceiling fans, vanities, and power tools all posting comps well above the company average. The customer engagement we are seeing was also evident in our annual Halloween event. During the third quarter, we hosted our most successful Halloween event with both in-store and online offerings. Customers responded to our larger assortment of animatronics, inflatables, and yard decor as evidenced by our 12-foot giant skeleton that sold out before October, helping drive a record level of sell-through for the event.", "As we turn our attention to the fourth quarter, we are excited about the upcoming holiday season and believe we are in a great position for continued customer engagement. During the quarter, we will be hosting our annual holiday, Black Friday, and gift center events. However, this year, they're going to look a little different as we remain committed to prioritizing the health and safety of our customers and associates and promoting a safe shopping environment. We've adjusted our Black Friday event this year to cover an extended period of time and not just focus on one day.", "Additionally, for both our Black Friday and our gift center events, we've reorganized how we place and stage our product to assist with social distancing. For example, we've reduced the amount of product displayed on our front racetrack, and we've created more space for our gift center presentation. We've made deeper buys on fewer SKUs to bring great values to our customers. And we've also included some of our core SKUs in our event, which will help with replenishment as we continue to see strong comps.", "For example, featured in our gift center and Black Friday events this year are exclusive power tool products from our industry-leading assortment of Milwaukee, Makita, DEWALT, RIDGID, RYOBI, and more. This year, we are especially excited about the launch of RYOBI 18-Volt ONE+ HP brushless tools. These tools have been designed from the ground up to serve our DIY and pro customers with more features and performance than ever. HP tools are up to 20% lighter and 30% more compact while delivering improved power and durability with brushless motors.", "The RYOBI ONE+ platform has more than 100 million batteries in our customers' homes and job sites today. And this new HP lineup brings a strong pipeline of future innovation to the more than 175 RYOBI ONE+ tools in the marketplace today. Our Black Friday and gift center events kicked off a little over a week ago, and we are thrilled with the early results. With that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ted, and good morning, everyone. We appreciate everyone joining the call today, and we hope you and your loved ones are safe and healthy. In the third quarter, total sales were $33.5 billion, a 23.2% increase from last year. Foreign exchange rates negatively impacted total sales growth by approximately $100 million.", "Our total company comps were positive 24.1% for the quarter, with positive comps of 21.8% in August, 27.8% in September, and 23% in October. Comps in the U.S. were positive 24.6% for the quarter, with positive comps of 22.6% in August, 28.5% in September, and 23% in October. Our comps in August and September of this year were impacted by a shift in our Labor Day event.", "This year, our Labor Day event fell in fiscal September, and last year, it fell in fiscal August. If we adjust for this shift, our monthly comps in the U.S. would be 24.7% in August and 26.4% in September. All 19 of our U.S.", "regions, as well as Canada and Mexico, posted double-digit positive comps in local currency. In the third quarter, our gross margin was 34.2%, a decrease of approximately 30 basis points from last year. Gross margin was negatively impacted during the quarter by several factors, including product mix and pressure from shrink. Mix pressure from lumber alone negatively impacted gross margin by approximately 35 basis points in the third quarter.", "The decline in gross margin was partially offset by the benefit of reduced promotional events during the quarter. During the third quarter, operating expenses were approximately 19.7% of sales, representing a decrease of approximately 30 basis points compared to last year. Let me take a moment to comment on a few of our expense items. First, during the quarter, we continued to support our associates with enhanced benefits in response to COVID-19, which totaled approximately $355 million, resulting in approximately 105 basis points of expense deleverage.", "As you heard earlier from Craig, through the end of the third quarter, we have spent approximately $1.7 billion on enhanced associate pay and benefits in response to COVID-19. We've also made the decision to transition from our temporary weekly bonus program to permanent compensation enhancements for our frontline hourly associates. This will result in approximately $1 billion of incremental expense on an annual basis. We began making these adjustments in the third quarter, and we'll continue to make the majority of them in the fourth quarter on a market-by-market basis.", "Second, we incurred approximately $60 million of operational COVID-related expenses, including personal protective equipment for our associates and customers and enhanced cleaning of our stores, resulting in approximately 20 basis points of operating expense deleverage. Third, we recorded expenses related to our strategic investment plan of approximately $325 million, an increase of approximately $48 million compared to last year. And finally, during the third quarter, we showed strong expense control in other areas of the business and drove approximately 155 basis points of expense leverage. Included in these 155 basis points of leverage is approximately 70 basis points of pressure-driven by accrued bonus expense primarily related to our current outperformance for our biannual store Success Sharing program and store- and field-based management bonuses for the second half.", "The Success Sharing and store and field-based management bonuses are in addition to the $1.7 billion of enhanced pay and benefits in response to COVID-19. Our operating margin for the third quarter was approximately 14.5%, flat with the same period last year. Interest and other expense for the third quarter grew by $49 million to $329 million due primarily to higher long-term debt levels compared to one year ago. In the third quarter, our effective tax rate was 24.1% compared to 24.5% in the third quarter of fiscal 2019.", "Our diluted earnings per share for the third quarter were $3.18, an increase of 25.7% compared to the third quarter of 2019. At the end of the quarter, merchandise inventories were $16.2 billion, an increase of $444 million versus last year. And inventory turns were 5.9 times, up from 5 times from the same period last year. Moving on to capital allocation.", "Our long-term principles for how we think about deploying capital have not changed. After investing in the business, it is our intent to return excess cash to shareholders through a balanced approach of paying a healthy dividend and through share repurchases. Let's take a moment to talk about our first priority. We are committed to reinvesting in the business to drive growth faster than the market, and the acquisition of HD Supply strategically positions us to drive accelerated sales growth in a highly fragmented MRO space.", "Under the terms of the merger agreement, a subsidiary of The Home Depot will commence a cash tender offer to purchase all outstanding shares of HD Supply common stock for $56 per share for a total enterprise value, including net cash, of approximately $8 billion. The closing of the tender offer is subject to customary closing conditions, including regulatory approvals and the tender of the majority of the shares of HD Supply common stock then outstanding on a fully diluted basis and is expected to be completed during The Home Depot's fiscal fourth quarter, which ends on January 31, 2021. We plan to finance the acquisition with cash on hand and new debt. We also expect the transaction to be accretive to EPS in fiscal 2021, with potential for significant shareholder value creation over the long term.", "During the quarter, we invested approximately $470 million back into our business in the form of capital expenditures and paid $1.6 billion in dividends to our shareholders. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 41.6%, down from 45.1% in the third quarter of fiscal 2019. This decrease primarily reflects our decision to temporarily enhance our liquidity position, including the suspension of our share repurchase program back in March. Turning to the macro environment.", "The strong demand we've seen has continued. Comps have slightly accelerated in the first two weeks of November, reflecting an earlier start for our Black Friday and holiday events versus last year. We are encouraged by consumer sentiment and consumption trends, which show home improvement receiving more than its historical share of consumer spending. Housing metrics are significantly stronger than when we entered this crisis.", "Turnover is rising, we see continued growth in household formation and home prices are appreciating as inventory on the market hovers near record lows. Our customers tell us their homes have never been more important, and they intend to continue their investment in the improvement of their homes. While the current demand environment is strong, it is important to remember that we are not through the COVID-19 pandemic. And we do not think it is prudent to extrapolate recent trends to predict future performance.", "Our main focus remains on meeting our customers' needs while prioritizing safety. And we believe that the investments we have made over the last several years have uniquely positioned us to capture market share regardless of the environment. Thank you for your participation in today's call, and we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question comes from the line of Christopher Horvers with JP Morgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, guys. So I know you mentioned about the slight acceleration quarter to date, but I was wondering what you've seen in areas where COVID cases have spiked. What do you think the business looks like as it gets colder and outdoor DIY gets tougher? You mentioned the low 20% ex garden comp, do you think that's a good proxy for the underlying trend? Or would you expect the large pro to continue to improve and provide a benefit?" ] }, { "name": "Craig Menear", "speech": [ "So, Chris, the first comment would be we see no correlation in the business as it relates to COVID cases. I mean, our performance overall was actually really tight geography-wise, and we saw broad strength across the store. So as Ted mentioned, we had an extended season because of the weather in garden, but we were extremely pleased with the performance outside of our outdoor categories. So we feel good about that.", "And we've seen the pro continue to recover and the large pro recover." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. And then a couple of follow-up questions on the investment outlook. It sounds like you're making progress on the store investments again. Will you end up on track versus the original plan? And what do you think about the degree at which investment dollars and SG&A are down year over year in '21 – year over year in 2021? And then now that you have HD Supply, I was curious, how many of the 150-or-so new buildings that you've planned to build under the current investment plan related to the MRO? And does the acquisition of HD Supply impact the outlook for building those buildings and capex related to that? Thank you." ] }, { "name": "Richard McPhail", "speech": [ "So with respect to the investment outlook, as we've said in the past, we have deferred certain investments that principally relate to investments made inside the store. A large number of those investments remain deferred. We started the year with a capex plan of approximately $2.8 billion. We have deferred less than $0.5 billion.", "And so while I won't give you an exact number, I would say we will see deferral of, call it, $300 million to $400 million from our original plans in 2020. Some of that may push into 2021, and we'll update you as time goes on. But I would say that overall, 2021 is going to be very similar to 2020 in terms of capex." ] }, { "name": "Craig Menear", "speech": [ "And as it relates to the HD supply asset base in total, obviously, we'll take a look at that, and we'll evaluate the combined asset base once this gets approval. And we'll move forward with what we think the best leverage point is to serve our customers and grow in the MRO space, which is a $55 billion fragmented market that we're pretty excited about." ] }, { "name": "Ted Decker", "speech": [ "And if I could just take a minute, Chris, on what we've accomplished. While we did push a bit into 2021, we're just thrilled that we are finishing the investment in our new look and feel of the store. Our sign packages will be done in all U.S. stores this year.", "I think that is probably the first time the brand standard across all the United States stores has been the same, maybe since our first two stores opened in 1979. We've completed all our self-checkout refreshes. We've added storage to most of our stores for online pickup. We've implemented electronic sign labels in all our appliance departments.", "Completely refreshed our color wall experience in our paint department. We've completed the tool corral by brand standards in those leading brands in our tool business. And we've also taken that to our outdoor power equipment, and we'll be done early next year, resetting all our outdoor power equipment, again by those battery platforms that are leading brands in the industry. So we've completed a ton of work despite some of the setbacks with COVID this year.", "The team just did a terrific job getting all that work done." ] }, { "name": "Christopher Horvers", "speech": [ "So then, Richard, I know you mentioned capex deferring in. But I think originally '21 was, from an opex perspective, so source of funds, incremental investment dollars down year over year versus being up the past few years. Do you still expect those investment dollars in opex to be down in '21?" ] }, { "name": "Richard McPhail", "speech": [ "They'll be flat to down in '21, those specific expense dollars, with respect to the investment program that continue alongside the deferred spend in '20." ] }, { "name": "Christopher Horvers", "speech": [ "Got it. Have a great holiday season." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with RBC. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. So you did talk about product mix as the primary factor for the gross margin decline. Was there much of an impact on gross margins from channel mix as e-commerce has outpaced store growth? Or was it really all on the product side? Or were there any other factors we should be mindful of? Thanks." ] }, { "name": "Ted Decker", "speech": [ "Nothing in particular, Scot. By far, the big driver was the lumber penetration, the lumber mix as strong as that business was." ] }, { "name": "Scot Ciccarelli", "speech": [ "So just thinking about this kind of going forward, Ted, should we think about if we wind up seeing any more normalized mix kind of getting back to, let's call it, flattish kind of gross margins, is that the right way to think about it from a cadence perspective?" ] }, { "name": "Richard McPhail", "speech": [ "I think at this point, with the level of uncertainty in the environment and the dynamics in the business today, we wouldn't give any forward expectations with respect to margin. We're running a very healthy business. We run it on a portfolio basis. You bring up channel mix.", "We run this as a portfolio and have for many, many years, and you've seen the stability in our gross margin that reflects that. Remember that over 60% of sales that are purchased on our digital assets are picked up in the store and have an identical mix, in essence, to our store mix. So that's where we stand. We're very comfortable with the mix of business we see." ] }, { "name": "Scot Ciccarelli", "speech": [ "OK. Very helpful. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. There's a lot of moving pieces with Home Depot's longer-run earnings power between any changes in consumer behavior, the incremental costs that you're paying your associates, the acquisition of Home Depot Supply, channel mix, so relative to the 14% operating margin expectation you put out previously, recognizing that the sale expectation you're not providing longer-run guidance, do you think the business can now earn a higher, lower or about the same margin knowing what you know today than what you had thought previously?" ] }, { "name": "Richard McPhail", "speech": [ "Well, I'd say a lot is dynamic, but many things stay the same. I think we have executed exceptionally well in terms of expense management throughout the year. And I think you can expect that from us in the future. I think one thing I will just make sure that we clarify is how the shape of our investments to support our associates goes from 2020 into '21.", "So as we said, our expenses through the first three quarters of the year in support of our associates totaled approximately $1.7 billion. We are transitioning the nature of those investments into permanent wage investments during the fourth quarter. So if you think about the fourth quarter, we're not going to quite be down to that $1 billion annualized run rate as some of these programs leak into the beginning of the fourth quarter. We will be lower than the third-quarter run rate.", "But add it to $1.7 billion and say that 2020 will likely end at a total of $2 billion of investments in our associates. Of that $2 billion, only $1 billion will remain in our cost base in 2021. So I think that's the most important fact with respect to our cost base that I'd like to make sure we clarify." ] }, { "name": "Craig Menear", "speech": [ "And, Michael, the only other comment I'd add to that is everything that we've been doing through our investment program is to try to position The Home Depot to grow faster than the market on a consistent basis no matter what the operating environment is and to deliver incremental op margin dollars as a result. That's our focus. That's what we're trying to get done." ] }, { "name": "Michael Lasser", "speech": [ "Craig, that's a good segue to my second question, which is recognizing that it's very hard to prognosticate how demand for overall home improvement is going to shape up next year, if you had to make an estimate, what percentage of your categories or your SKUs do you think you'll be ordering inventory down next year?" ] }, { "name": "Craig Menear", "speech": [ "Look, first of all, the inventory planning for The Home Depot is on a very short cycle. We plan really week to week. We release orders every single day. And 70% of what we purchase is domestic goods and comes from short lead time-type performance.", "So we'll manage that on a day-by-day, week-by-week basis based on what we see in demand. And really, we're not looking to extrapolate anything at this point from current performance. Our whole focus is on being able to be flexible and agile and adjust accordingly." ] }, { "name": "Michael Lasser", "speech": [ "OK. I guess the heart of the question was, do you think home improvement demand is going to grow next year?" ] }, { "name": "Craig Menear", "speech": [ "So, look, the only thing I can tell you at this point is when we talk to our customers and we do work on surveys, the customer tells us that the home has never been more important. Maintenance in the home is going up as people spend way more time in their home. And there's a significant percentage of folks that say they're going to do a project within the next six months. And so everything that we see at this point in terms of customer feedback would suggest they're going to continue to invest in their homes." ] }, { "name": "Richard McPhail", "speech": [ "And at the same time, there's a lot of uncertainty in the environment. There are macroeconomic fundamentals that we're all going to be subject to. And so I think if you think about it on a comparative basis, as Craig said, home improvement is a great space to be in at the moment. And as customers -- it's interesting.", "You look at the housing dynamics and you say, when customers see their home price appreciate, they tend to invest more in their homes. Again, we're guarding our comments because of the uncertainty in the macro environment. And so at this point, we really can't comment on '21, but we do think there's a lot of confidence with respect to home improvement in our customers' minds." ] }, { "name": "Michael Lasser", "speech": [ "Understood. Thank you so much and have a really nice holiday." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks very much. Just a couple of questions. I guess I'm wondering with respect to your inventory, following up on Michael's question, do you actually think you'd maybe lost sales with the inventory that was a little too lean? And then wondering how to think about inventory for the fourth quarter.", "And then the second question I had is just you obviously have more and more information on your DIY customer than you have for the last several quarters given the e-comm penetration. I'm wondering if you could give a little more color on what the general demographic is looking like now and what the biggest shifts or changes that you've seen from an, I guess, age or income cohorts." ] }, { "name": "Ted Decker", "speech": [ "On inventory, Karen, it would be hard to gauge some of the lost sales opportunity. That would have likely been more of a Q2 impact for us because we did go in with a little more conservative approach when the pandemic hit. As you know, we limited customer hours, limited customer counts, and we also pulled back a bit on inventory. Since that time, though, between the merchandising team and the supply chain team and the sourcing teams and transportation team, they really have just done an incredible effort flowing product into the store.", "And as I said in my prepared remarks, we improved in-stock levels every week of the quarter. Our inventory grew over $400 million from the prior year. That was our first year-over-year increase that we had seen this year. And in pure volume, if you look at our accounts payable, that gives you an indication of how much goods we have flown into the buildings.", "It's over $3 billion from our low point. So the in-stocks still are not exactly where we'd like them to be, but incredible improvement. And the work the merchants have done, even though the in-stocks still have some ways to go, by working on the right SKUs with our supplier partners, updating planograms, and the like, we believe we have the product and the type of items in the store that our customers are looking for. As it relates to online trends, you're absolutely right.", "Our online business, we couldn't be happier with the performance of our digital assets. And remember, we are an interconnected business. So with everything I'm about to say, remember that over 60-odd percent of our goods are picked up in our store. Nonetheless, our interconnected business grew by 80%.", "The penetration was 13% to the business. The sales, that translates to nearly $2 billion of sales growth in the quarter for our online business. Our visits are up dramatically. We're up in mobile, desktop, mobile web.", "Our conversion is up despite the hyper-growth in app and mobile web that tend to have lower conversion rates than desktop. Our app downloads are way up. Our active app users are way up. Our orders are up.", "Our My Account, these are folks who are setting up an account with Home Depot, so obviously, we know them better when they set up an account or weigh up. Millennials are highly engaged with The Home Depot. You asked about customer profile. Our pros are highly engaged.", "Our B2B website is seeing record volumes and engagement with our pro customer. So I'll stop there, but it is a robust interconnected digital environment right now at The Home Depot." ] }, { "name": "Karen Short", "speech": [ "Great. Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Kate McShane with Goldman Sachs. Please proceed with your question." ] }, { "name": "Kate McShane", "speech": [ "Hi, good morning. Thanks for taking my question. I know you gave your comments on HD Supply, but I wondered if there was any more color you could give on the source and magnitude of any synergies and how much debt might be taken or raised for the deal." ] }, { "name": "Richard McPhail", "speech": [ "We're really excited about what the combination of these two MRO businesses will bring to our customer. We think we've got the opportunity to create significant shareholder value creation through that combination. We're not going to talk about the degree of accretion but confident that we'll see earnings per share accretion in 2021." ] }, { "name": "Craig Menear", "speech": [ "Kate, what we're excited about is if you -- these are rough numbers. If you think about 130 million occupied households in the United States, about 80 million of that is kind of owned household single-family. There's 50 million, and that is rental. And of the 50 million, about 30 million, give or take, is in kind of the multifamily operations-type business.", "That is a huge opportunity for The Home Depot to continue to grow not only on the MRO side. But as we build relationships with customers on the MRO side, we build relationships to be able to participate in capital refreshes of those facilities as well, which is something we're pretty focused on. So we're super excited about the opportunity that comes with this MRO space." ] }, { "name": "Kate McShane", "speech": [ "OK. Thank you. And I wondered if I could ask an unrelated follow-up question. Just regards to your seasonal business that you do in the fourth quarter, is there any way to dimensionalize or size how big of a business that is becoming for you in the fourth quarter?" ] }, { "name": "Craig Menear", "speech": [ "I'm trying to remember off the top of my head. We talked about seasonal breakout of outdoor categories. The fourth quarter is the lowest of the year, right, Ted?" ] }, { "name": "Ted Decker", "speech": [ "Yes. So generally, it's been shifting a little bit this year given the extended garden season and as engaged as customers have been. But usually, think of Q4 as low 21-ish percent penetration of what we would deem outdoor business. And that very much is the low point with Q2 traditionally being the high point.", "Think of mid-30s. So that's sort of the range of changes in the business." ] }, { "name": "Kate McShane", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks. Good morning, everyone. First, a question for Richard. You mentioned a few macro factors, and I'm trying to extrapolate.", "It sounds like you're a little bit more bullish on those than maybe you were in prior calls. Can you give us any sense -- I know you said directionally getting better. Can you give us a sense of what these inputs could look like for 2021 just in terms of magnitude, whether it's home price appreciation, housing turnover, etc.?" ] }, { "name": "Richard McPhail", "speech": [ "So in my earlier comments, I said we're really pleased with the current level of consumer sentiment and consumption in the economy. I'm not going to make a prediction on where those macroeconomic levers go in the future." ] }, { "name": "Craig Menear", "speech": [ "I mean, the other thing, Simeon, that I would say is I think the last number I saw is somewhere in like the 2.7 months of supply in housing. And the historical average on that is six months, so you'd have to believe that's going to continue to hold up home values. And I think home value improvements have been the surprise this year." ] }, { "name": "Richard McPhail", "speech": [ "I think it's a positive housing environment. We're not extrapolating that into expectations for sales principally because of the uncertainty in the macro environment. So we are optimistic and current conditions are certainly favorable for home improvement, but there is uncertainty. We'll learn a lot in the fourth quarter." ] }, { "name": "Simeon Gutman", "speech": [ "OK. Fair enough. And then my follow-up, based on the results by customer type, right, the pro customers coming back, can you talk about the backlog that you're seeing? Are you seeing the jobs that are coming back to normal, indoor jobs? And I think it may have been asked earlier, but the transition from outdoor to indoor as how is that taking place?" ] }, { "name": "Ted Decker", "speech": [ "So, Simeon, you're right. The pro has been coming back. We see double-digit comps in pro. We did last quarter as well.", "Small pro is leading the large pro. We've seen that large pro really strengthened in the larger metro markets. In our services business, if you look at that as a benchmark to pro's business, we have one of the larger backlogs of to-be-installed sales jobs that we've ever seen. And as you'd imagine, a lot of this is special ordered goods.", "So getting the bespoke special order made and shipped to the particular job and then getting the labor to install that job continues to be a bit of a pressure and more so in certain markets, leading to that large backlog. But if what we're seeing in our services business translates to what the larger pros are also seeing, that would be sizable backlog." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hey, good morning. Can you talk about where you are in the supply chain buildout that you've outlined over the past few quarters and maybe how much of a delay COVID caused and the degree to which you can make that up in '21?" ] }, { "name": "Craig Menear", "speech": [ "Sure. Largely, COVID hasn't had a big impact. And I'll let Mark comment on where we are." ] }, { "name": "Mark Holifield", "speech": [ "Yes. Good morning. Mark Holifield here. Yes, we've continued to open facilities through the pandemic.", "I've been incredibly impressed that the team has been able to keep our program on track in terms of the One Supply Chain initiative. In Q3, we opened up about 11 MDOs. We now have three -- those are market delivery operations. We now have three flatbed delivery centers open, and we've got a very solid pipeline for '21 that we're working.", "And so we're very much on track with the One Supply Chain initiative." ] }, { "name": "Chuck Grom", "speech": [ "OK. That's great. And then just maybe one for Richard. You spoke a lot over the past year about the ongoing margin headwind from shrink.", "And I realize maybe you've been limited in your ability to do some of the inventory, the physical inventories. But I guess where are we in that life cycle? It seems like it was an issue again here in the third quarter. Any line of sight of when you think the shrink could flip from a negative to a positive?" ] }, { "name": "Richard McPhail", "speech": [ "Well, at the beginning of the year, we said that impacts from our initiatives weren't really going to be seen until the year 2021. It takes time to roll these out. We did anticipate at the beginning of the year that we would see pressure on a year-over-year basis. The results through the third quarter have been essentially consistent with our original expectations." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "Hi. Thanks. A couple. One, Halloween being strong, does that typically act as a leading indicator for Christmas or even Thanksgiving? In other words, if people are buying the big blowups for Halloween, does that translate into big Christmas? Or I don't know if you do a big Thanksgiving business on that, but does that translate at all to what we should expect in the fourth quarter?" ] }, { "name": "Craig Menear", "speech": [ "I think what we saw in the Halloween business probably is more correlated to what we've historically seen in storm markets. When you have a hurricane hit -- our thinking years ago was that, oh, geez, we needed to pull back on all that kind of product because that wouldn't be where the customer focus was, and we needed the space for rebuild-type product. And what our customers told us was, no, actually, we're looking for some kind of normalcy. And we actually want to buy that product from you.", "And I think that's exactly what we anticipated and are seeing through the holiday programs as Halloween was the strongest event we've ever had. So we had anticipated in the beginning of the year -- because that's a long-cycle product that you purchase well in advance, we had anticipated that the customer would want to engage in holiday and purchased accordingly." ] }, { "name": "Michael Baker", "speech": [ "And so do you have that same expectation for Christmas? Did you purchase that similarly?" ] }, { "name": "Craig Menear", "speech": [ "Yes, that's what I mean. We bought into the whole holiday decor for the entire season, Halloween all the way through Christmas, because we anticipated that customers are going to want some kind of normalcy in their life." ] }, { "name": "Ted Decker", "speech": [ "The holiday set has been set now for Christmas for several weeks in the store now. And as I said, we're very pleased with the early engagement and sales in the program." ] }, { "name": "Michael Baker", "speech": [ "Yes. Got it. Understood. If I could ask one more follow-up on the Home Depot Supply.", "Thinking back a few years to an analyst day that you had, I think you implied that you -- or said that your share in MRO was about 5%, which would have implied about $2.5 billion, and then we add on 3-plus for Home Depot Supply. You're getting above $5 billion about 10% share. Is that the right way to think about it?" ] }, { "name": "Craig Menear", "speech": [ "We think it's about a $55 billion market that we play in with the combination of our current MRO business and what will be added with HD Supply." ] }, { "name": "Michael Baker", "speech": [ "And what do you think your share is of that $55 billion?" ] }, { "name": "Richard McPhail", "speech": [ "We won't speak on HD Supply's financial information. The transaction hasn't completed yet. We'll refer you back to theirs. But as Craig said, call ours roughly $2 billion." ] }, { "name": "Michael Baker", "speech": [ "Understood. We can do that math. Thank you. Appreciate it." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Good morning. So with your digital sales up 80% in the quarter, I think that would imply that your in-store sales accelerated in Q3. And I'm curious if you would attribute this more so to the impact of easing some of the early COVID restrictions on stores? Or do you think there are other factors like better in-stocks or incremental demand from pro customers that you would call out?" ] }, { "name": "Craig Menear", "speech": [ "I think it's all of the above, Zach. I think we learned how to better operate. We ended up turning control of constraints in stores over to our store managers who are closest to the situation on the ground versus a companywide approach. We did that at roughly the beginning of the quarter.", "We improved our in-stock position, as Ted indicated. We saw overall improvement with our pro customers. And our smaller pros have been steady. Our larger pros improved.", "Yet there's still opportunity for them. And we saw our services business improve overall. So I think there's a number of factors that led to this performance in the quarter. So we're pleased with the trends that we're seeing in the business right now." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And then lastly, on the decision to reacquire HD Supply. Could you talk about why you think the timing makes the most sense now, particularly with some of their end customers like hospitality and facilities impacted due to COVID? And on the strategic investments, curious how you would think about prioritizing that incremental investment dollar across the MRO business relative to your existing strategic plans." ] }, { "name": "Craig Menear", "speech": [ "Look, I'd say a couple of things. First of all, over a period of time, the HD Supply business came down to essentially the MRO maintenance facility business that it is today that we just put the offer in on. And so it strategically lines up with what we're trying to get accomplished in the MRO business, much more so than it did a few years ago. So from a timing standpoint, that's the logic there.", "And look, as we close this deal, hopefully, during our fiscal year-end here, then we'll determine the go-forward approach and how we allocate and prioritize. But we got to get this deal closed first." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Thanks, Craig. I appreciate the time." ] }, { "name": "Craig Menear", "speech": [ "Sure." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning and thanks for fitting me in. I was hoping to maybe expand on the compensation enhancements for the hourly associates. I don't know if it's possible, Richard or Craig, if you could discuss whether the investments are concentrated in absolute wage rates or if there's other sort of aspects of the compensation or benefits that are being changed as we think about the cost structure going forward." ] }, { "name": "Craig Menear", "speech": [ "Now, look, Steve, we believe that our associates are a competitive advantage to The Home Depot, and they're critical to the overall customer experience. And this investment is essentially in wage. And as we do everything as it relates to our associates, that's done on a market-by-market basis overall. But, yes, you can think of it as largely -- it's wage." ] }, { "name": "Steven Forbes", "speech": [ "And then as a follow-up to that, I mean, should we expect any incremental pressure stemming from higher implement cost for the full-time associate pool? Or I don't know if you could sort of discuss, right, is the best way to think about 2021, Richard, you mentioned $2 billion transitory versus $1 billion permanent. But are there any other potential cost factors we should be considering in our models as it pertains to the full-time pool?" ] }, { "name": "Richard McPhail", "speech": [ "It's all of our frontline associates, essentially, whether they're full-time, part-time, doesn't matter." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and thank you, everybody, for joining us today. We look forward to speaking with you on our fourth-quarter earnings call in February." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2020-05-19	[ { "description": "Vice President, Investor Relations and Treasurer", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, Chief Executive Officer and President", "name": "Craig Menear", "position": "Executive" }, { "description": "Executive Vice President-Merchandising", "name": "Ted Decker", "position": "Executive" }, { "description": "Chief Financial Officer and Executive Vice President", "name": "Richard McPhail", "position": "Executive" }, { "description": "Executive Vice President, Outside Sales & Service", "name": "Bill Lennie", "position": "Executive" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "RBC Capital Markets -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Karen Short", "position": "Analyst" }, { "description": "Gordon Haskett -- Analyst", "name": "Chuck Grom", "position": "Analyst" }, { "description": "JPMorgan -- Analyst", "name": "Christopher Horvers", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zachary Fadem", "position": "Analyst" }, { "description": "Nomura -- Analyst", "name": "Michael Baker", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "Greg Melich", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings, and welcome to The Home Depot First Quarter 2020 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.", "It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Joining us on our call today are Craig Menear, Chairman, CEO and President; Ted Decker, Executive Vice President of Merchandising; and Richard McPhail, Executive Vice President and Chief Financial Officer. Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call Investor Relations at 770-384-2387.", "Before I turn the call over to Craig, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission.", "Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Craig." ] }, { "name": "Craig Menear", "speech": [ "Thank you, Isabel, and thanks to all of you for joining us on our call this morning. We hope that you and your loved ones are safe and healthy, and our thoughts and prayers are with all of those who have been directly impacted by COVID-19. I also want to thank all of our incredible associates and supplier partners for their hard work and dedication to serving our customers and communities in this time of need. And while the purpose of the call today is to update you on our first quarter results, I thought it would be helpful to explain how we are thinking about and making decisions at The Home Depot.", "When our founders started the company over 40 years ago, they did so by first defining the type of culture and value system that they wanted to promote. These values are the foundation for our business and provide the lens through which we evaluate our decisions. Anchoring to these values in this time of crisis has never been more critical. Our decisions and actions are rooted in a commitment to do the right thing, to take care of our people and be there for our customers and communities. To that end, as the situation around COVID-19 has evolved, our focus has been and continues to be on two key priorities, the safety and well-being of our associates and customers, and providing our customers and communities with essential products and services. The team's alignment around these two objectives has enabled critical speed and flexibility when making decisions and implementing a number of changes across the business in a rapidly evolving and incredibly fluid environment.", "I'd like to briefly touch on just a few of the early and decisive actions that we took in support of these primary objectives. To promote a safe environment for associates and customers, we implemented a number of operational changes starting in mid-March. We've adjusted our store hours, closing earlier than usual to give our associates more time to properly clean and sanitize and restock our shelves. We took a proactive and early stance on limiting customer traffic in our stores to better maintain physical and social distancing protocols. At the height of our spring selling season, we also made the decision to cancel our Annual Spring events, including Spring Black Friday. This was not a decision that we took lightly, and yet we made it confidently giving our belief that having this event would drive footsteps to our stores and directly undermine our commitment to prioritizing safety.", "To take care of our associates, we expanded our paid time off for all hourly associates that can be used at their discretion and will be paid out at year-end if unused. We also are offering additional paid time off for associates who are 65 or older, or deemed to be at higher risks by the CDC guidelines. We have instituted weekly bonuses for our hourly associates in our stores and distribution centers. We are providing double pay for over-time work, and we have extended dependent care benefits and waive related co-pays.", "Our more than 400,000 orange blended associates are the heartbeat of The Home Depot and supporting them is a core value of our company. Beyond the grounding that our culture and values provides and the actions we have taken to support them, we believe that The Home Depot is uniquely positioned to weather COVID-19. Nobody could have predicted what has unfolded since we spoke with you three months ago on our earnings call in February, and yet the distinct competitive advantages and overarching benefits of an interconnected One Home Depot strategy that were reinforced then are perhaps even more in focus and relevant today.", "Investments we have made over the years in our stores, market-leading digital assets, flexible supply chain and a world-class merchandising organization have allowed us to quickly adapt to shifts in customer needs, preferences and behaviors. Our interconnected retail strategy and underlying technology infrastructure have supported record level web traffic for several weeks without disruption.", "Sales leveraging our digital platforms increased approximately 80% in the quarter. And more than 60% of the time, our customers opted to pick up their orders at a store. We were able to extend our in-store focus capabilities to curbside pickup in the US in a matter of days, offering customers an additional choice with respect to fulfillment. In the case of our Ontario stores in Canada, this curbside capability was turned on essentially overnight when it became the only option to remain open and operational with those stores operating under these circumstances for more than a month.", "The flexibility and agility of our business model, coupled with our focus on execution and strong partnership with our suppliers, help deliver solid results in the quarter and gave the Board the confidence to declare a $1.50 per share quarterly dividend. Sales for the first quarter were $28.3 billion, up 7.1% from last year. Comp sales were up 6.4% from last year with US comps of positive 7.5%. Diluted earnings per share were $2.08 in the first quarter.", "Richard will walk you through the details in a moment, but I want to stress that while we were pleased with the results in the quarter and we see an engaged customer, there is significant volatility. Month-to-month and even week-to-week, we saw extreme ups and downs across different categories and geographies. As a result, we are cautious to extrapolate trends from the first quarter into a forecast for the remaining of the year, particularly given the tremendous amount of uncertainty we face with regards to the duration and continued impacts of the virus.", "Despite the many unknowns of the current environment, we are confident that we have taken the steps to ensure that we will emerge from this crisis stronger and even be better positioned for the future. Though this crisis is unparalleled in size and scope, we have built a reputation through our history of doing whatever it takes to be there for our associates, customers and communities in the most critical times, and this situation is no different.", "Once again, I want to thank our incredible associates and express how grateful and proud I am of the resiliency and strength that our teams have demonstrated as we navigate these extraordinary circumstances together. This reminds me of the words of our founder, Bernie Marcus, that have never resonated more deeply than they do today. If you take care of our associates, they take care of the customers, and everything else takes care of itself.", "And with that, I'd like to turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thanks, Craig, and good morning, everyone. I also want to start by thanking all of our associates and supplier partners for the incredible collaboration over the last several months. Supplier relationships and partnerships matter, and during the times of crisis is when they matter the most. One of the actions we took early on when COVID-19 was impacting the supply chain in China was to establish regular and frequent contact with our suppliers, both internationally and domestically.", "As cases increased in the US, our suppliers helped source the essential products that our customers and communities needed. We established an effective plan, shifted resources as needed, and worked on getting the right products to the right stores across the country. While in-stock levels varied from store to store and region to region, our focus remains on replenishing and restocking high demand products as quickly as possible. We are grateful for our strong strategic partnerships. Our supplier partners are helping us in many ways, including supplying essential products for our own use.", "Let me give you an example. Very early on in the pandemic, we reached out to PPG, one of our key paint suppliers, for help. We asked PPG if they could help supply hand sanitizer for our store associates. They quickly converted several of their manufacturing lines and, within a few short weeks, they produced an initial order of approximately 100,000 gallons of hand sanitizer. They are planning to produce 3 times that amount for future in-store use that will help our associates for the remainder of the year. This is just one of many examples, and I want to thank PPG and all of the other supplier partners that have stepped up to help us prioritize the safety and well-being of our associates and customers.", "The challenges we faced as a result of COVID-19, including the most fluid operating environment we've ever experienced, have further reinforced our strategy of the One Home Depot interconnected shopping experience. As a direct result of our investments across the business over the last decade, our teams were able to make decisions quickly and adapt to changing local government mandates and customer behavior. And as you heard from Craig, we did this while focusing on two priorities; keeping our associates and customers safe and continuing to serve our communities with the essential products and services they need for their homes and places of work.", "Our continued investment in our interconnected capabilities has positioned us well as customers turned online for their shopping needs. As shelter-in-place orders were rolled out across the country in mid to late-March, we saw our digital businesses accelerate from approximately 30% growth in early March to triple-digit growth by the end of April. In fact, daily traffic to homedepot.com reached new records toward the end of the quarter. During the last three weeks of the quarter, traffic to homedepot.com was consistently above Black Friday levels. And as a result of our continued investment in our digital infrastructure, and with the great work of our technology teams, we provide a continuous service to our customers, and our conversion rate continued to increase.", "During the quarter, we continued to leverage our different fulfillment capabilities like buy online, pickup in-store, and our enhanced delivery capabilities, whether it be on a flatbed truck, a box truck or our car and van service. Our focus in deliver from store fulfillment options saw triple-digit growth in the first quarter. In fact, the flexibility that we have built into our systems allowed us to quickly rollout a new fulfillment option for our customers to buy online and pickup at our stores through a contactless curbside pickup option.", "Looking at the first quarter in total, we saw positive comps in 11 of our 14 merchandising departments. Comps in kitchen and bath, flooring and millwork, departments with a heavy reliance on in-home installation were negative during the quarter. During the first quarter, we saw three distinct phases of sales performance. The first phase covered the first seven weeks of the quarter. During this phase, we saw strong sales across the store with all departments showing mid-single to double-digit comps. As customers prepared shelter-in-place, we saw particularly strong growth with certain categories like cleaning and safety and security, but we also saw growth above our expectations in other core categories.", "The second phase of our sales performance relates to the last week of March and the first two weeks of April. During this phase, as the number of shelter-in-place orders were issued across the country, we're among the first essential retailers to take immediate and decisive action geared at limiting customer traffic in our stores. These actions included reducing store hours, limiting the number of customers in our stores and canceling our Annual Spring events, including Spring Black Friday. In addition, we made the decision to suspend certain non-essential installation services such as kitchen remodels. During these three weeks, we saw negative comps in most departments.", "Finally, during the last three weeks of the quarter, while maintaining safety protocols around distancing and proactively restricting customer traffic in stores, we saw strong comps across most of our departments as customers focused on a number of home improvement projects. We continue to see a significant pressure in products requiring installation services like kitchen and bath and flooring.", "During the first quarter, comp average ticket increased 11.1% and comp transactions decreased 4%, reflecting the lower traffic that we just discussed. The strength in our comp average ticket was driven by a notable increase in basket size. Core commodity categories like lumber and copper did not have a material inflationary impact on our comp average ticket during the first quarter.", "During the first quarter, big ticket comp transactions, or those over $1,000, were up 2.5%. We saw strong performance in big ticket categories like appliances and riding lawn mowers. However, this strength was offset by pressure in categories like special-order [Phonetic] kitchens, countertops and flooring where we intentionally limited these installation services in customers' homes.", "Sales of both our DIY and Pro customers grew during the quarter with DIY sales growing faster than Pro sales. We continue to have a high level of engagement with the Pro, however certain states and municipalities restricted in-home activity, which had a direct impact on some of our Pro customers. In addition, certain social distancing actions we took during the first quarter also served as a headwind to Pro activity. As we look ahead, we are focused on continuing to provide essential products and services to our customers and communities in a safe and responsible way. The investments we have made across our business has helped us to be flexible and agile in this fluid and dynamic situation. We will continue to adapt and improve the ways in which we serve customers in this new environment.", "And with that, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ted, and good morning, everyone. We appreciate everyone joining the call today and we hope you and your loved ones are safe and healthy. This was certainly a unique quarter with COVID-19 dramatically changing our operating environment, but it has also reinforced that the investments we have made in the business over the last decade have been the right ones. They have allowed us to be more flexible and agile than ever before. And we've taken unprecedented actions to respond to the virus, primarily focused on supporting our associates, keeping them and our customers safe while providing essential products to our communities.", "Today, I'll review our consolidated results for the first quarter and will provide some color in the context of the three distinct periods that Ted mentioned we observed. I'll also review some of the direct actions we took as a company to support our associates and further strengthen our capital structure. In the first quarter, total sales were $28.3 billion, a 7.1% increase from last year. Our total company comps were positive 6.4% for the quarter with positive comps of 9.3% in February, 7.1% in March and 4.2% in April. Comps in the US were positive 7.5% for the quarter with positive comps of 9.7% in February, 7.5% in March and 6.4% in April.", "From a geographic perspective, all three of our US divisions posted positive comps, and 17 of our 19 US regions had positive comps in the first quarter. The two exceptions were our New York Metro and South Florida regions. New York and its surrounding areas were negatively impacted given the outsized impact that the virus had on the region, and our South Florida region was negatively impacted by our stores in Puerto Rico being closed for a period of time in accordance with local mandates.", "During the pre-COVID period in February and stretching into mid-March, comps were double-digit positive in the US with relatively uniform strength across all regions. As we moved into late March and early April, we experienced peak shelter-in-place mandates across the country. During this time, we implemented early and decisive measures to restrict customer traffic in our stores, which had a direct negative impact to our sales, most acutely felt in higher volume stores in densely populated urban areas. Over the course of these three weeks, shelter-in-place mandates and self-imposed limitations on traffic pressured our weekly performance to double-digit negative comp sales with higher volume stores underperforming lower volume stores by over 30 percentage points in certain areas.", "And finally, during the last three weeks of April and continuing into the first two weeks of the second quarter, we have seen a significant acceleration to double-digit comp sales growth with strong performance across most of the store as customers turn to repairs and home improvement projects. As a result of ongoing measures to promote social distancing practices in our stores, customer limits continue to constrain sales in our higher volume stores, but we have flexed our operating model to improve our ability to serve these strong levels of demand.", "In the first quarter, our gross margin was 34.1%, a decrease of 12 basis points from last year. This decrease was primarily driven by changes in the mix of products sold and continued pressure from shrink. This pressure was offset in part by favorability and supply chain expenses and by the cancellation of our Annual Spring Black Friday event this year.", "During the first quarter, operating expense as a percent of sales increased approximately 190 basis points to 22.5%. This increase primarily reflects our decision to extend enhanced benefits for our associates totaling $850 million in incurred and accrued expense, reflecting the provision of additional paid time off for all our hourly associates, which can be used any time during the year and will be paid out at year-end if our associates choose not to use it. The provision of incremental additional paid time off for associates considered to be at higher risk based on CDC guidelines, weekly bonuses for our hourly associates, double pay for overtime hours worked and other benefits.", "These enhanced benefits created approximately 300 basis points of expense deleverage during the quarter. In addition, we recorded expenses related to our strategic investment plan of approximately $270 million, a slight increase versus last year, creating 10 basis points of expense deleverage. Finally, we showed strong expense control in all other areas of the business as we navigated the quarter and drove approximately 120 basis points of expense leverage on that basis.", "Our operating margin for the first quarter was 11.6% compared to 13.6% in the first quarter of 2019. If we were to exclude the 300 basis points of deleverage related to the COVID-19 expenses to support our associates, our operating margin would have been approximately 14.6%. Interest and other expense for the first quarter grew by $34 million to $307 million, due primarily to higher long-term debt levels than one year ago. In the first quarter, our effective tax rate was 24.4%, flat with the first quarter of fiscal 2019. Our diluted earnings per share for the first quarter were $2.08 compared to $2.27 in the first quarter of 2019. The $850 million of expense related to enhancements we made in support of our associates negatively impacted our first quarter diluted earnings per share by approximately $0.60.", "During the quarter, we opened one new store in Mexico and one in Puerto Rico, bringing our store count -- our total store count to 2,293. Selling square footage at the end of the quarter was 238 million square feet. At the end of the quarter, inventory turns were 5 times, up from 4.7 times last year. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 40.8%, down from 45.4% in the first quarter of fiscal 2019. This decrease primarily reflects higher long-term debt balances than one year ago as we took steps to enhance our liquidity position during the onset of the COVID-19 pandemic, and I'll take a moment to comment on those actions in a little more detail.", "We began the first quarter with a very strong liquidity position and we moved early in the quarter to strengthen that position. In mid-March, we suspended our share repurchase program indefinitely. Prior to that suspension, we had repurchased approximately $600 million or 2.5 million shares of outstanding stock. In late March, we upsized our A1/P1 commercial paper program from $3 billion to $6 billion. In conjunction with upsizing our commercial paper program, we expanded our revolving credit facility capacity from $3 billion to $6.5 billion. As of today, we have no commercial paper outstanding and our credit facilities are undrawn. And finally, on March 30th, we raised $5 billion of staggered maturity long-term debt with an average coupon of approximately 3%. This average coupon is below the average coupon of our overall debt portfolio. These actions were important to ensure we had more than adequate liquidity during this period of uncertainty.", "In addition, we took actions to reduce non-essential activity in our stores and, as a result, postponed some of our strategic investments that touch our stores directly, including changes to our front-end and resets of our merchandising base. While these actions reflect our focus on social distancing, we remain committed to our One Home Depot strategy. Fiscal 2020 marks the third year of our strategic investment plan to create a seamless and frictionless interconnected experience. These investments are designed to leverage and extend our competitive advantage and have already begun to prove their value as we pivot to serve our customers in new ways.", "Now, I'll comment on how we're thinking about guidance. Recall that the fiscal 2020 guidance that we provided on our fourth quarter call in February excluded any impacts from COVID-19. Our performance to-date has surpassed our initial expectations, and it is also disconnected from traditional metrics like GDP, which we have historically used as a foundational element of our sales guidance. As a result of this and the level of uncertainty that exists with respect to the impact of COVID-19 on future economic activity and customer demand, we are suspending our fiscal 2020 guidance until further notice.", "Our stance is not a reflection of current demand for home improvement, but rather a reflection of the broad range of potential outcomes for the economy and our business. Our strategic investments have positioned us well to continue to serve our customers with the essential products they need for their homes and places of work. Our company is in a strong financial position, and we have taken steps to further strengthen that position. We will continue to invest to strengthen our competitive advantages, and we believe we will emerge from this COVID-19 environment a stronger team and a stronger company.", "Thank you for your participation in today's call, and we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. I know it's uniquely difficult to quantify, but if you use the spread in the difference in performance between your high volume stores and the rest of your chain as a guide, what do you think the overall impacts from metering, limiting promotions and not having installation in the first quarter was?" ] }, { "name": "Craig Menear", "speech": [ "Hey, Michael. We've -- it's hard to determine why we took a crack. Richard, do you want to fly through it?" ] }, { "name": "Richard McPhail", "speech": [ "Yeah. It is hard to determine. If you just look at sort of traffic limitations that we imposed, if you look at the restricted operating hours and caps on customer accounts in our stores, I can't give an exact number, but it would be several points of comp impact to the quarter." ] }, { "name": "Michael Lasser", "speech": [ "Several points of comp meaning more than a couple of hundred basis points, just to clarify? And you're not referring to several hundred basis points?" ] }, { "name": "Richard McPhail", "speech": [ "You're in the right neighborhood, several hundred basis points of comp." ] }, { "name": "Michael Lasser", "speech": [ "Okay. And to what degree has the strong sales that Home Depot had experienced as of late simply pulled forward sales from future period? And as part of that, are you planning for negative comp in any given quarter of this year?" ] }, { "name": "Craig Menear", "speech": [ "Yeah, Michael, I mean, spring is always one of those scenarios where you have first quarter, second quarter kind of how much happens in the first quarter? Is there a pull forward if you have an early great spring? Those are dynamics that we deal with every single year. And we've seen strength as we've begun the second quarter, and we're not planning for any negative comp in the business." ] }, { "name": "Michael Lasser", "speech": [ "Thank you very much. Stay safe and good luck." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with RBC. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. And again, also hope everyone's well. Obviously current demand is strong. You just talked about that. And I would also think that there's going to be a greater focus on wallet share from consumers toward home-related investments because you've all been under lockdown for the last two months. Now, on the flip side, we've had a pretty sizable contraction in mortgage credit since really mid-February. So, I understand I'm asking an opinion or a view here, but when you kind of look out over the next six to nine months, how do you kind of net out those two forces because one is obviously very positive, and one is potentially meaningfully negative?" ] }, { "name": "Craig Menear", "speech": [ "Again, we started the year with an overarching strong housing environment. It's hard to determine what impacts are going to play out as a result of this at this stage of the game. I still don't know how we predict that. Clearly, the current demand is strong and the capabilities that we've built really fall around flexibility and we're going to use that flexibility to drive engagement with the customer on an ongoing basis." ] }, { "name": "Scot Ciccarelli", "speech": [ "Okay. And then, if I could sneak in another one then, Craig. I'm just curious your average ticket was so strong but big ticket sales were up only about 2.5%. I think that's kind of an unusual disparity between those two figures. So I just wonder if you could provide a little bit more color in terms of the average ticket performance. Thanks." ] }, { "name": "Craig Menear", "speech": [ "Yeah, let me -- I'll make a comment and then, Ted, you can add anything. Look, I think in this situation, customers were very focused on making sure that they reduce their exposure in terms of going into retail environments, and here we're really focused on getting everything they needed in one trip." ] }, { "name": "Ted Decker", "speech": [ "Yeah. Scot, if you can imagine, we look at the breakdown in comps and items per basket, etc, in every permutation of ticket. And what we experienced is, as Craig said, people were limiting trips to the store, so our smaller tickets or smallest tickets had a negative comp -- transactions had a negative comp. And while we had a positive comp in the over $1,000, or 2.5% as I said, remember that was limited by all the special order and installation businesses that we purposefully curtailed. What we're particularly excited about was the performance from the $200s, the $300s, the $500 ticket, those are your core basket building project oriented tickets that were extremely strong across the whole store." ] }, { "name": "Scot Ciccarelli", "speech": [ "Very helpful. Good luck, guys." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Good morning, everyone. A little bit of a twist on the prior questions. The virus obviously makes the backdrop very uncertain. In the past, Home Depot has offered a framework for a potential next recession, it was hypothetical. I think it was comps flattish in a downturn, assuming the downturn wasn't driven by housing and then given how big maintenance and repair is. I realize the virus is unpredictable and that's a variable no one can predict, but does the economic backdrop argue for that type of scenario? Any perspective I realize with this variable it's hard.", "And Craig, did you say for Q2, obviously you're not expecting negative, but that wasn't for the whole year, that comment, just for Q2?" ] }, { "name": "Craig Menear", "speech": [ "Yeah, we're not planning for negative. It's obviously very uncertain as to how the year plays out in total. We're not planning for negative comps in Q2 or for that matter for the year at this point. We'll watch carefully and see how this all plays out and react accordingly. And again, the flexibility that we've built in our business should give us the ability to react." ] }, { "name": "Richard McPhail", "speech": [ "And, if you just -- if you go back to your recession question, we entered the year with a healthy housing environment. We haven't seen anything in that housing environment that's changed materially. And typically when you look at recessions that are non-housing led for us, the performance decline is much more shallow, more of a flat type environment. But, again, this is a unique situation and the duration of the situation is one of the more important dynamics that just can't be predicted." ] }, { "name": "Simeon Gutman", "speech": [ "Yeah. Fair enough. And then, my follow up is, so you've been open throughout this crisis. You've seen a surge, you've adjusted how you've operated, and there's probably more adjustments to come. Any thoughts on the margin profile? I know it's going to be hard to talk about structural change and how it relates, but any other puts and takes in how you think about the long-term margin of the business?" ] }, { "name": "Richard McPhail", "speech": [ "Yeah. I'd say, margin was sort of relatively where we would have anticipated it prior to COVID. We run up a portfolio approach at The Home Depot, and you have puts and takes every quarter. I wouldn't say that our long-term view of margin has changed from what we've seen in the situation." ] }, { "name": "Simeon Gutman", "speech": [ "Okay. Thanks. Good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Karen Short with Barclays. Please proceed with your question." ] }, { "name": "Karen Short", "speech": [ "Hi. Thanks for taking my question. I wanted to just talk about e-commerce just a little bit, obviously you called out an extremely strong growth rate and it looks like e-com is now around 17% of sales, which is almost double what it ended '19 at. So, wondering if you could talk a little bit about what the composition was and whether not do you think you gained share with a particular demographic? And I'm wondering what your thoughts are just in terms of the stickiness with respect to e-com and home improvement just going forward?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. Our penetration did jump to just under 15% for the quarter, so we had strong penetration. And we gained a lot of new customers exposed to homedepot.com. Now, we -- as Richard said, we run this on a portfolio. And so, there are heavy engagement in both channels, customer using dot-com to order goods can be then 60-some-percent of those picked up at a store.", "Ted, I don't know if you have any further?" ] }, { "name": "Ted Decker", "speech": [ "Yeah. Karen, the performance of online, as Craig said, the penetration increased to 15%. We had a 79% growth, accelerating throughout the quarter. So we started strong at the beginning of the year, similar to the growth in the prior years, accelerated into triple-digits in the last weeks and meaningful triple-digits. And the growth is really across all categories. What's particularly encouraging is the number of new customers and the opportunity in the future. We more than doubled our number of customers when we look at our customers from repeat customers, six to 12 months, less than 12 months, 12 to 24, reactivated over 24 months, brand new customers, every one of those segments was healthy and effectively doubled.", "Again, purchasing categories across the entire store, the engagement with email and My Account signups tripled the normal run rate as we went through the quarter. Our app downloads nearly doubled from their normal quarterly and weekly run rate. So, just terrific engagement across the business in our devices, and we're very encouraged with this new and reenergized online customer base to work with these folks and contact them, engage with them in the future." ] }, { "name": "Craig Menear", "speech": [ "Karen, one other comment I'll make on it is, the great news is, the majority of this growth came through earned channels. We didn't have to go pay for it." ] }, { "name": "Karen Short", "speech": [ "Yeah, no, that's very helpful, and I appreciate that. I just wanted to ask a slightly separate follow-up. Obviously, we have -- you talked about the TAM -- $650 billion TAM in the past. I'm wondering if you have a sense of what -- how big, I guess, the smaller and more fragmented competitor base is in terms of the total dollars, meaning, will they actually make it kind of the other side of it? And how much of an advantage you might have in terms of taking share from weaker more fragmented players?" ] }, { "name": "Craig Menear", "speech": [ "So, I believe you've broke up a little bit there, but I believe you were asking about the $650 billion TAM. And so, what we've always said is, at our size, there is plenty of share out there, plenty of fragmentation, you think about categories like flooring which are truly penetrated more greatly by the small mom and pops. There is plenty of share out there to grab." ] }, { "name": "Karen Short", "speech": [ "Got it. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question." ] }, { "name": "Chuck Grom", "speech": [ "Hi. Good morning, and hope everyone's well. Just wondering, if you guys could talk about the cadence of the Pro and the DIY business separately throughout the quarter? And if the reacceleration that you spoke about in May, the double-digit increase was seen in both camps." ] }, { "name": "Craig Menear", "speech": [ "So, clearly the DIY customer is reengaged with DIY, there is no doubt about that, very strong DIY business. What was interesting is, we actually saw the Pro grow in the quarter, but we did see bifurcation in the quarter with the Pro as we moved into the different phases that Ted and Richard described. And the smaller Pro actually performed well throughout the quarter with more pressure on the larger Pro.", "And Bill, if you want to jump in and provide some additional color there?" ] }, { "name": "Bill Lennie", "speech": [ "Yeah. Thanks, Craig. So, Chuck, we saw more sale impact in the highly shelter-in-place regions or zones versus the states that had moderated or no actions in place. So, the Pros definitely faced some headwinds from the state mandates. We also had some restrictions in the form of inability to get permits issued or job site inspections completed so they can move on with their project. And finally, there were some headwinds there with homeowners just having the reluctance to have crews working in their home when they were sheltered in place. As Craig said, high spend Pros were more impacted. That makes sense if you think about them being more concentrated in metro areas likely or they have some of those mandates impact their business, but also larger jobs and more crews more likely to be impacted from the inability to get permits or job inspections.", "I would give you one additional point of reference though, and I would draw that parallel to our services business. If you look at job cancellations, they are running at historic trends, which really means that more customers have just pushed their jobs and haven't canceled the work. So, as these mandates are lifted, we're seeing the Pros come back to work. It's just a slower recovery than what we've seen from consumers." ] }, { "name": "Chuck Grom", "speech": [ "Okay. That's very helpful. And then, just on the $850 million of cost that you incurred in the first quarter, is there a way to handicap what you think that could look like in 2Q and maybe in the back half if you decide to continue to pay your employees a little bit more?" ] }, { "name": "Craig Menear", "speech": [ "Well, I wouldn't want to comment on what the second quarter or the rest of the year will look like, but maybe if I gave you some color around the $850 million, that would give you clarity on how to think about it. So, there are really kind of two categories of that spend. The vast majority of the $850 million reflects expense related to the extension of paid leave. So, in mid-March, we extended additional paid leave to all of our hourly associates and subsequently extended paid leave for associates who would have been deemed at-risk. For both those groups, if leave is not taken, we fully committed to pay it out during the year. A portion of the paid leave has already been taken, but we have fully accrued for all of the remaining leave eligible to be taken.", "So, the vast majority of that $850 million has already been accrued. Then we have expenses that are paid as earned by our associates. This bucket of expenses was about $150 million of the $850 million. And so, these are really in the form of the weekly bonuses we're paying to our associates as well as the enhanced overtime rates that we're paying. We began payment of those benefits roughly halfway into the quarter. So that $150 million was paid over roughly half a quarter. We are continuing the payment of those benefits into June, and we will continue to review the continuation of those payments as the situation develops. Does that help?" ] }, { "name": "Chuck Grom", "speech": [ "Yeah. I guess, is there any way to heading up what the accrual portion of the extended time would be? Because I think that's the point I'm getting at. You've essentially captured forward costs here in the first quarter." ] }, { "name": "Richard McPhail", "speech": [ "If you want to think very roughly, you've got the $150 million that is sort of expensed as incurred. So that leaves about $700 million. Of that $700 million, that is loosely associated with paid leave, about $150 million has already been utilized, but again, we fully accrued for the remainder of the paid leave that our associates are eligible for under this enhanced program. So it is already reflected in our Q1 financials." ] }, { "name": "Chuck Grom", "speech": [ "Yeah. Makes sense. Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Christopher Horvers with JPMorgan. Please proceed with your question." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks. Good morning, everybody. A few follow-up questions. So, first, on the last question, just in terms of like the ongoing expense obviously in a socially distance world, retail is changing, there is an article last week around what McDonald's is changing, and these expenses are going to stick. So, how does the higher sanitation cost and different things that are going to stick around for the next year? Is there a number that you could associate it with that?", "And then, on the Pro business, can you talk about what you're seeing in areas that are opening up? Do you have a sense of what the Pros order book looks like, it sounds like people are completing jobs, but do you have any sense or any view on what the new business coming into that Pro looks like?" ] }, { "name": "Craig Menear", "speech": [ "Let me just comment on the Pro, and I'll turn it over to Richard for the cost element. On the Pro, as Bill mentioned, in our own services business, which is some of our best Pros, we're not seeing a high cancellation rate of the jobs, it's just a postponement. The customer still wants those to go on. The assumption that we have because we don't have visibility necessarily into it other than talking the Pros. And anecdotally, the assumption that we have is that, that is holding true throughout the Pro business, and we think that the -- as we see the volume with the Pro pickup, it's an indication that the same thing is happening in their business that's happening in our services business." ] }, { "name": "Richard McPhail", "speech": [ "And to tackle the first part of it. So, if you think about our expense performance and you remove the $850 million of benefit enhancement, Chris, we actually under-spent our expense plan by over $120 million in the quarter. And that is net of the increased operating costs required, whether it's in the form of cleaning or other operating costs. And so, there are gives and takes in that. We're actually quite pleased with our expense performance. And credit to our amazing team -- our amazing store operations team and all our associates out in the field for running the business in this way." ] }, { "name": "Christopher Horvers", "speech": [ "And so, as -- so it doesn't sound like any of that is like a shift in timing, the cost control is something that's in the business." ] }, { "name": "Craig Menear", "speech": [ "It's really one of those -- one of those incidents." ] }, { "name": "Christopher Horvers", "speech": [ "Right. And then, my final question is, I think this is the latest into a Home Depot call, the word weather hasn't coming up -- come up at all, which is always interesting. Can you just talk about the weather that you saw in the first quarter and perhaps even quarter-to-date? Obviously you have the bathtub effect, like so things can push around the shelter-in-place and work-from-home, do you think pull forward some of the seasonal business and any comments on sort of regionality in terms of where the weather has [Indecipherable] is still on the come?" ] }, { "name": "Craig Menear", "speech": [ "Chris, as Ted and Richard described, in the beginning -- in the first seven weeks of the quarter, clearly there was a good early strong beginning of spring. And so, that was a great beginning to the quarter. From there, everything changed. And so, we have no way of extrapolating. At this point, there's probably more demand than you would typically see in a given quarter because people are spending on other things. So, even if there was early purchasing, I'm not sure that has, based on what we're seeing right now, has any impact whatsoever." ] }, { "name": "Christopher Horvers", "speech": [ "Thanks very much. Best of luck." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zachary Fadem", "speech": [ "Hey, good morning. I wanted to clarify the 200 basis point comp impact you called out. Is that the total comp left on the table from lower promo and enhanced social distancing? And do you think there were any offsets here in terms of categories that were pulled forward like lawn and garden or maybe a DIY demand that wouldn't have otherwise occurred?" ] }, { "name": "Craig Menear", "speech": [ "Well, first of all, just to clarify, I didn't say 200 basis points of comp, I would say it's several hundred basis points of comp. You sort of have to think about it as a gross impact. There is no doubt that when we took steps to move our operating hours to close at 6:00 PM, really in advance of a lot of the shelter-in-place orders out there, we knew it would have a significant impact on sales. It did, but if you -- and then if you think about customer account limits, you had a similar impact. It's very hard though to dissect what offsets were to that. I would just tell you that we know the gross impact would have been in the several hundred basis points of comp." ] }, { "name": "Zachary Fadem", "speech": [ "Got it. And then, at the gross margin line, could you walk through the moving parts in a little more detail around the lower impact of fewer promotional events as well as the mix shift to online sales, and to what extent that had a negative impact that you think could fade as consumers go back into your stores?" ] }, { "name": "Craig Menear", "speech": [ "With respect to mix, it was -- it was really more about product mix. You think about growth in certain categories like appliances and lumber that had a mix impact. Beyond that, we run this business as a portfolio. And if you think about interconnected sales, over 60% of the sales ordered on homedepot.com were picked up in our stores. And so, that margin profile is, in essence, we have one company margin profile. We -- our goal is to ensure that our customers can order product the way they like and to fulfill it in the way they're choosing. So, we -- aside from those few categories, let's say, that was the most significant impact in the quarter." ] }, { "name": "Zachary Fadem", "speech": [ "Got it. Appreciate the time." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Mike Baker with Nomura. Please proceed with your question." ] }, { "name": "Michael Baker", "speech": [ "Hi. Thanks. First question, and then I'll have a follow-up. But what are you seeing in some of the states that are starting to loosen some of their restrictions now? I understand that you've been open in all states, but some of the areas like your hometown, are you seeing anything significant over the last couple of weeks as they start to open up?" ] }, { "name": "Craig Menear", "speech": [ "Yeah. I mean, we see -- again, as we've shared, our early second quarter sales are strong, and we see that across geographies." ] }, { "name": "Michael Baker", "speech": [ "So, can I interpret from that that you're not seeing anything different in states that are starting to open?" ] }, { "name": "Craig Menear", "speech": [ "I mean, everything is lifting. And as you can imagine, where you still have hotspots, there is still pressure. But everywhere else, it's lifting." ] }, { "name": "Michael Baker", "speech": [ "Okay. Understood. And if I could ask one more follow-up, just a bit more color in some categories. I don't -- unless I missed it, I don't think I did, but usually give a little bit more detail on some categories. Lawn and garden and paints -- DIY paint -- are two that I was particularly interested in. And if you think are presumably they were strong, I guess I'll let you tell me that, but if so, do you think there was a pull forward or does that sort of fade over time? Thanks." ] }, { "name": "Craig Menear", "speech": [ "No. We actually didn't call that out, because it's kind of not relevant. When you look at the changes in the three segments of business, there is wild swings like I shared both month-to-month, week-to-week, category-to-category, so we just -- we didn't call that out." ] }, { "name": "Michael Baker", "speech": [ "Okay. Thanks. Appreciate the color." ] }, { "name": "Isabel Janci", "speech": [ "And Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question will come from the line of Greg Melich with Evercore ISI. Please proceed with your question." ] }, { "name": "Greg Melich", "speech": [ "Hi, thanks. Richard, I had a follow-up. Thanks for the breakdown of the $850 million, and you mentioned digital margins are part of the company. Is it fair to say that even on the dot-com, the part that is in focus, that you make money on digital? And then, the second question is really for Craig. Given on the sort of period of volatility in your balance sheet, etc, how are you thinking about incremental investments whether they be at the company or M&A or strategic, given what's going on out there and the opportunities that might arise? Thanks." ] }, { "name": "Richard McPhail", "speech": [ "On the margin question, we don't split that out, but I can tell you, we're very happy with our business across the portfolio." ] }, { "name": "Craig Menear", "speech": [ "And as it relates to investment, starting with our strategic investment, we feel like we're investing in the right places for sure. We're going to continue to evaluate as we learnt in this and see if there is any modifications or tweaks that need to happen in terms of our approach, but we feel like we're in the right places. Clearly we postponed some of the things that impact the stores because we don't want to create more disruption in the stores right now. And we'll bring them back when it's appropriate to be able to do that in our stores.", "I mean, as far as our approach to anything else beyond that, we've shared all along that our M&A approach is around capabilities that would be our continuing thought process and approach. I candidly can't imagine anybody doing an M&A in this environment right now, because I'm not sure how a Board would ever value what you're paying for something, but that's our approach. I mean, our thought process has stayed the same that we would always look for capabilities." ] }, { "name": "Greg Melich", "speech": [ "That's great. Good luck." ] }, { "name": "Craig Menear", "speech": [ "Thank you." ] }, { "name": "Greg Melich", "speech": [ "Great job." ] }, { "name": "Isabel Janci", "speech": [ "So thank you for joining -- sorry. Christine, go ahead." ] }, { "name": "Operator", "speech": [ "I was going to just turn the floor back over to you, Ms. Janci, for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "So,thank you for joining us today. We look forward to speaking with you on our second quarter earnings call in August." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
HD	2023-05-16	[ { "description": "Vice President, Investor Relations and Treasurer", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, President, and Chief Executive Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Billy Bastek", "position": "Executive" }, { "description": "-- Executive Vice President, U.S. Stores and International Operations", "name": "Ann-Marie Campbell", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steven Zaccone", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "KeyBanc Capital Markets -- Analyst", "name": "Brad Thomas", "position": "Analyst" }, { "description": "Executive Vice President, Outside Sales and Service", "name": "Hector Padilla", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Barclays -- Analyst", "name": "Seth Sigman", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steven Forbes", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to The Home Depot first-quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded.", "It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Christine, and good morning, everyone. Welcome to Home Depot's first-quarter 2023 earnings call. Joining us on our call today are Ted Decker, chair, president, and CEO; Billy Bastek, executive vice president of merchandising; Ann-Marie Campbell, executive vice president of U.S. stores and international operations; and Richard McPhail, executive vice president and chief financial officer.", "Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors, and as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our Investor Relations Department at (770) 384-2387. Before I turn the call over to Ted, let me remind you that today's press release and presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.", "These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentations will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thank you, Isabel, and good morning everyone. Over the past three years, we grew our business $47 billion, or 43%. After this period of unprecedented growth., we expected demand would moderate in fiscal 2023, which our first-quarter results reflect. Sales for the first quarter were $37.3 billion, down 4.2% from the same period last year.", "Comp sales declined 4.5% from the same period last year, and our U.S. stores had negative comps of 4.6%. Dilutedearnings per sharewere $3.82 in the first quarter, compared to $4.09 in the first quarter last year. Our sales for the quarter were below our expectations, primarily driven by lumber deflation and unfavorable weather, particularly in our western division as extreme weather events in California disproportionately impacted our results.", "As you will hear from Billy, where weather was favorable, we saw strength in key spring-related categories such as live goods and other garden-related categories. As we look beyond weather and lumber deflation, our underlying performance in the quarter was mixed. We saw more pressure across the business compared to what we observed when we reported fourth-quarter results a few months ago. While there was relative strength in project-related categories like building materials, plumbing, and hardware, we had many departments with negative comps in the quarter and continue to see pressure in a number of big-ticket discretionary categories.", "DIY customers outperformed the pro in the quarter, but both were negative. All internal and external surveys suggest that pro backlogs are still healthy and elevated. Relative to historical norms, they are lower than they were a year ago. Additionally, recent external data point suggests that the types of projects in these backlogs are changing from large-scale remodels to smaller projects.", "Though we are only one quarter into the year, we believe the underperformance this quarter relative to our expectations, lumber deflation, and continued uncertainty around underlying demand were in some more cautious sales outlook for the remainder of the year. Richard will take you through the details in a moment, but we are now guiding to a comp sales decline between 2% and 5%. Reflecting this updated comp guidance, we now expect our operating margin rate to be between 14.3% and 14%, and earnings per share to decline between 7% and 13%. We continue to navigate a unique environment.", "We remain agile and respond to evolving customer dynamics while always being an advocate for value. In addition, we feel confident in the investments we have made in wage are driving the intended results. As Ann will discuss, in the short time frame since our most recent wage enhancements took effect, we are attracting a greater number of qualified applicants and attrition is down. Lastly, and as you would expect, we will continue to focus on driving productivity and efficiency across the business.", "While the near-term environment is uncertain, we remain bullish on the medium to long-term outlook for home improvement and our ability to grow share in this large and fragmented market. We look forward to sharing our perspective on the many opportunities ahead when we meet at our Investor and Analyst Conference coming up on June 13th. Our team continues to focus on what is most important. Our associates and customers, our merchants, store and MET teams, supplier partners, and supply chain teams did an outstanding job delivering value and service to our customers throughout the quarter.", "I'd like to close by thanking them for their dedication and hard work. I'd also like to introduce Billy Bastek who was recently named EVP of merchandising. Billy is a 33-year veteran of The Home Depot and brings tremendous experience to the role, having spent his entire career with us in various roles of increasing responsibility throughout the merchandising organization. Not only is Billy a world-class merchant and leader, he's also a fantastic steward of our culture, and it's my pleasure to welcome him to the call today." ] }, { "name": "Billy Bastek", "speech": [ "Thank you, Ted, and good morning, everyone. I want to start by also thanking all of our associates and suppliers, partners for their ongoing commitment to serving our customers and communities. As you heard from Ted, during the first quarter, our sales were below our expectations, primarily driven by lumber deflation and unfavorable weather. We also saw a continuation of the trend we observed in the fourth quarter with consumers pulling back on big-ticket and some discretionary-type purchases.", "However, where weather was favorable, we saw strength in smaller-ticket outdoor projects. Turning to our department comp performance for the first quarter. Four of our 14 merchandising departments posted positive comps, which were building materials, hardware, plumbing, and millwork. During the first quarter, our comp average ticket increased 0.2% and comp transactions decreased 5%.", "Excluding core commodities, comp average ticket was primarily impacted by inflation across several product categories, as well as the demand for new and innovative products. Deflation from core commodity categories negatively impacted our average ticket growth by approximately 335 basis points during the first quarter, driven primarily by deflation in lumber. During the first quarter, we saw a significant decline in lumber prices relative to a year ago. As an example, on average, framing lumber was approximately $420 per 1,000 board feet, compared to approximately $1,170 in the first quarter of 2022, which is a decrease of 64%.", "Turning to total company online sales. Sales leveraging our digital platforms decreased approximately 2.9% compared to the first quarter of last year. For those customers that chose to transact with us online during the first quarter, over 45% of our online orders were fulfilled through our stores. DIY customers outperformed the pro in the quarter, but both were negative.", "Pro results experienced a disproportionate impact as a result of lumber deflation and a wet start spring -- a wet start to spring negatively impacted both customer cohorts. Big-ticket comp transactions, or those over $1,000, were down 6.5% compared to the first quarter of last year. We saw some big-ticket strength across pro heavy categories like portable power, gypsum, and pipe and fittings. After a couple of years of unprecedented demand in the home improvement market, we continue to see softness in big-ticket discretionary categories like patio, grills, and appliances that likely reflects deferral of the single-item purchases in pull forward.", "In addition, we've seen demand soften across other parts of the business including flooring, kitchen, and bath. This softer demand may reflect consumers moving away from larger to smaller projects. And while there are factors impacting the home improvement market, our merchandising organization will continue to focus on being our customers' advocate for value. This means continuing to provide a broad assortment of best-in-class products that are in stock and available for our customers when they need it.", "We will also continue to lean into products that simplify the project, saving our customers time and money. That's why I'm so excited about the innovation we're bringing to the market, whether it's Leviton's Decora Edge, Viega copper press fittings, or the launch of BEHR DYNASTY exterior paint, just to name a few. At our upcoming investor conference, I look forward to sharing more about these products and some of my favorite product innovations with you in person. It's the power of our vendor relationships, coupled with our best-in-class merchant organization, that allows us to offer our customers the best brands with the most innovation to solve pain points, increase functionality, or enhance performance at the best value in the market.", "Now let's turn our attention to spring. While we've had a slower start to the season, we continue to be excited about the lineup of products we have for our customers and remain ready to help them with their outdoor projects or outdoor living needs. As you've heard us say many times, we have a great lineup of outdoor power products, and our assortment of Ryobi, Milwaukee, DeWalt, and Makita offer something for everyone, building on an ecosystem of innovative tools powered by the same battery platforms. And our live goods look incredible.", "We're ready for spring with everything from shrubs to a variety of flowers, herbs, vegetables for every type of gardener. With that, I'd like to turn the call over to Ann." ] }, { "name": "Ann-Marie Campbell", "speech": [ "Thanks, Billy, and good morning, everyone. We believe that in order to provide the best customer experience, we must focus on cultivating the best associate experience in retail. Last quarter, I spoke about the investments we have made to make it easier for our associates to succeed at The Home Depot. We also announced that we would be investing approximately $1 billion in annualized compensation for front-line hourly associates.", "Today, I want to update you on key areas of improvement that we've seen thus far. Our ability to attract qualified pools of candidates and hire from the top tier of these pools has improved even in our high volume -- higher-volume stores. And in March, we saw the greatest year-over-year improvement in our attrition rates across all associate tenure cohorts that we have seen in some time. As a result, we are seeing improvements in key customer service metrics, as well as benefits to our operations in the form of consistent staffing and less safety incidents across all our regions.", "These improvements are exactly what we set out to achieve with this wage investment. The consistency and talent of our workforce is an important foundation for driving both customer service and productivity. It also gives us the ability and confidence to accelerate other key initiatives that are yielding positive results with respect to customer service and productivity. We have implemented changes to our order fulfillment processes to drive speed and efficiency when picking and staging orders for customers.", "Historically, we have allocated fulfillment hours based on overall order volume. Now we have transitioned to allocating hours more accurately based on the types of products being picked. Just for example, it takes us less time to pick and stage a paint brush versus a patio set. We are also grouping fulfillment orders in batches so that associates can pick multiple orders at one time.", "We also continue to focus on simplification. We've talked about leveraging the Sidekick application to help associates prioritize the highest-value tasks more effectively. Powered by our machine learning logic. Sidekick directs associates to key base where on-shelf availability is low or outs exist.", "Since Sidekick was rolled out last year, we have seen improvement in all on-shelf availability for all SKUs, but we've seen the most improvement in our high-velocity SKUs or the products that are key drivers of our business. This has translated to an increase of approximately 300 basis points in our shelf availability customer service scores. While this app is helping us to be more efficient with our tasking activity and improving our customer experience in the process, Sidekick is just getting started. These initiatives are just a few examples of the many different types of projects that can drive significant impacts for customers, our associates, and/or shareholders.", "I am so excited about all that our store teams are doing to focus on both the customer and associate experience and look forward to sharing a lot more in a few weeks. None of this would be possible without our amazing associates, and I want to thank them all for what they do every day to take care of our customers. With that, let me turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Ann, and good morning, everyone. In the first quarter, total sales were $37.3 billion, a decrease of approximately $1.7 billion, or 4.2 %, from last year. During the first quarter, our total company comps were -4.5% with comps of -2.5% in February, -7.5% in March, and -3.7% in April. Comps in the U.S.", "were -4.6 % for the quarter with comps of -2.8% in February, -7.5% in March, and -3.7% in April. Our first-quarter comp sales missed our own expectations, particularly in the months of March and April, driven primarily primarily by two notable factors. First, lumber deflation drove a negative comp impact of approximately 220 basis points versus the first quarter of 2022. Second, unfavorable weather, particularly in our western division, further impacted our results.", "In the first quarter, our gross margin was 33.7%, a decrease of eight basis points from the first quarter last year, primarily driven by increased pressure from shrink. We continue to successfully offset supply chain and product cost pressures while maintaining our position as the customers' advocate for value. During the first quarter, operating expense as a percent of sales increased approximately 25 basis points to 18.8% compared to the first quarter of 2022. Our operating expense performance during the first quarter reflects the planned compensation increases announced during our fourth-quarter 2022 call, as well as a one-time benefit from a legal settlement.", "Our operating margin for the first quarter was 14.9%, compared to 15.2% in the first quarter of 2022. Interest and other expense for the first quarter increased by $72 million to $441 million due primarily to interest on our floating rate debt, as well as higher debt balances than a year ago. In the first quarter, our effective tax rate was 24.2%, up from 23.9% in the first quarter of fiscal 2022. Our diluted earnings per share for the first quarter were $3.82, a decrease of 6.6% compared to the first quarter of 2022.", "During the first quarter, we opened two new stores, bringing our total store count to 2,324. Retail selling square footage was approximately 241 million square feet. At the end of the quarter, merchandise inventories were $25.4 billion, essentially flat compared to the first quarter of 2022, and inventory turns were 3.9 times, down from 4.4 times last year. Turning to capital allocation.", "After investing in our business and paying our dividend, it is our intent to return excess cash to shareholders in the form of share repurchases. During the first quarter, we invested approximately $900 million back into our business in the form of capital expenditures. And during the quarter, we paid approximately $2.1 billion in dividends to our shareholders, and we returned approximately $3 billion to shareholders in the form of share repurchases. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 43.6%, down from 45.3% in the first quarter of fiscal 2022.", "Now I will comment on our guidance for fiscal 2023. As you may recall, last quarter, we provided flat sales and comp guidance for fiscal 2023. As we mentioned last quarter, our guidance did not include potential impacts from lumber deflation, which we noted, could negatively impact our performance for the quarter and the year. As a result, lumber negatively impacted comps by approximately 220 basis points in the first quarter.", "Given the negative impact to the first-quarter sales from lumber and weather, further softening of demand relative to our expectations, and continued uncertainty regarding consumer demand patterns, we are updating our guidance to reflect a range of potential outcomes. We now expect fiscal 2023 sales and comp sales to decline between 2% and 5%. As a result of the change in our sales outlook, we are now targeting an operating margin between 14.3% and 14% for the year. Our effective tax rate is targeted at approximately 24.5%.", "We expect interest expense of approximately $1.8 billion, and we are anticipating between a 7% and 13% decline in diluted earnings per share compared to fiscal 2022. As Ted mentioned, we expected 2023 to be a year of moderation in the home improvement market driven by monetary policy actions to dampen overall consumer demand. In our view, we are in a transitional period in the consumer economy. Setting the short-term impacts of monetary policy aside, we know that the home improvement customer is healthy.", "And we believe the medium to long-term underlying fundamentals of home improvement make it one of the most attractive markets in retail and the economy as a whole. We believe that we are well positioned to meet the needs of our customers with a broad assortment of products, strong in-stock levels, and knowledgeable associates. The investments we've made in our business have enabled agility in our operating model. As we look forward, we will continue to prudently invest to strengthen our competitive position, leverage our scale and low-cost position to outperform our market and deliver shareholder value.", "Thank you for your participation in today's call. And, Christine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conducting a question-and-answer session. [Operator instructions] One moment, please, while we poll for questions. Thank you.", "Our first question comes on the line of Chris Horvers with J.P. Morgan. Please proceed with your questions." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, everybody. So, I have two questions. On the ticket side, average ticket was flat in the first quarter.", "I think, last year, you had same SKU inflation, ex-commodity, of about high single digits all year. So, how much of the ticket deceleration relative to 1Q last year was just simply a same SKU disinflation on a year-over-year basis versus, you know, things like project size and trade-down?" ] }, { "name": "Ted Decker", "speech": [ "Hey, Chris, good morning. You know, we -- we are still seeing inflation in same SKU items. So, putting commodity aside that we -- we gave the example of lumber being down 64%, we're still experiencing inflation in our ticket and our average unit retail. So, the -- the non-index, so the noncommodity prices, are still lapping cost in price from last year.", "And then, there's still moderate inflation, you know, live this year in 2023. So, inflation is still present in the average ticket." ] }, { "name": "Chris Horvers", "speech": [ "So -- so, as you look ahead, how are you thinking about how much of a headwind that becomes over the year and what did you incorporate in the guidance? And then related to that, you know, transactions are sort of back to '19 levels, but in the first quarter, ticket's still up 37% versus the first quarter of '19. I'm guessing maybe a third of that is same SKU. So, just trying to put in a context the risk around ticket in terms of disinflation and then also, you know, project size and trade-down." ] }, { "name": "Ted Decker", "speech": [ "Right. Well, you know, it's something we clearly look at carefully. There certainly has been a lot of cumulative inflation in price, in our average unit retail, in our ticket, but that is not something that we are expecting to broadly deflate. Now commodity prices, those -- those price essentially weekly, and we will price those up or down on a weekly basis.", "But price levels in a number of our products, you know, have increased and been established over the past three years. Embedded in that higher ticket is innovation. So, when you think of -- of ticket, a lot of that is not just cost and price; it's trading up to -- to better product when you think of battery-powered outdoor power equipment, what we've done in the paint department with better and better paints. There's innovation, and with innovation, it's usually higher price points.", "So, we don't see those deflating broadly as -- as we we work through this period of moderation." ] }, { "name": "Chris Horvers", "speech": [ "I guess just in terms of, do you think -- you know, if you sort of look at the trend on project size, does that become -- you know, will that cause ticket to become negative over the year, is that how you're thinking about it?" ] }, { "name": "Ted Decker", "speech": [ "I wouldn't say over the years. Certainly, right now, we are seeing two of the biggest factors on -- on each of ticket and transaction is, as we said, we have specific, you know, discretionary items. You know, best -- best examples are things like a grill, a patio set, and appliance, those tend to be one-off discretionary items. And we are seeing pressure in those.", "We've been seeing pressure on those for some time. What was newer, in our observations this quarter, is that while projects are still strong and pro project backlog is still elevated, the size of the projects are getting a bit smaller. And it could be that the projects being deferred or it could be that the project is being broken up into chunks. So, whether -- you know, rather than do an entire room or an entire basement, you start working away at it in smaller smaller chunks, and that clearly, you know, impacts items per basket in overall activity." ] }, { "name": "Chris Horvers", "speech": [ "Got it. Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Zaccone with Citi. Please proceed with your question." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Good morning. Thanks for taking my question. I was hoping you could comment a bit on what you're seeing in the second quarter to date, just given the fact that weather has been so volatile across the U.S.", "And then, just in the context of that, how should we think about second quarter maybe versus the back half of the year? What can kind of get you to the high end versus the low end of your full-year guidance range?" ] }, { "name": "Richard McPhail", "speech": [ "Sure. Well, thank you. Thank you, Steven. So, the first two weeks of May are in line with the guidance we've provided.", "We don't break out quarterly guidance, but the two first -- the first two weeks are consistent with the guidance we provided. We're going to learn a lot over the next few weeks with respect to underlying demand as we still have some of our largest-selling weeks ahead of us. If you -- if you think about what -- what our guide implies from a shape of the year, first, let's -- let's perhaps talk about the building blocks of our range. So, how we got to the negative two to the negative five, and then we'll talk about the shape of the year.", "The negative two was really built on flowing through the Q1 performance, adding the Q1 lumber impacting the guidance, adding a little further lumber pressure that we'll see in Q2. We think that there could be 120 basis points of comp pressure in Q2 based on current lumber price. And then that negative two scenario also reflects our share of PCE which shifted at a more accelerated rate than expected in the first quarter, sort of holding at that rate for the rest of the year. So, those are the underlying assumptions in the negative two.", "The negative five case simply takes that PCE share shift assumption, our share of PCE, and assumes that we revert back to 2019 levels of PCE share by the end of the fiscal year. So, that would -- that would imply the -5% case. When we talk about the shape of the year, for the -- for the negative two, high end of the range, we would expect that the second half would be better than the first half really due to normal -- lumber normalization in the second half on a year-over-year basis. The vast majority of lumber pressure year over year exists in that first half.", "So as that normalizes in the negative two case, second half improves versus the first half. In the lower end of our range, we would expect the first half would outperform the second half, again, due to that assumption of continued acceleration in our share of -- of PCE." ] }, { "name": "Steven Zaccone", "speech": [ "Great. Thanks for all the detail on that. And then, I wanted to follow up on the comment about this being a transitional period for the consumer. And the context of the question is, how do you think about this year as the potential trough in demand for home improvement versus it potentially being a multiyear trend and maybe 2024 is another step down? And I know you'll have a -- there's a lot of moving pieces and you'll have an Analyst Day in a month, but if you could comment on that at all, be helpful." ] }, { "name": "Ted Decker", "speech": [ "Yeah, why don't I just, you know, take it up a bit on on the consumer and their health and then their engagement in home improvement? If you look at the consumer overall, you know, they're still relatively strong as evidenced by continued increases in personal consumption. And then, when you look at our customer -- I mean we have -- we have one of the best customer sets, you know, in any market sector. Our -- our customer, you know, is stronger than -- than the overall consumer when you think they tend to have good jobs, increasing wages, and own their homes. And collectively, those home values have increased by about $15 trillion since 2019.", "So, as we said, we grew disproportionately these past few years, $47 billion in growth, 43% cumulative comp, as consumers shifted their spending, as these healthier consumers shifted their spending into home improvement. And undoubtedly, after that period of growth, you're going to -- you're going to see moderation, which is exactly what we saw in Q1. So, when you -- when you think about what this reflects about the consumer in the future engagement in home improvement, you know, think about a few -- a few things. We've seen an accelerated shift out of goods to service spending as the broader economy has gotten back to normal, and that's, in particular, in home improvement.", "Obviously, people aren't spending all their time at home as they did in the prior few years. And then, there's an impact of pull forward or deferral of certain categories, like I spoke about earlier, appliances, patio grills that saw, you know, outsized growth in the early years of the pandemic. And then, a newer dynamic now that -- that we're really seeing again this just this past quarter is a more cautious consumer given the broader macro concerns, including credit availability. And that aligns with what we're observing in our business, in the comments I made about our pros, in consumers taking on smaller, less discretionary projects.", "And then, lastly, with the buildup of inflation that we've seen, there's certainly some price sensitivity, particularly with respect to those bigger-ticket discretionary items. So, in general, our homeowner consumer is -- remains very healthy. It's a matter of digesting the outsized growth in shift of consumption spend out of services into goods and, particularly, into home improvement. So, we'll get through this -- this period.", "Richard's talked about the PCE normalization. It -- we don't know where that ends or how quickly it goes. There's an argument that PCE and home improvement stays elevated, all the reasons we've talked about before, the home values are so much higher, the age of the home is -- is considerably older on average, people are spending more time at home. So, all those dynamics could suggest, you know, normalization might be, in fact, a higher level of PCE spending in our sector.", "But regardless of all that, we'll get through this -- this transition period, and we remain incredibly bullish on the health of this sector. It's one of the absolute best sectors in all of retail. It's a large and fragmented market, and we have tremendous growth opportunities going forward." ] }, { "name": "Steven Zaccone", "speech": [ "Thanks for all the detail. Best of luck for the remainder of spring." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. Can you help us bridge the gap from the 15.3% EBIT margins last year to the 14 to 14.3 today? And specifically, how should we think about the moving parts around gross margin versus SG&A? And then, specifically for -- for Q1, cost controls were a bit better than expected. Can you talk us through the impact of the legal settlement and anything else you'd highlight there?" ] }, { "name": "Richard McPhail", "speech": [ "Yes, Zach, thank you for -- thank you for the question. So, let's first walk from 15.3, which is our actual operating margin in 2022, to our original guide of 14.5% margin. At a flat comp, particularly in an inflationary environment, our business will see a degree of deleverage in expenses. And so, really, three factors: natural deleverage in the business; a $1 billion investment in wage which has proven to, as Ann said, provide real benefit from a customer experience point of view; and then, productivity initiatives designed to offset some of that deleverage.", "And so, when you net all those three against each other, that led to our guide of 14.5% of flat comp. As we reflect on the revision to guidance, the range of operating margin that we have guided toward reflects the natural operating margin at these negative comp levels. In other words, there -- there is -- there are levers that help blunt deleverage, but there is deleverage still in our model. The greatest mitigator is that we have an activity-based payroll model.", "And so, as activity in our stores decreases, so does our lever -- sorry, our level of payroll. So, you do have a natural buffer there. But again, the 14.3 to the 14.0 would be the natural operating margin at the negative two and the negative five. When we think about the -- the one-time legal settlement, so we did realize a large one-time benefit from a legal settlement.", "Our guidance assumes this benefit will be offset during the remainder of the year, and so that's just a simplified assumption. We will protect that 14% operating margin. We'd agree with -- operate with a degree of financial flexibility. And as the year progresses, we'll be evaluating the levers available to us against the backdrop of the environment." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Appreciate the color. I've got a big-picture question. Could you talk about the macro and housing indicators that you believe are now most correlated to your business today? And then, considering the golden handcuffs of sub-3% mortgages out there, do you think this takes longer now for housing turnover to materially recover?" ] }, { "name": "Richard McPhail", "speech": [ "Well, I'll take the second one first. You know, we've already seen the impact to housing turnover. I think that we've probably fully seen the impact of higher mortgage rates on -- on potential sellers. In this environment, if you have a low fixed-rate mortgage -- and let's just remind ourselves, 40% of owner-occupied homes are owned outright.", "And of the households that hold a mortgage, close to 90% of those hold fixed rate mortgages under 5%. So, with mortgage rates where they are today, there's a reluctance to sell your home, and there is a greater incentive to stay in place and improve in place. And as Ted said, you're spending more time at home and that home is getting older, and you do not have an incentive to sell and take on a higher-rate mortgage. So, I think we've already seen that in housing turnover.", "With respect to macro indicators, I think -- as Ted said, I think what we're seeing in the business now is reflective of the broader impact of tighter monetary policy and tighter credit conditions. You know, it's interesting, as we saw the quarter unfold, if you look at at how we did during February, our business was actually trending quite positively. In fact, February's dollar run rate adjusted for normal seasonal curves would have implied a positive comp for the year. When you think about March, well, first of all, March was impacted by extreme weather, most notably in California.", "And, you know, that was also the point where we saw accelerating share shift. There were some external factors there that maybe don't have direct influence, but as you know, in March we saw the collapse of SVB. And you think about the tighter credit conditions that -- that were a result of of the external environment. We think all of those just build to a broader -- a broader caution among consumers.", "As Ted said, our homeowner customer is extremely healthy, very healthy balance sheet, healthy income. This is a broader consumer economy dynamic we think we're seeing." ] }, { "name": "Zach Fadem", "speech": [ "Thanks, Richard. I appreciate all the color." ] }, { "name": "Richard McPhail", "speech": [ "Thanks, Zach." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thanks a lot for taking my question. As you look across your entire assortment and trying to set current unit demand versus what would be a normalized rate, how many product categories are still well above what would be suggested by a normalized rate? Perhaps if you look at appliances, grills, and patio furniture, and where units are today versus 2019 and extend that math to the rest of the business, what would that suggest about a downside comp scenario even from here?" ] }, { "name": "Ted Decker", "speech": [ "Michael, great question. I wouldn't say we've gone into that level of detail by -- by category. Certainly, a number of those categories were -- were elevated, the ones you called out, patio grills, appliances were elevated on retails with innovation, as well as as units with -- with outsized demand. I think, you know, you think of normal replacement cycles and pull forward on some of that product, that's just going to take a little little bit of time to -- to normalize.", "Other categories that we haven't talked so much about that are that are really booming, frankly, are categories like building materials, where, you know, we're seeing unit volume still -- still running quite strong. We see units in lumber picking up meaningfully as prices come down and you get attachment with building materials. And then, hardware, which attaches to -- to both building materials, in lumber, we're seeing our strongest hardware unit productivity. And attach rate to those project-starter categories, I think, Billy, it's the highest attach rate we've ever recorded." ] }, { "name": "Billy Bastek", "speech": [ "Yeah, that's right. You know, think about our building materials performance, we call that out as outperform, along with lumber, still seeing great unit productivity across those businesses and seeing the attached smaller, certainly smaller projects taking place. And then, Ted did mention some of the -- you know, we did see some pull forward in some of those -- those businesses that we -- we talked about initially as well." ] }, { "name": "Michael Lasser", "speech": [ "My follow-up question is if we consider 2023 to be the transition year and comps for The Home Depot do return to growth in 2024, would you start seeing leverage on your expenses on the first dollar of growth? Or will there be some catch-up like, Richard, you mentioned this legal expense, you expect to give back some of that over the course of this year. Presumably, there'll be an incentive comp benefit as you lowered your guidance. So, will you see some of those items come back next year such that if we have in our models a positive comp, we wouldn't necessarily expect you to leverage your expenses on the first dollar of growth next year?" ] }, { "name": "Ted Decker", "speech": [ "Well, we'll -- we'll get into a bit more detail on -- on outlook in 2024 when we get together in June for the investor conference. You know, we're not -- we're not modeling 2024 to that level of specificity as we're only a few months into 2023. But broadly, Michael, you know, our model is meant to leverage and will leverage with volume. And, you know, we have some costs to take out of the business for sure, you can think on -- on the product side.", "With transportation in particular, you'll -- you'll -- you'll see significant costs come out as we work through our current inventory levels with the higher transportation rates experienced during COVID. And then, on the operating model, the store and labor, that will always leverage with growth." ] }, { "name": "Richard McPhail", "speech": [ "And obviously, you know, we manage costs and price independently, Michael, and transportation costs are a market dynamic. And so, you know, we'll make sure that we're positioned as the customers advocate for value with respect to price. But as Ted said, we'll get -- we'll get more into this in 2023 -- or sorry, in June -- June 13th." ] }, { "name": "Michael Lasser", "speech": [ "Can I just clarify what that -- that comment is intended to say? Because one of the debates is costs have come down, whether transportation costs, certain raw materials, so there's a question of whether that means there's going to be like-for-like product deflation in noncommodity-related areas over the course of this year. And it sounds like Home Depot is going to continue to be an advocate for growth, but how would you clarify that? For -- advocate for value, sorry." ] }, { "name": "Richard McPhail", "speech": [ "Right. No, again, we -- we manage cost and price independently. As Ted said, we don't expect broad-based deflation in this market." ] }, { "name": "Michael Lasser", "speech": [ "Understood. Thank you very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hi. Good morning" ] }, { "name": "Ted Decker", "speech": [ "good morning." ] }, { "name": "Brian Nagel", "speech": [ "My first question, I know we've discussed a bit already about the weather. I was wondering if you can go in a little more detail on what you saw kind of a spread between -- in comps between markets where weather was an issue and markets where weather may have been more normal. And then, as -- you know, I mean, looking at our data, you know, the spring has come -- you know, has arrived and in a lot of markets. So, what are you seeing then as far as any type of pickup in seasonal categories as -- as the spring-like conditions are starting to take hold?" ] }, { "name": "Ted Decker", "speech": [ "Yeah, Brian, thank you. So, weather, as we said, was most pronounced in the west and very unique weather pattern. This wasn't a bad weekend; this -- this was, you know, record rain and even things like snow in Southern California. So, where -- where weather, you know, was sustained in bad, when we look at the west versus our northern and southern divisions, the impact was a multiple of what we saw in the other parts of the country.", "And generally, we -- we -- we've talked in the past about the bathtub effect and we wouldn't have updated guidance based on -- on stronger or relatively weaker sales in Q1 based on weather because we would look to get that back. So, when you think of of a shorter spring season in the north where people are going to get that activity done in a -- in a limited number of weeks, if you don't get it done in the first quarter, people tend to -- to make it up in the second quarter. The dynamic in the west in -- you know, this one into our -- you know, our guidance of the -2 to -5, is the west. You know, it's more level weather patterns.", "We have very large stores, very high pro concentration. And when you get bad weather, you're not really looking at a bathtub effect to make it up in a short season, you just sort of missed that selling week. So, the difference geographically, you know, was pronounced in the west. And -- and we just look at that as sort of lost selling weeks.", "In the north, you know, the behavior is, you know, more typical to the bathtub. I mean, we didn't have many good weekends, but when we did, you know, sales were incredibly strong. So, we're certainly hoping for better weather in Q2." ] }, { "name": "Brian Nagel", "speech": [ "That's OK. That's helpful -- very helpful. Then my second question, again, recognizing there's lots of moving parts here and you're dealing with varied comparisons through the year. But as you look -- as you think about or as -- you know, the updated guidance for 20 -- for '23 you gave us today, does that basically assume kind of a continuation of what we've seen so far in '23? Or are you assuming some type of either, you know, improvement, further deterioration, etc.", "through the year?" ] }, { "name": "Richard McPhail", "speech": [ "That's right, Brian. That's why we gave the range. I mean, you would say that that, particularly the bottom end of the range, would assume greater deceleration than we've observed to date. And it's consistent with a hypothetical case we laid out at the beginning of the year, which was to say, look, if our share of PCE reverts to 2019 levels by the end of the year, that is what you would see.", "And again, that would be an accelerated rate of reversion versus -- versus what we've seen. So, the negative two, again, sort of has -- it takes into account -- into account the fact that we saw sharper reversion than expected in Q1, and that we would hold that share through the -- through the end of the year. It's not a perfect science and that's why we gave you a range." ] }, { "name": "Brian Nagel", "speech": [ "Great. I appreciate it. Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Thanks, Brian." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, guys. So, Richard, you talked about protecting a 14% operating margin even with the wage investments that you guys have made this year at this point. What other -- I mean, how much flexibility do you think you have on the SG&A line? Because I know labor is your biggest kind of plus bucket, but you're actually investing more in labor, not less. So, like, how should we think about how you guys are managing that component?" ] }, { "name": "Richard McPhail", "speech": [ "Well, the investment in wage, again, which is really proven to have driven a lot of benefit on the customer experience side, that's embedded in our guidance. We've made the investment, and that will be roughly a $1 billion addition to our cost structure, but it's embedded in our margin structure. Again, you know, as the year progresses, we'll be evaluating levers available to us against the backdrop of the environment. We -- we invest to win over the long term.", "We're comfortable with our level of investment as it stands today. We'll continue to assess our investments against the backdrop of the environment, and we have some flexibility there too." ] }, { "name": "Scot Ciccarelli", "speech": [ "And just a quick follow-up, with higher interest rates in the marketplace, does that change how you guys are thinking about capital allocation, not necessarily from a strategic basis but how aggressive you want to be in terms of issuing debt to buy back stock? Thanks." ] }, { "name": "Richard McPhail", "speech": [ "We feel good about where we stand from a debt to EBITDAR perspective. We had a maturity -- a $1 billion maturity in April. And we repaid that, didn't refinance it. We have no -- no need necessarily to go to the debt capital markets in the short term, and we'll watch market conditions as they unfold.", "But we feel good about where we are from a leverage perspective/" ] }, { "name": "Scot Ciccarelli", "speech": [ "Roger that. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from a line of Brad Thomas with KeyBanc. Please proceed with your question." ] }, { "name": "Brad Thomas", "speech": [ "Hi. Thanks for taking my questions. I was hoping you could talk a little bit more about the trends you're seeing in the pro business. I think this is the first time in a few quarters that it had underperformed DIY.", "What are you seeing out of the pro? Has it improved as the weather's gotten better? And how are you thinking about it going forward?" ] }, { "name": "Ted Decker", "speech": [ "Yeah, I'll let Hector talk a bit about the pro and what we like that we're seeing. But from the broadest perspective, don't forget, the pro was disproportionately impacted by lumber, and then, again, a very strong pro-business out west. But we like what we're seeing with our -- with our customers as they engage with our capabilities." ] }, { "name": "Hector Padilla", "speech": [ "Yeah, good morning, Brad. This is Hector. On a two-year basis, our performance was positive. And as Ted just mentioned, and Billy, we saw that disproportionate impact from lumber and weather.", "What we're most excited about is what we're seeing with our pros, who are engaging with our new supply chain assets and expanded pro capabilities that we have. We have talked about in the past, we're gaining share wallet with them and as they're growing their spend with us to have a willingness to consolidate their purchases with The Home Depot, the lumber brand, the lower assortment, and our value proposition, and we're seeing that across many markets. I really look forward to speaking with you in more detail in June about how the pro business is doing and around the capabilities that we're building." ] }, { "name": "Brad Thomas", "speech": [ "Great. And as a quick follow-up, obviously, some moving pieces here with -- with weather and deflation, I believe your prior outlook for the home improvement market was a decline of low single digits. What are you assuming in your new outlook?" ] }, { "name": "Richard McPhail", "speech": [ "So, we, you know -- we began the year with a flat outlook for PCE There are economists who have lifted that outlook slightly for PCE. But as we observe PCE share that our market holds and the shifts that we've seen, we expect our market to be down mid to high single digits. And so, implicit in our guide is the expectation that we'll continue to take share." ] }, { "name": "Brad Thomas", "speech": [ "Great. Thanks so much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Hey, thanks. Good morning, everyone. I want to ask about home prices. There's been a case that's made that demand decoupled a bit from turnover and that prices could matter more.", "I want to ask specifically about how that could inform the cadence of the year, because if you are strict adherent to prices, the lag effect could suggest that the back half core gets a little bit worse. I'm curious how you think about that." ] }, { "name": "Ted Decker", "speech": [ "Well, of all the housing metrics, Simeon, we think home value has the tightest correlation to home improvement spend. Certainly, you know, turnover and household formation also are -- influence the spend. And there's -- there's generally a lag effect, as you say, to home price appreciation or depreciation. I think the difference here is how sensitive are people going to be that I was up 45% in home value from the end of 2019, and yes, now month over month, the values are off slightly, but I'm still up 40% or 38% from where I was at the end of 2019.", "You know, that psychology is -- is tough to -- to -- to weed out with the general, you know, consumer apprehension, given -- given general inflation and macro and rising interest rates and, you know, all the talk are we going to have a recession, are we not going to have a recession. So, I wouldn't think that -- that that would have that big of an impact. We're not thinking that's a big impact in 2H." ] }, { "name": "Simeon Gutman", "speech": [ "OK, that's fair. One more question around the updated guide, for Richard. The midpoint of this -2 to -5, just to clarify, that assumes that the core worsens from Q1 as well as the impact of lumber worsens from Q1?" ] }, { "name": "Richard McPhail", "speech": [ "You can think of the impact of lumber being kind of an assumption that is equal across all cases. It's about 120 basis points of pressure to Q2, and then very, very slight, really nonmeaningful pressure in the second half. And again, we've -- we've given a range, Simeon, to just provide sort of a balanced view here. It's -- it's tough to extrapolate this early in the year.", "And so, we feel like the -- the range approach is the most helpful guidance that we can give." ] }, { "name": "Simeon Gutman", "speech": [ "Right. OK. Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from a line of Seth Sigman with Barclays. Please proceed with your question." ] }, { "name": "Seth Sigman", "speech": [ "Hey, everybody, good morning. I wanted to follow up on that assumption that home improvement wallet share will normalize back to 2019 levels. I mean, obviously, that implies things get worse from here. But I guess there's also been some prior cycles where wallet share overshoots on the downside and goes lower than where it was before.", "And we talked a lot about pull-forward already today, but how do you think about that scenario and why that scenario would be wrong this time?" ] }, { "name": "Ted Decker", "speech": [ "Well, you know, as we've said, we've given the guide for -- for our best -- best view of 2023. And the downside of a minus five would be that you've reverted by the end of the year to 2019 levels. So, mathematically, you could say, well, there'd be some hangover of that into 2024. And then, your question, does it overshoot? You know, frankly, we -- we don't know.", "As I said earlier, there's as strong a case, if not stronger, that where you settle is a higher share. If based nothing more than your asset class, is -- is so much higher. I mean, we're not -- we're not talking billions of dollars; we're literally talking trillions of dollars that this asset class has more value. So, if you're thinking about percent of -- of investment in any asset class, you've got a much bigger base.", "We talked about the average age of the home is now over 40 years old. And we have big chunks of homes that are reaching that 20-year and 40-year sort of witching hour of age. We all know we're spending more time at home. So, wear and tear is higher.", "So, we've talked about all these dynamics in the past. And I'd say if you had to call it, you would say the spend would ultimately settle out potentially higher." ] }, { "name": "Seth Sigman", "speech": [ "OK, fair enough. Just want to follow up on the EBIT margin guidance for this year. I think what you laid out here at the low end, so 14 % margin on negative midsingle-digit comps, very consistent with the scenarios you talked about last quarter, but it does include that Q1 SG&A benefit. Can you just help us better understand, does that imply the underlying? It's actually lower? I think you may have said there's an offset to that.", "Maybe you can just clarify that point. Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Thanks for the question. To clarify, it's not assuming that the underlying would be lower. Our guide actually assumes that that gain would be offset through the remainder of the year." ] }, { "name": "Seth Sigman", "speech": [ "OK. Thanks very much." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question will come from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steven Forbes", "speech": [ "Good morning. Just wanted to follow up on lumber trends. You made a comment about price deflation. Curious if you could talk about what specifically happened with unit volume during the quarter, and then what the guidance assumes in the back half as the price compares ease in terms of unit expectations right in the second half." ] }, { "name": "Billy Bastek", "speech": [ "Yeah, thanks, Steven. This is Billy. You know, as we talked about, Richard mentioned in his previous comments, we do anticipate the greatest pressure from lumber in the first half. For the total year, we think lumber deflation impact to the comp is about 100 basis points.", "Now with that, we're seeing, you know, strong unit movement across, you know, plywood, dimensional lumber, PT decking. You know, it's 220 basis points, as we mentioned in Q1, another 120 basis points roughly in Q2, which is in the guide. And then, we don't expect a material impact from lumber for the back half of the year but still seeing really strong unit performance in the category as they called out." ] }, { "name": "Steven Forbes", "speech": [ "And so, maybe just -- so -- so, you do expect unit volume to improve in the back half? Or what is sort of the trajectory of unit dynamics right with lumber specifically implied in the guide?" ] }, { "name": "Billy Bastek", "speech": [ "Well, as -- as the pricing normalizes year over year, you'll see -- you know, you'll see the units reflect in that as we get toward -- toward a more rational state that we had in the back half of last year." ] }, { "name": "Steven Forbes", "speech": [ "And then, just a quick follow-up, any -- any sort of preview of what we should expect at the upcoming Analyst Day? I think made a comment before potentially about speaking to 2024, but I wasn't sure if you can maybe clarify any sort of preview thoughts on what we should expect to hear at the Analyst Day." ] }, { "name": "Isabel Janci", "speech": [ "Thanks for that question, Steve. I think what you'll hear us talk about is the -- the updated TAM that we will lay out for you, our growth opportunities to go after that TAM, and a little bit more about why we're so excited about the sector and the business." ] }, { "name": "Steven Forbes", "speech": [ "Thank you." ] }, { "name": "Isabel Janci", "speech": [ "You're welcome." ] }, { "name": "Operator", "speech": [ "Thank you. Ms. Janci, I would now like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thanks, Christine, and thanks, everybody, for joining us today. We look forward to speaking with you at our Investor Conference on June 13th." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
HD	2023-11-14	[ { "description": "Vice President, Investor Relations", "name": "Isabel Janci", "position": "Executive" }, { "description": "Chairman, President, and Chief Executive Officer", "name": "Ted Decker", "position": "Executive" }, { "description": "-- Executive Vice President, U.S. Stores and International Operations", "name": "Ann-Marie Campbell", "position": "Executive" }, { "description": "Executive Vice President, Merchandising", "name": "Billy Bastek", "position": "Executive" }, { "description": "Executive Vice President, Chief Financial Officer", "name": "Richard McPhail", "position": "Executive" }, { "description": "Morgan Stanley -- Analyst", "name": "Simeon Gutman", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Zach Fadem", "position": "Analyst" }, { "description": "Truist Securities -- Analyst", "name": "Scot Ciccarelli", "position": "Analyst" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Chris Horvers", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Michael Lasser", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Steve Zaccone", "position": "Analyst" }, { "description": "Senior Vice President, Outside Sales", "name": "Chip Devine", "position": "Executive" }, { "description": "Oppenheimer and Company -- Analyst", "name": "Brian Nagel", "position": "Analyst" }, { "description": "Robert W. Baird and Company -- Analyst", "name": "Peter Benedict", "position": "Analyst" }, { "description": "D.A. Davidson -- Analyst", "name": "Mike Baker", "position": "Analyst" }, { "description": "Guggenheim Partners -- Analyst", "name": "Steve Forbes", "position": "Analyst" }, { "description": "AllianceBernstein -- Analyst", "name": "Dean Rosenblum", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Greetings and welcome to The Home Depot's third-quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded.", "It is now my pleasure to introduce your host, Isabel Janci. Please go ahead." ] }, { "name": "Isabel Janci", "speech": [ "Thank you, Kristine, and good morning, everyone. Welcome to Home Depot's third-quarter 2023 earnings call. Joining us on our call today are Ted Decker, chair, president, and CEO; Ann-Marie Campbell, senior executive vice president; Billy Bastek, executive vice president of merchandising; and Richard McPhail, executive vice president and chief financial officer. Following our prepared remarks, the call will be open for questions.", "Questions will be limited to analysts and investors. And as a reminder, please limit yourself to one question with one follow-up. If we are unable to get to your question during the call, please call our Investor Relations Department at 770-384-2387. Before I turn the call over to Ted, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.", "These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to the factors identified in the release and in our filings with the Securities and Exchange Commission. Today's presentation will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website.", "Now, let me turn the call over to Ted." ] }, { "name": "Ted Decker", "speech": [ "Thank you, Isabel, and good morning, everyone. Sales for the third quarter were $37.7 billion, down 3% from the same period last year. Comp sales declined 3.1% from the same period last year, and our U.S. stores had negative comps of 3.5%.", "Diluted earnings per share were $3.81 in the third quarter, compared to $4.24 in the third quarter last year. The third quarter was in line with our expectations. Similar to the second quarter, we saw continued customer engagement with smaller projects and experienced pressure in certain big-ticket discretionary categories. In addition, lumber and copper and wire deflation and storm-related overlaps negatively impacted results in the quarter. Billy will discuss these and other business trends shortly. During the third quarter, our Pro customer outperformed our DIY customer.", "While internal and external surveys suggests that Pro backlogs are lower than they were a year ago, they are still healthy and elevated relative to historical norms. With only one quarter left in the year, we believe the endpoints for previous guidance range are no longer likely outcomes. As a result, and as we announced in this morning's press release, we narrowed our guidance range for fiscal 2023. Richard will take you through the details in a moment.", "As we've discussed, this year reflects the period of moderation. However, we are confident in our ability to navigate through this unique environment. We remain very excited about our strategic initiatives and are committed to investing in the business to deliver the best interconnected shopping experience, capture wallet share with the Pro, and grow our store footprint. As we discussed at the investor conference in June, we continue to invest in focus on creating a frictionless interconnected shopping experience for our customers. We are pleased with the progress we are making. Homedepot.com is one of the largest retail websites in the United States, and our digital app is one of the most highly rated in all of retail. And yet we believe there's still opportunity to reduce pain points across the shopping journey.", "Our teams are identifying areas of improvement like better communication throughout the shopping journey and easier returns process and the ability to seamlessly and intuitively make changes to an order once placed. For our Pros, we're investing in a multitude of initiatives. We remain focused on building out our unique ecosystem of products and services. As a result, we are evolving our organizational structure and recently elevated Ann-Marie Campbell to senior executive vice president, better aligning our outside sales and service business in the global stores organization. Pro is one of our biggest growth opportunities, and this organizational change will allow us to better serve them by leveraging our full ecosystem of expertise, product assortment, fulfillment, and operations.", "Our merchants, store and MET teams, supplier partners and supply chain teams did an outstanding job delivering value and service to our customers throughout the quarter, and I'd like to close by thanking them for their dedication and hard work. In addition, The Home Depot is proud to have tens of thousands of veteran servicemembers and military spouses in orange aprons. Last week, we announced that The Home Depot Foundation surpassed the goal of $500 million invested in veterans causes and also increased the total commitment to $750 million by 2030. And with that, I'd like to turn the call over to Anne." ] }, { "name": "Ann-Marie Campbell", "speech": [ "Thanks, Ted, and good morning, everyone. Let me start by saying that I'm very excited about my new role and the alignment it will create between the outside sales and services business and the global store organization. As you heard at our investor conference in June, capturing a greater share of the Pros' wallet is one of our largest growth opportunities. It represents roughly $475 billion in addressable market, and today, we have relatively little share. The beauty of The Home Depot is that we have unique competitive advantages: our convenience stores, our leading brands, our engaged associates, our expansive fulfillment options that are on maps and that can be leveraged for the benefit of our customers, and that's exactly what we aim to do.", "To do that, our new organizational structure will create stronger momentum with our teams to drive success with the Pro. Hector Padilla will focus on improving the experience for Pros shopping our stores. His 29-year tenure and knowledge of our store operations and new Pro capabilities will be instrumental in achieving our goals. And Chip Devine, our head of outside sales, brings nearly 30 years of distribution experience. He will work on building out capabilities to better serve more complex product needs.", "Ultimately, we must focus on removing friction within our operations so our customers have a great experience every single time, no matter how they choose to shop with us, whether in the aisles of our stores, picking up product at the store, receiving product at their job site with a sales associate, or digitally. We know that most of our Pros use many of these capabilities across our ecosystem when shopping with us. For us, we are building trust and a partnership that lasts for decades and across generations. This means we have to work hard to deliver a great experience regardless of their point of interaction. As you know, we have identified additional growth opportunities with the Pro, which requires us to invest in new capabilities and functionalities across the business. Think about the initiative we are undertaking with the complex Pro.", "This customer interacts differently. They are accustomed to interacting with their suppliers in a different way than our traditional business model. Pros working on complex projects want to reserve product, use trade credit, and have product delivered to their job site in a staged manner. While these capabilities exist in the market today, we are incorporating them in our full ecosystem to serve Pro customers in a way no one else can. I could not be more excited about the opportunity that lies ahead.", "And for the in-store experience, over the last several years, we have talked about the importance of in-stock and, ultimately, on-shelf availability ,or OSA. Having the right products in stock in the right quantity and on the shelf available for purchase is critical. And we've implemented several initiatives to help us do this more effectively and efficiently. In the past, we've talked about GSR, or get stores right. GSR drives productivity by using our proprietary space allocation model coupled with tenured field merchandising teams to determine which categories to invest in on a store-by-store basis. More recently, we have talked to you about our rollout of Sidekick and computer vision.", "Using machine learning technology, computer vision helps our associates quickly find D-power-sized products in the overhead, and Sidekick helps direct associates to key bays where OSA is low or outs exist. Today, these tools have been deployed across all U.S. stores. And while early days, they have driven meaningful improvement in our on-shelf availability. The beauty of these initiatives is that they also drive productivity.", "They make it easier for associates to restock product, have a greater depth of high-velocity product, and ensure we remain in stock with more product on the shelf and available for sale. As a result, we enable our associates to focus on the most important task and allocate more time to deliver a better shopping experience. These are just a few examples of the many different types of initiatives that can drive significant value for customers, our associates, and our shareholders. Despite a challenging year, our amazing associates have remained engaged and ready to serve our customers, and I want to thank them for all they do. With that, let me turn the call over to Billy." ] }, { "name": "Billy Bastek", "speech": [ "Thank you, Ann. Good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their ongoing commitment to serving our customers and communities. As you heard from Ted, during the third quarter, our sales were in line with our expectations.", "However, we did have some unfavorable impacts from core commodity deflation and storm-related overlaps. We saw a continuation of a trend that we have been observing throughout the year with softness in certain big-ticket discretionary-type purchases. Instead of engaging in larger projects, customers continue to take on smaller projects. Turning to our department comp performance for the third quarter. Our building materials department posted a positive comp, and seven of our remaining 13 merchandising departments posted comps above the company average including plumbing, appliances, hardware, outdoor garden, millwork, tools, and paint. During the third quarter, comp transactions decreased 2.7% and comp average ticket decreased 0.3%.", "Excluding deflation from core commodities, we experienced comp average ticket growth primarily driven by demand for new and innovative products. Deflation from core commodity categories negatively impacted our average ticket growth by approximately 60 basis points during the third quarter, driven by deflation in lumber and copper. During the third quarter, we continued to see a decline in lumber prices relative to a year ago. As an example, on average, framing lumber was approximately $420 per 1,000 board feet, compared to approximately $545 in the third quarter of 2022, representing a decrease of over 20%. Big-ticket comp transactions or those over $1,000 were down 5.2% compared to the third quarter of last year. We continue to see softer engagement in big-ticket discretionary categories like flooring, countertops, and cabinets.", "However, we saw big-ticket strength in pro-heavy categories like roofing, installation, and portable power. Turning to total company online sales. Sales leveraging our digital platforms increased approximately 5% compared to the third quarter of last year. We continued to invest in the digital experience across our website and app and released a variety of enhancements in the third quarter. These range from simple improvements to help customers track orders to more complex things like updating our search and recommendation algorithms.", "For those customers that transacted with us online during the third quarter, nearly half of our online orders were fulfilled through our stores. During the third quarter, we hosted our annual Labor Day appliance and Halloween events and were pleased with the results. In appliances, we were encouraged with the customers' engagement during the event. And 2023 was another record sales year for our Halloween program, both in-store and online, as our customers continue to add to their collection with our unique and exclusive product assortment.", "As we turn our attention to the fourth quarter, we intend to continue this momentum with our annual holiday Black Friday and gift center events. In our gift center, we continue to lean into brands that matter most for our customers with our assortment of Milwaukee, Ryobi, Makita, DeWalt, Ridgid, Husky, and more. We will have something for everyone, whether it's our wide assortment of cordless Ryobi tools, DeWalt Atomic Drill and Impact kits, or our new Milwaukee M18 Forge batteries. These new M18 Forge batteries will be a game changer for our Pro customer, providing the most powerful, fastest charging, and longest life of any battery on the Milwaukee M18 platform. This quarter, I'm also excited to announce the addition of Wago to our powerhouse assortment of Pro brands including Milwaukee, USG, Custom Building Products, Leviton, and QEP, to name a few. It is these strategic vendor relationships that make us the product authority in home improvement, and the addition of Wago will help extend our position. Wago is one of the top requested most innovative programs in the wire connector segment that features a releasable lever lock wire connector that speeds up installation and saves space in tight applications.", "We recently launched a number of SKUs in our stores which are exclusive to The Home Depot in the national big-box retail channel. Our merchandising organization remains focused on being our customers' advocate for value. This means continuing to provide a broad assortment of best-in-class products that are in stock and available for our customers when they need it. We will also continue to lean into products that simplify the project, saving our customers time and money. That's why I am so excited about the innovation we continue to bring to the market. With that said, I'd like to turn the call over to Richard." ] }, { "name": "Richard McPhail", "speech": [ "Thank you, Billy, and good morning, everyone. In the third quarter, total sales were $37.7 billion, a decrease of approximately $1.2 billion, or 3% from last year. During the third quarter, our total company comps were negative 3.1% with comps of negative 2.1% in August, negative 3.4% in September, and negative 3.7% in October. Comps in the U.S.", "were negative 3.5% for the quarter with comps of negative 2.5% in August, negative 3.8% in September, and negative 4.1% in October. In local currency, Mexico and Canada posted comps above the company average. It is important to note that adjusting for storm-related overlaps and some seasonal shifts, monthly comps were relatively consistent across the quarter. In the third quarter, our gross margin was 33.8%, a decrease of approximately 20 basis points from the third quarter last year, which was in line with our expectations. During the third quarter, operating expense as a percent of sales increased approximately 120 basis points to 19.4% compared to the third quarter of 2022. Our operating expense performance during the third quarter reflects our previously executed compensation increases for hourly associates, as well as deleverage from our top-line results. Our operating margin for the third quarter was 14.3%, compared to 15.8% in the third quarter of 2022.", "Interest and other expense for the third quarter increased by approximately $30 million to $438 million. In the third quarter, our effective tax rate was 23.3%, down from 24.4% in the third quarter of fiscal 2022. Our diluted earnings per share for the third quarter were $3.81, a decrease of 10.1% compared to the third quarter of 2022. During the third quarter, we opened seven new stores, bringing our total store count to 2,333.", "Retail selling square footage was approximately 242 million square feet. At the end of the quarter, merchandise inventories were $22.8 billion, down $2.9 billion, or 11%, compared to the third quarter of 2022, and inventory turns were 4.3 times, flat to one year ago. Turning to capital allocation. After investing in our business and paying our dividend, it is our intent to return excess cash to shareholders in the form of share repurchases. During the quarter, we invested approximately $670 million back into our business in the form of capital expenditures.", "And during the quarter, we paid approximately $2.1 billion in dividends to our shareholders, and we returned approximately $1.5 billion to shareholders in the form of share repurchases. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 38.7%, down from 43.3% in the third quarter of fiscal 2022. Now, I'll comment on our guidance for fiscal 2023. As you heard from Ted, with one quarter remaining in fiscal 2023, we no longer expect the endpoints of our previous guidance range as likely outcomes, and therefore, we are narrowing our guidance for 2023. We expect fiscal 2023 sales and comp sales to decline between 3% and 4%.", "We are targeting an operating margin between 14.2% and 14.1% for the year. Our effective tax rate is targeted at approximately 24.5%. We expect interest expense of approximately $1.8 billion, and we are anticipating between a 9% and 11% decline in diluted earnings per share compared to fiscal 2022. In addition, as you heard from Anne, we continue to focus on driving productivity in the business. We have taken a number of actions that will help us realize the previously announced $500 million in annualized cost savings in 2024 and are fully confident that we will deliver on this commitment. We also remain focused on meeting the needs of our customers with our leading product authority in home improvement, strong in-stock levels, and knowledgeable associates. We will continue to prudently invest to strengthen our competitive position and leverage our scale and low-cost position to outperform our market and deliver shareholder value.", "Thank you for your participation in today's call. And, Kristine, we are now ready for questions." ] } ]	[ { "name": "Operator", "speech": [ "Thank you. We will now be conducting a question-and-answer session. [Operator instructions] Our first question comes from a line of Simeon Gutman with Morgan Stanley. Please proceed with your question." ] }, { "name": "Simeon Gutman", "speech": [ "Hey, good morning, everyone. In thinking about inflections and when we might see one, looking at the spread maybe between DIY and Pro, is the story of this quarter that maybe DIY is stabilized but the Pro is getting a little bit worse? And then, if that's right, and feel free to correct if that's wrong, you know, would that mean that it could take a little longer then for the Pro sort of normalizing to play out, and actually, the overall comp could get a little worse before it gets better?" ] }, { "name": "Ted Decker", "speech": [ "Morning, Simeon, thanks for the question. I would say Pro and consumer, you know, it had the narrowest performance gap in some time, so they both performed reasonably well. You know, if you step back and look at the quarter, we -- we feel really good about the third quarter, and we narrowed our -- our comp guidance for the year because of that. And in fact, if you look at the performance of the business overall this year, if you look at the seasonality of Q1 and Q2, were pretty smooth in that minus 3% comp through the first three quarters of this year. And that's normalized for weather and storms and commodity price deflation.", "And then, our regional businesses are also pretty consistent. We've seen the least variability in regions, and as I said, the narrowest gap between Pro and consumer. We had really good seasonal sell-through. And as prices have settled with abating deflation, we feel -- feel pretty good about that. And our operations are increasingly getting back to normal.", "The supply chain is operating very well. Our inventory positions are better. Our in-stock rates are much better, as Ann took you through all the things we're doing in the store to improve on-shelf availability. Our value propositions, as Billy mentioned, are in great shape, and product innovation is better than it's ever been, and the wage investments are paying off. Our attrition is way down. And with that attrition being down, our associates have had more -- more time in the store, their ability to serve customers has improved.", "So, all of that really is what delivered that consistent comp throughout the year. But, you know, to answer your specific question, as we sit here feeling really good about the operations, the, you know, share shift of PCE from pre-COVID to today, you know, has not completely reverted. And we're still not exactly sure where, you know, that reverts to. The asset class for home improvement is worth 15-odd trillion dollars more than it was pre-pandemic. And we know now that the Fed, it definitely has a higher for longer monetary posture, and that's going to continue to pressure durable goods and financing or -- or motivation for larger home improvement projects. So, as we said, you know, we see great engagement -- engagement in seasonal goods, engagement with smaller projects.", "It's that the larger projects are -- are a bit down at the moment. So, that's what we're watching. I mean, we're not obviously talking about 2024 today, but you know, lots of good news in the operations of the business. Great news with still a very resilient customer. I mean, we just came off of a 4.9% GDP in Q3 driven by the consumer.", "But as you know, we're -- we're looking at it this year this period of moderation for home improvement spend but couldn't feel better about -- about the business in our operations overall." ] }, { "name": "Simeon Gutman", "speech": [ "Thanks for that. And then, and maybe the follow-up, you mentioned GDP. Given that home prices seem to be pretty sticky even with pretty weak turnover and may not get -- get any better, how should we -- should we think about GDP -- should we revert to GDP as maybe a better proxy for how the business could do?" ] }, { "name": "Richard McPhail", "speech": [ "Simeon, this is Richard. You know, we have tried to take the most thoughtful approach possible in over the last few years of what the drivers of the business are and those things that indicate to us, you know, how we have settled back out of the pandemic period. And that's why we focused on share of PCE. Like Ted said, we're not going to talk about 2024 today. There is an underlying kind of layer of economic activity that supports the business.", "But as Ted pointed out, number one, we still haven't reverted all the way back to -- to 2019 levels of PC share. And the Fed's stance of higher for longer has had and could have increasing pressure on the outlook for durables and housing-related spend. So, like Ted said, that's what we're watching at the moment. And we will -- we'll talk about 2024 when we get to our call next quarter." ] }, { "name": "Simeon Gutman", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Zach Fadem with Wells Fargo. Please proceed with your question." ] }, { "name": "Zach Fadem", "speech": [ "Hey, good morning. Richard, considering all the ins and outs of your cost base this year with wage investments, you've got the legal settlement in Q1, plus the cost saves next year, is it fair for us to assume your operating margins can expand in 2024? Or is there a certain level of comp that you will need to see to hold this 14%-plus margin?" ] }, { "name": "Richard McPhail", "speech": [ "Morning, Zach, thanks for that question. You know, margin expansion is largely a function of top-line growth. there is a point there in the low positive comp digits where you see expense turn from deleverage to leverage. We're not going to take on 2024 guidance today.", "What -- what we have done is we have put in place measures and, in fact, now have essentially completed actions that will provide us with a $500 million cost buffer heading into 2024. And so, regardless of the outlook, that provides some buffer in -- in margin." ] }, { "name": "Zach Fadem", "speech": [ "Got it. And then, you mentioned that you would reinvest the legal settlement gain from Q1. So, first of all, any color on what this reinvestment actually is or what it would look like? And then, is it fair to say the investment will be largely in Q4, or was there part of that in Q3?" ] }, { "name": "Richard McPhail", "speech": [ "We've had -- we've had part of that spent throughout the year. I think it is still a correct assumption that that favorability will be fully offset by the end of the year. And so, I really point you to our guidance as the best jumping-off point for your modeling." ] }, { "name": "Zach Fadem", "speech": [ "Got it. Thanks for the time." ] }, { "name": "Richard McPhail", "speech": [ "Thanks, Zach." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question." ] }, { "name": "Scot Ciccarelli", "speech": [ "Good morning, everyone. So, in some other retail verticals or a lot of other retail verticals, we're seeing a return to pre-COVID purchasing patterns, where you probably see more activity purchasing activity on weekends and around holidays and events with frankly bigger lulls in between. So, the questions are, one, are you seeing a similar general pattern? And two, assuming that is the case, are there ways for you guys to take advantage of that pattern from an operational standpoint to improve productivity? Thanks." ] }, { "name": "Billy Bastek", "speech": [ "Yeah, thanks for the -- for the question, Scott. It's Billy. Listen, as it relates to you know, different fluctuations in customer patterns and so forth, we haven't seen that. It's been very consistent throughout the quarter and, as Ted mentioned in his prepared remarks, really throughout the year when you account for some of the weather and some of the bathtub effect we saw in the first half. So, we haven't seen that.", "As it -- listen, as it relates to promotional activity whatsoever, we have events in our stores that we love to execute and drive excitement for our customers. But from a promotional activity standpoint, it's really reverted back to pre-COVID times. It's -- you know, our pricing has certainly, as Ted mentioned, settled over the last several months. The environment certainly stabilized, so, you know, we operate in a very -- we operate in a very rational market and promotional environment, as I said, just as a return to kind of pre-pandemic times." ] }, { "name": "Ted Decker", "speech": [ "And we will always -- Scot, we will always focus on EDLP. I mean we have events during, you know, certain seasons that there are a lot of fun. They're engaging for the associates, they're engaging for our customers. But day in and day out, 12 months a year, we strive to be an EDLP retailer with great values every day." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it, thanks. And then, just -- just a quick follow-up. On the big ticket discretionary, is there any specific areas where you actually seeing a positive inflection, or are they all still trending, call it, mid-single-digit negative?" ] }, { "name": "Billy Bastek", "speech": [ "No, we -- we called out in my prepared remarks categories like portable power and so forth where we have seen great engagement. And candidly, you know, we're thrilled with the innovation that we continue to partner with our supplier base on that we bring to the market. And where we continue to see innovation, we continue to see great engagement with both the Pro and the consumer." ] }, { "name": "Scot Ciccarelli", "speech": [ "Got it. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Chris Horvers with J.P. Morgan. Please proceed with your question." ] }, { "name": "Chris Horvers", "speech": [ "Thanks. Good morning, everybody. So, a couple of follow-ups to prior questions. My first one is with the gross margin decline in the third quarter.", "Can you talk a little bit about what drove that? You were lapping storm-related demand and you had some commodity deflation, so I'd thought that those would be positive. So, is that fair, and what were the offsets that -- that drove it lower?" ] }, { "name": "Richard McPhail", "speech": [ "Thanks for the question, Chris. You know, I'll go back to Billy's comments, and Ted mentioned this as well. I think the most important observation we've made is that the worst of the inflationary environment is behind us. And as a result, as Billy said, retail prices are settling in the market.", "Some prices are settling at levels higher than 2022, others are settling lower. But we're seeing some stabilization there that -- that Billy can talk about. Specific to the quarter and gross margin, there are some timing differences as some prices settled ahead of anticipated product and transportation cost benefits that will come through as we turn through our inventory. But those are -- I'd really sort of consider those timing. For the full year, our view on gross margin hasn't changed, and we expect to see slight pressure year over year.", "But, Billy, maybe just talk about kind of the, you know -- the settling of prices." ] }, { "name": "Billy Bastek", "speech": [ "Yeah, I mean as you -- as you mentioned the, you know, the inflation environment seems to be behind us. Prices absolutely settled in, and again, I reiterate what I said, you know, work in a very rational market. And the other thing I'd add is this is no different than any other time frame. Frankly, we have a portfolio approach to how we take on whether it's lumber deflation that we've talked a lot about throughout the year or other, you know, ins and outs as it relates to the P&L.", "So, very normalized environment, rational, and really a stabilization that we've seen across the board as it relates to pricing." ] }, { "name": "Chris Horvers", "speech": [ "Got it, got it, got it, got it. So, that -- that makes sense. And then, on the -- on the variable cost side, you talked about a low single-digit leverage point historically and the 500 million of cost savings next year. You've had -- at the same time, you've had negative transactions for quite some time now.", "So, can you talk about, you know, where we are in terms of the -- how -- how labor can maybe become -- how it becomes less variable over time maybe in the context of, you know, the percentage of stores on minimum staffing levels? And, you know, if -- if there is negative comps in '24 or over the next six months, you know, is the flexibility that you get from the 500 million offset by the fact that you'll be -- you could be having still negative transactions and less flexibility?" ] }, { "name": "Richard McPhail", "speech": [ "Chris, thanks for the question. There's a lot of kind of 2024 conjecture built into that answer. I'll tell you that, right? So, I think when you're talking about changes in the nature of our labor model, the degree of -- of change in transactions really isn't material enough to say that changes the nature of our labor model." ] }, { "name": "Chris Horvers", "speech": [ "Got it. Sounds good. Thanks very much." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question." ] }, { "name": "Michael Lasser", "speech": [ "Good morning. Thank you so much for taking my question. You talked about the promotional environment discounting being very rational. If the cycle or the downturn for home improvement remains protracted and extended, under what conditions would you expect that discounting will be more intense than it was in 2019 across the industry? And if that were to be the case, would Home Depot choose to remain true to the everyday low price and the portfolio approach that it has, or would it look to protect market share and participate in some of that activity?" ] }, { "name": "Ted Decker", "speech": [ "Morning, Michael. Yes, we will stay committed to -- to EDLP. And our promotional cadences, as we said earlier, the Black Friday, you know, appliances, and gift center, and -- and, you know, some spring events for -- for seasonal garden items to get traffic in stores, those -- those have -- have been, you know, the playbook for years and years, right, Billy?" ] }, { "name": "Billy Bastek", "speech": [ "That's right." ] }, { "name": "Ted Decker", "speech": [ "And -- and we don't see us going away from that. In fact, we've -- we've stayed truer to reductions of promotions when you think of -- of categories like ceiling fans that I remember with constantly on and off, you know, 10% and 20% off; paint, which was a promotional category, where, you know, fives and 10s, and then, it went to 10 and 20s, We've backed off all of that in -- on the margin. We prefer to be even less promotional than we are today. If you had a -- a protracted downturn in the market, I mean for sure, we're going to be competitive, and for sure, we are going to protect our share. But when you think of the nature of a -- of a large home improvement projects, certainly one done by a Pro, you know, the labor component is such a big piece of that job. I mean just take paint, for example.", "You know, if you're painting your -- your living room for, you know, $500, the paint in that job is going to be less than $100, and in it's your -- your labor bill, either your opportunity cost as a consumer or the Pro doing the job for you. So, you know, being super aggressive to -- to take $10 off the $100 component of a $500 job, I don't think really moves the needle. And that's why our -- our bias, our starting position would be no, we wouldn't -- we wouldn't chase a lot of price in that dynamic." ] }, { "name": "Michael Lasser", "speech": [ "Thank you. Very helpful. My follow-up question is, historically, Home Depot has under-promised and over-delivered in just about all facets. Is it -- is it realistic to think that you took the same approach when building this $500 million of -- of net cost savings for next year such that there could be upside to that number?" ] }, { "name": "Richard McPhail", "speech": [ "That -- well, that that cost number was really more a function of having built capacity to handle the explosion in our volume during COVID, and then, the sort of other side of that hill where we pulled capacity in many forms back. And so, it was the right thing to do regardless of the environment. It does happen to provide a buffer for our operating margin as we move into 2024." ] }, { "name": "Michael Lasser", "speech": [ "OK, thank you very much, and have a great holiday." ] }, { "name": "Richard McPhail", "speech": [ "You too." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Zaccone with Citi. Please proceed with your question." ] }, { "name": "Steve Zaccone", "speech": [ "Thank you. Good morning, everyone. Thanks for taking my question. Congrats, Ann, on the new role.", "I wanted to focus on the Pro side of the business. So, the commentary about growing with the complex Pro, in the past, there's been a focus on the flatbed distribution centers and the rollout on a regional basis. Is that still very much the strategy for the next couple of years? And as you zoom out and think about the opportunity with the complex Pro, what are the top priorities within those next one to two years?" ] }, { "name": "Ann-Marie Campbell", "speech": [ "Steven, thank you. Thank you so much for the kind words there. You know, Chip is in the room, and he has been intimately, you know, knowledgeable about that. And so, I'm going to throw it over to Chip, and he'll talk a little bit about some of the capabilities that we continue to leverage and some of the functionalities and capabilities that we will continue to build." ] }, { "name": "Chip Devine", "speech": [ "Yeah, thank you, Steven. We are going to continue certainly our march down to the expansion of our outside sales teams and continue to grow the complex Pro as it was mentioned in the earlier marks. The connectivity into the store is an important part of this asset build as well. Our Pros shop in our stores every single day, and connecting that ecosystem to our flatbed delivery systems is part of that.", "So, as we look and expand into different markets as we move forward from where we currently are, we will continue to evaluate the best opportunity to expand those distribution assets as well to support our growth in Pro." ] }, { "name": "Steve Zaccone", "speech": [ "OK, thanks. I wanted to revisit Simeon's question about inflection because I know it's a -- it's a challenging backdrop to predict. But I guess, as you think about the business, what are the key building blocks to take the business from this period of moderation to a more stable market backdrop when you talked about low single-digit market growth? You know, I'm curious if you could opine on, is it really PCE shift, you know, is it rates. Just -- just any -- any help you provide will be helpful.", "Thank you." ] }, { "name": "Ted Decker", "speech": [ "Yeah, Steven, for that, you know, we're always looking at a balance between ticket and transactions. And, you know, what was -- what was interesting during the COVID period, we had inflation. So, we had -- we had AUR up, and we had had ticket up, also driven by basket size, but the engagement was so high, you really didn't have elasticities. You had -- you had driving ticket and transactions, and that's what led to the 25% comp. As inflation has abated in, primarily, commodities, and those prices have come down, you've seen, you know, a fall-off in ticket.", "And you didn't -- you didn't get the elasticity, you know, initially that you'd expect, and that was because people were still powering through projects. And now, it's a mix of, you know, what's -- what's the -- the level of -- of response from pricing versus pull forward versus, you know, the Fed's stance and higher interest rates. So, that -- that's all the dynamic that's muddying the traditional ticket and transaction dynamic. But what's healthy for us, you know, is a solid comp, you know, equally balanced between ticket and transactions, and that's -- that's what we'd be looking for. And now, we -- we've said, you know, prices have essentially leveled. Our -- our ticket, you know, was down modestly.", "And if you take out commodity, our ticket would have been up for the quarter. And then, transactions, you know, we're still working through a bit of that PCE shift, pull forward, you know, whatever that dynamic might be. But, you know, we'd be looking for -- for growth in each in a nice balance going forward." ] }, { "name": "Steve Zaccone", "speech": [ "Very helpful. Thanks, guys." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question." ] }, { "name": "Brian Nagel", "speech": [ "Hi, good morning. Thanks for taking my question. The question I have, I think Michael may have asked previously just about price actions, but I guess maybe to expand that a bit further. So, we've been discussing now this trend in weakness in bigger ticket for a while.", "I mean, obviously, a very unique demand backdrop. But again, from your perspective, particularly as you look toward '24, are there other levers that Home Depot could pull, you know, to potentially spur better demand within -- within big ticket other than -- other than price?" ] }, { "name": "Ted Decker", "speech": [ "Well, the No. 1 way that we're focused to -- to drive demand is with the complex Pro. So, it's -- it's -- that is our key strategy, and that's what we're focused on. It's a $200 billion space.", "As we've defined the 950 split evenly Pro in consumer and at the 475 that's Pro, there's 200 billion that is, you know, larger pros, more complex spend that we're building out the capabilities to serve that -- that demand. And that, Brian, you know, is what we're, you know, very very focused on and think for years and years that is going to be a driver of our business as we take share in that sort of $200 billion white space." ] }, { "name": "Brian Nagel", "speech": [ "Yeah, thanks, Ted. Got it. And then, my second -- my follow-up, a much quicker. We obviously -- you narrowed your guidance for the balance of the year.", "We talked about trends in the fiscal third quarter, but any commentary on sales trends early here in fiscal Q4?" ] }, { "name": "Richard McPhail", "speech": [ "Our performance in the first two weeks is on track to achieve our full-year 2023 guidance." ] }, { "name": "Brian Nagel", "speech": [ "Very good. I appreciate it. Congrats again." ] }, { "name": "Richard McPhail", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our question comes from the line of Peter Benedict with Baird. Please proceed with your question." ] }, { "name": "Peter Benedict", "speech": [ "Hey, guys, thank you for taking the question. Another one on average ticket here. So, pre-COVID average ticket around $67. I think now it's kind of trending closer to $90, so up 35%.", "Richard, just wondering if you have any perspective on kind of a like-for-like SKU inflation component there versus the big-ticket mix. It sounds like your like-for-like inflation is -- seems to be stabilizing. I know there's innovation that can make things not like for like, but just curious as you think about the big-ticket exposure there and what -- what -- what could potentially play out there, you know, how big of a deal is that? Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Thank you for the question. I think there are -- there are a few answers to that. First of all, we have seen inflation abate and really kind of settle on a like-for-like basis across the portfolio. I think it's interesting, you see some -- you know, we've seen different dynamics in big ticket over the years as we've had lumber inflation and deflation, in particular, skewing those results in big ticket.", "But, Billy, maybe you talk a little bit about trends there." ] }, { "name": "Billy Bastek", "speech": [ "Yeah, I mean, and I just -- you know, Ted's response back to Brian on unique categories like drywall, where we have capabilities, roofing, installation, portable power, where we've added innovation, we continue to see great both Pro and consumer reaction to just the innovation and things we're seeing. Ad it relates to big ticket, you know, obviously, you've seen some deferral and so forth as we talked about. And certainly, you know, the pull forward is probably still playing a part in that as we continue to get further away from, you know, the pandemic. So, we'll watch that closely.", "We don't see anything -- as I mentioned, stabilized pricing, a rational environment. And we don't see anything, you know, differing from -- from what we've seen over the last, you know, multiple months now." ] }, { "name": "Peter Benedict", "speech": [ "OK, thanks for that, guys. I just -- I guess turning to maybe leverage and the pace of buyback. And if we stay in this environment of, let's call it, moderation in demand, how do you think about just maybe balancing your buyback approach leverage? I mean you're still operating below the two times. Is there anything that prevents you from kind of moving up to that two times, or are you -- just kind of curious, your latest thoughts around those -- those topics.", "Thank you." ] }, { "name": "Richard McPhail", "speech": [ "Thank you. You know, we've -- we've maintained a position very close to that two times debt to EBITDA leverage ratio, and we intend to do so in the foreseeable future. We will also, you know, really maintain consistency with respect to capital allocation. We invest in the business first.", "We pay our dividend. And then, as we determine excess cash, we flow that to our shareholders in the form of repurchases. To your point, to date, we've repurchased $6.5 billion. There's really no change in our stance.", "And so, I think that's -- that's the important takeaway there." ] }, { "name": "Peter Benedict", "speech": [ "OK, thanks so much. Good luck." ] }, { "name": "Operator", "speech": [ "Our next question comes from a line of Michael Baker with D.A. Davidson. Please proceed with your question." ] }, { "name": "Mike Baker", "speech": [ "OK, thanks. Just thinking about the fourth quarter, if we take the midpoint of the implied guidance, it does suggest a little bit of a deceleration, yet you know, it does seem like your business has been consistent. Is that just a function of -- you know, am I reading too much into that, or do we expect a deceleration? And maybe a second part of that, as you said, Halloween was really strong historically [Audio gap] to your trimmer tree or your holiday decorating business. I think it's like in 10 of the last 14 years, your fourth-quarter comp has been better than the third quarter.", "Why should this year be different than that? Thanks." ] }, { "name": "Richard McPhail", "speech": [ "Thanks for the question. You know, we -- we -- the narrowing of the range is truly what it is. We -- we saw the extreme points of that range become less likely, and so we felt it would be helpful for our investors for us to narrow that range. There has been an assumption all year, from the beginning of the year, that our guidance reflected a reversion of our share of PCE from the pandemic time period back to 2019 levels.", "Our prior guidance range assumed that that share would continue to revert throughout the year. We've seen that reversion gradually and steadily, and our current range still has that assumption built in for Q4 that we're largely reverted but not all the way back. So, there is some -- some notion of that in our guidance." ] }, { "name": "Mike Baker", "speech": [ "OK, so sounds like it's -- like you said, it's just a function of getting to -- to the middle of the range. If I could ask one other question. You talked a little bit about -- about storms and seasonality. I think a lot of retailers have said it's been a warm fall.", "How does that impact you? Do you need it to get cold and, you know, as we go through the fourth quarter to -- to drive your business? How should we think about that? Thanks." ] }, { "name": "Billy Bastek", "speech": [ "It's been a little warmer, obviously, but not a big impact. We started to see -- where the weather is normalized, we started to see some of that fall clean-up and fall business really really take off. You know, haven't seen obviously snow and so forth. So, you know, it's kind of right in line with what we'd say is a little more normalized year where you see the weather act a little more flawless.", "You've seen, you know, the -- the categories and businesses that you'd expect to trend up -- trend in that -- in that positive direction." ] }, { "name": "Mike Baker", "speech": [ "Appreciate it. Thanks for -- thanks for taking the time." ] }, { "name": "Billy Bastek", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Our next question comes from the line of Steven Forbes with Guggenheim. Please proceed with your question." ] }, { "name": "Steve Forbes", "speech": [ "Good morning. Ted -- or maybe for Ann, just a follow-up on Pro sales, really focusing on the Dallas market versus the chain average. Can you -- can you update us on how that market is performing? And then, maybe just comment on any behavioral differences that you're noting between Pro markets based on the maturity of your strategic initiatives. Focus on the complex pro, I mean can you -- are you -- are you seeing and being able to analyze very, like, predictable behavioral changes?" ] }, { "name": "Ann-Marie Campbell", "speech": [ "Yeah, I'll start off by just saying that the capabilities and functionalities that Hector and Chip has been working on over the last several years is certainly going to help us engineer a great deal of momentum and success with the Pro. And you know, Chip, you know, I'll throw it over to you again because of how intimately you are knowledgeable about that. But there is this -- the Pro ecosystem is what we're focused on now, and not the in-store side or the come -- not only the in-store side but the complex Pro. And as we build out these capabilities and we see the effectiveness of these capabilities, we're going to continue to leverage those.", "And, Chip, you know, I'll throw it over to you to kind of give a little bit more details on Dallas." ] }, { "name": "Chip Devine", "speech": [ "Yeah, thanks, Ann. And, Steven, yes, absolutely, where we built capabilities inclusive of assets -- distribution assets and where we've expanded our sales force, we've seen meaningful impact and growth. Our outside sales team is the best-performing cohort of all Pro. So, we're going to continue, as I mentioned before, to invest in that and then add assets, where necessary, in the appropriate markets." ] }, { "name": "Steve Forbes", "speech": [ "Thank you. Maybe just a quick follow-up for Richard or Billy. All the ticket conversations here, any way to just sum up how the quarter for big ticket progressed relative to expectations? It sounds like it performed better than expected. You have sort of stabilization in multiyear big-ticket comp trends.", "I would imagine that wasn't the expectation, but any -- any way to help us frame on how the quarter progressed for big ticket versus internal plan?" ] }, { "name": "Billy Bastek", "speech": [ "Yeah, I think -- you know, listen, it was -- it was largely how we -- we planned it. We -- you know, I called out, you know, some great interaction from our consumers as it relate to appliances. Having said that, we were in a better inventory position there. So, we saw some tailwind from just our better inventory position as it relates to that.", "But it largely played out exactly how we had thought it would, really, again, back to the prior comment to a very balanced year across the board when you -- when you account for some of the weather shifts early on and then what we -- what we were lapping with the hurricane. Very balanced across the -- across the board and across the regions." ] }, { "name": "Richard McPhail", "speech": [ "I think it's important, though, thematically just to sort of repeat the point, this -- this stance by the Fed of -- of higher for longer, you know, is sort of coming across in surveys. You know, there is -- there is a deferral of larger projects. And so, if you just want to zoom all the way back to the true macro here and the forces on ticket that we're watching, that's probably the largest macro force." ] }, { "name": "Billy Bastek", "speech": [ "That's right." ] }, { "name": "Steve Forbes", "speech": [ "Thank you." ] }, { "name": "Isabel Janci", "speech": [ "Christine, we have time for one more question." ] }, { "name": "Operator", "speech": [ "Thank you. Our final question comes from the line of Dean Rosenblum with Bernstein. Please proceed with your questions." ] }, { "name": "Dean Rosenblum", "speech": [ "Hey, guys, thanks so much for taking my call, my question. My question is about the Pro and really just understanding the performance of the Pro relative to the comp overall and then splitting that out between store sales to Pro versus complex project sales to Pro. Or just to make sure I'm understanding, you put up a -- call it a negative three comp. DIY and Pro very close to one another, U.S.", "slightly worse than Canada and Mexico. So, I'm assuming, you know, U.S. Pro, call it, down two, 2.5. And then, can you just either verify or correct that? And then, can you characterize Pro sales in the store relative to Pro sales outside of the store through the outside sales force and the CFCs? Thanks." ] }, { "name": "Richard McPhail", "speech": [ "Well, I'm taking the last part first. It's an ecosystem like Ann said. We're actually not -- we don't have goals or targets with respect to the separation of store and delivered sales. The point is actually lifting all sales, and that's what we've seen consistently in every market where we've rolled out capabilities.", "You know, originally, we worried, OK, our delivered sales going to begin to cannibalize the store; the opposite has proven true. And so, we are progressing in a way that we're pleased. With respect to your first question, factually, the Pro did outperform the consumer in Q3, albeit at the narrowest margin we've seen in quite some time. If you actually normalize for commodity impact, the -- the Pro was essentially flat for the quarter." ] }, { "name": "Dean Rosenblum", "speech": [ "OK, great, thanks. And I guess my follow-up would be when you guys measure big project versus small projects, can you just clarify for us how you are determining what constitutes a big project versus a small? Is it like transaction size over a thousand bucks? And if you could clarify that for us, that'd be great." ] }, { "name": "Richard McPhail", "speech": [ "We infer from category sales and from class sales. You know, when you -- when you look at categories that are more likely to sell at higher volumes in larger projects, kitchens, flooring, millwork to an extent, we are doing some inference. We also ask our customers what they're seeing and what kind of projects they're working on. We use external survey data that tells us that the nature of projects is kind of shifting from larger to smaller, and so it's a triangulation." ] }, { "name": "Dean Rosenblum", "speech": [ "That's great. That's super helpful. Thank you so much, guys. Good luck in the fourth quarter." ] }, { "name": "Ted Decker", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Ms. Janci, I'd like to turn the floor back over to you for closing comments." ] }, { "name": "Isabel Janci", "speech": [ "Thanks, Kristine, and thank you, everyone, for joining us today. We look forward to speaking with you on our fourth-quarter earnings call in February." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]
AMAT	2020-02-12	[ { "description": "Vice President, Investor Relations", "name": "Michael Sullivan", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Gary E. Dickerson", "position": "Executive" }, { "description": "Senior Vice President, Chief Financial Officer", "name": "Dan Durn", "position": "Executive" }, { "description": "Evercore ISI -- Analyst", "name": "C.J. Muse", "position": "Analyst" }, { "description": "Citi -- Analyst", "name": "Atif Malik", "position": "Analyst" }, { "description": "Credit Suisse -- Analyst", "name": "John Pitzer", "position": "Analyst" }, { "description": "Cowen -- Analyst", "name": "Krish Sankar", "position": "Analyst" }, { "description": "JP Morgan -- Analyst", "name": "Harlan Sur", "position": "Analyst" }, { "description": "Newstreet -- Analyst", "name": "Pierre Ferragu", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Joseph Moore", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Vivek Arya", "position": "Analyst" }, { "description": "UBS Securities -- Analyst", "name": "Tim Arcuri", "position": "Analyst" }, { "description": "Stifel Nicolaus & Co. -- Analyst", "name": "Patrick Ho", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards you will be invited to participate in a question-and-answer session.", "I would now like to turn the conference over to Michael Sullivan, Corporate Vice President. Please go ahead, sir." ] }, { "name": "Michael Sullivan", "speech": [ "Good afternoon and thank you for joining Applied's first quarter of fiscal 2020 earnings call, which is being recorded. Joining me are Gary Dickerson, our President and CEO and Dan Durn, our Chief Financial Officer.", "Before we begin, I'd like to remind you that today's call contains forward-looking statements, which are subject to risks and uncertainties that could cause our actual results to differ. Information concerning the risks and uncertainties is contained in Applied's most recent Form 10-K and 8-K filings with the SEC.", "Today's call also includes non-GAAP financial measures. Reconciliations to GAAP measures are found in today's earnings press release and in our reconciliation slides which are available on the IR page of our website at appliedmaterials.com.", "And now, I'd like to turn the call over to Gary Dickerson." ] }, { "name": "Gary E. Dickerson", "speech": [ "Thanks, Mike. I am pleased to report that earnings for our first fiscal quarter exceeded the top end of our guidance reflecting outstanding execution across the Company in a market environment that is strengthening. Based on our calendar year revenues, we believe we outperformed both the market and our direct peers in 2019. We entered 2020 with momentum and the signals we see give us increased confidence that the years ahead will be very good for the industry and especially for Applied Materials. In today's call, I'll give you my perspective on how our markets are evolving and provide our near-term outlook. Then I'll highlight the key components of our strategy to address the changing needs of our customers and drive sustainable profitable growth for Applied Materials.", "Before I get started, I'll take a minute to address the implications of the coronavirus outbreak. To direct a comprehensive response across all the regions where we operate, we quickly activated our business continuity teams. Our top priority is the health and safety of our employees and their families. We're also doing everything we can to provide our customers the support they need to minimize disruption to their business. In addition, the Applied Materials Foundation is sending medical equipment into Wuhan and we've created humanitarian response fund for our employees in China and the communities where they live and work. In terms of the business, our current assessment is that the overall impact for fiscal 2020 will be minimal. However, with travel and logistics restrictions, we do expect changes in the timing of revenues during the year. We are actively managing the situation in collaboration with our customers and suppliers.", "While we're making the necessary adjustments to our near-term plans we are not taking our eye off the powerful trends that are driving the semiconductor industry forward and creating a structurally larger and less volatile market. At the low point of this recent downcycle and customer spending, which occurred in the second calendar quarter of 2019 the combined quarterly revenues of the top five semi equipment companies were only 17% lower than at the cycle's peak. In contrast, during the industry cycles that took place between 2000 and 2013, peak to trough revenues for the same five companies combined dropped on average 44%.", "Another important metric we look at is equipment intensity or annual equipment spending as a percentage of annual semiconductor industry revenues. Between 1990 and 2014, this equipment intensity metric fluctuated between 17% and 6%. However, when we look at the most recent five-year period, equipment intensity has been in a tight band of 10.5% to 12% with a mean of 11.5%. We believe this is a good estimate going forward and reflects the ever more complex technology challenges we're addressing and the increasing value we're delivering to the ecosystem. In addition to the higher growth and lower cyclicality we see in the market as a whole, Applied is demonstrating even lower volatility than our peers. The reasons for this include the breadth of our product portfolio and the balance we have across different device segments. Dan will provide more color on this topic in his section.", "Moving to our near-term outlook, we see robust foundry logic investment continuing. There is a strong commitment on the part of these customers to advance the leading edge as they get ready for demand related to the rollout of 5G. At the same time, we're also seeing healthy spending for specialty nodes to support growing demand from the IoT, communications, automotive, power and image sensor market.", "Progression in the memory market is consistent with the view we've shared over the past several quarters. NAND appears to be in the early stages of recovery with prices rising and inventory levels down to four to five weeks. That's compared to eight to 10 weeks this time last year.", "We also see a good setup for DRAM to recover. Encouraging signs include supplier and end market inventories that are starting to get back to normal levels and prices that appear to have bottomed. These leading indicators bode well for a pickup in investment by memory customers later in the year.", "Overall, we like the way the market is shaping up for 2020 and beyond. We believe that our semiconductor business can deliver strong double-digit growth this year and feel very good about our longer-term opportunities. In display, there are no major changes to the outlook we provided last quarter. We expect FY '20 revenues to be similar to FY '19 as the industry navigates the bottom of this spending cycle. We still believe that display is an attractive adjacent market for Applied that provides good long-term growth opportunities. The business remains solidly profitable even as we make the necessary investments to ensure that we have the right portfolio of products ready for when the market picks up. Stepping back and looking at this year in its broader context, it's important to note that the overall electronics industry is in a period of expansion and diversification. Major new growth drivers, including IoT, Big Data and artificial intelligence are layering on top of traditional demand for smartphones and PCs.", "As I look ahead, I strongly believe that the future will not be like the past. The emerging workloads that will shape the next era of computing require domain specific approaches, new system architectures and new types of semiconductor devices. I believe that we need a new playbook for semiconductor design and manufacturing to deliver the power, performance and area of cost improvements that will unlock the potential of AI and Big Data. At Applied we've aligned our strategy and investments around this new playbook so that we can enable new system architectures, new devices and 3D structures, the introduction of novel new materials, new advances in 2D geometric shrinks and new ways to connect chips together through advanced packaging. Applied has a unique portfolio of materials, engineering capabilities and products to enable the new playbook. Getting these new technologies to market faster has never been more valuable and this is a major emphasis across the Company.", "For example, we're using advanced metrology, sensors, data science and simulation to improve learning rates, speed up the transfer of new technologies from Applied's labs to customers' factories and reduce the time it takes to optimize device performance, yield, output and cost. In addition, we have more engagements with the broader ecosystem than ever before, focused on accelerating innovation all the way from materials to systems.", "Our strategy is yielding results for our customers and Applied. Calendar 2019 was a new record for our foundry, logic revenues and the current leading edge node transition further grows our opportunity. For an equivalent number of wafer starts our available market increases by more than 10%. We're also generating record revenue from specialty markets where customers build their technology upon trailing geometries. For these customers, the innovation roadmap is driven by materials innovation rather than geometric scaling. Strengthened leading edge combined with healthy investments in specialty nodes means that several of our leadership businesses, including metal deposition and EPI are delivering record revenue. At the same time we continue building momentum in areas of the market where we still have plenty of room to grow.", "In the quarter we secured major application wins for critical etch steps at both foundry, logic and memory customers. Our process diagnostics and control business delivered record quarterly revenue driven by strong adoption of our new optical wafer inspection system and continued strength in our leading eBeam products.", "We're also making great progress in packaging. As the industry introduces increasingly sophisticated packaging approaches, our strategy has been to focus on addressing the most critical process steps. As a result, we've been steadily gaining market share. Our packaging business delivered record revenues in 2019 while winning well over 50% of our available market.", "Another important growth factor for the Company is our service business. Equipment maintenance is an attractive recurring revenue stream for Applied and in calendar 2019 we added more than 2,000 systems to our installed base. As I've talked about before, we are finding new ways to deliver value through data-enabled services that accelerate customers' fab ramps and optimize their device performance, yield, output and cost in high-volume manufacturing. As we do this, we're increasing the number of installed base systems covered by long-term maintenance agreements. In the past 12 months alone, we have grown the number of systems covered by these agreements by nearly 15%.", "Before I hand the call over to Dan, I will quickly summarize. While we're adapting our near-term plans in response to the coronavirus outbreak, our outlook for 2020 remains very positive. We believe we can drive strong double-digit growth in our semiconductor business this year and significantly outperform the market. We also like the setup for 2021 and beyond. Our markets are better than ever with powerful new growth drivers still only in their early innings. Applied's opportunities have also never been better. We are uniquely positioned to enable the new playbook for semiconductor design and manufacturing while helping our customers accelerate innovation from materials to systems.", "And now I'll turn the call over to Dan." ] }, { "name": "Dan Durn", "speech": [ "Thanks, Gary. Applied Materials returned to year-over-year growth in Q1 with revenue up 11% and non-GAAP EPS up 21% versus the same period last year. Revenue and gross margin exceeded the midpoint of our guidance and earnings were above the high end of our range. Our revenue performance was driven by Semiconductor Systems, which was up 24% year-over-year. We generated nearly $1 billion in operating cash flow during the quarter and returned close to $400 million to shareholders. Our business outlook calls for continued strength in Q2 and our second half.", "Our relative performance is especially strong. We outgrew the overall semi equipment market in calendar 2019 and we significantly outperformed our closest peers. Applied has made strong investments across our portfolio in recent years. And today we are a larger and more resilient company that performs well in a variety of market conditions. One of Applied's unique attributes is our broad portfolio, which is more diversified across end markets and more balanced among semiconductor device types, including memory, leading edge and specialty nodes in logic and packaging. Our portfolio makes us more stable relative to our past and relative to our peers, the process of which were 50% to 100% more volatile in the recent cycle.", "Today, our traditional strength in foundry, logic is apparent as we set new quarterly records for overall foundry, logic revenue as well as in metal deposition and process control system sales. Our investments in memory have given us a balanced share profile and this will enable us to continue to generate strong returns when spending recovers later this year. A key pillar of our stability is our aftermarket business, which includes Applied Global Services and our 300 millimeter upgrades and refurbs.", "Our aftermarket revenue was a product of three drivers, installed base growth, the higher service intensity of new nodes and our data-enabled service agreements. Our service agreements provide a higher return on investment for our customers and subscription like recurring revenue for Applied. In Q1, AGS generated record revenue of nearly $1 billion. Our overall aftermarket business also set a new record in Q1 and it's grown in every year since 2013.", "Against this backdrop, we're pleased to be making further progress toward the acquisition of Kokusai Electric which has an outstanding equipment business, a very large installed base and a highly talented management team. During the quarter, we received regulatory approvals from Japan and Korea and we grew our cash position by over $350 million as we prepare for the transaction. As a reminder, upon close we plan to prioritize our free cash flow toward repaying the term loan we're using to help finance the transaction. We expect to limit buybacks until we've repaid the loan.", "Next, I'll comment on the near-term environment and provide our Q2 guidance. Since the middle of January, our business continuity team has been working around the clock assessing the needs and capabilities of our employees, customers and suppliers. I'm impressed by the decisive action and compassion being demonstrated by our people across the globe. Our Q2 guidance ranges are wider than usual and our revenue forecast reflects all of the risk factors we can see today. In Q2, we expect our overall revenue to be $4.34 billion plus or minus $200 million, which would be up by about 23% year-over-year. We expect non-GAAP earnings to be $1.04 per share, plus or minus $0.06. The midpoint would be up nearly 50% year-over-year.", "Within the outlook, we expect Semiconductor Systems revenue to be around $3.05 billion, up by around 40% year-over-year. Our services revenue should be about $955 million and display revenue should be around $310 million. We expect non-GAAP gross margin of around 45.4%, which would be up nearly 2 points year-over-year and non-GAAP opex should be around $820 million.", "Finally, I will give you some additional color on how our risk-adjusted Q2 guidance compares to the strong underlying demand for our products and services. Absent the near-term risks, our revenue guidance would have been about $300 million higher at the midpoint or up about 30% year-over-year and AGS revenue would have exceeded $1 billion. While the situation remains fluid, we believe we can address the vast majority of our unmet Q2 demand in Q3 and Q4 and deliver strong growth for the year.", "In summary, we are seeing very strong demand for our products, solutions and services. We have a broad, diverse and balanced portfolio that is delivering strong relative performance and stability in a variety of market conditions. As Gary outlined, the semiconductor industry is enjoying a new wave of growth and the equipment industry is growing along with our customers. For Applied's part, we're investing in new products and solutions that will accelerate the new playbook and position Applied Materials to deliver superior performance, stable growth and shareholder returns.", "Now Mike let's begin the Q&A." ] }, { "name": "Michael Sullivan", "speech": [ "Thanks, Dan. Now, I know there are a lot of people on the call today. To help us reach as many of you as we can, please ask just one question and not more than one brief follow-up. Operator, let's please begin." ] } ]	[ { "name": "Operator", "speech": [ "[Operator Instructions] And our first question comes from the line of C.J. Muse from Evercore. Your line is now open." ] }, { "name": "C.J. Muse", "speech": [ "Yeah. Good afternoon. And apologies for the noise in the background. I guess first question, can you speak to gross margin leverage as you look forward, particularly around accelerating service business combined with on materials side, where you are mix-wise in leadership versus growth and some of the new products as they layer in? Would love to hear your thoughts around that." ] }, { "name": "Dan Durn", "speech": [ "Thanks C.J. As we look at gross margins, I think it's important to look at the evolution of the business over time. We're a different business today. We're driving a significant amount of growth in foundry, logic, but we're also a more diversified business than we've been in the past. If you were to go back a handful of years, you would have seen us spike highly in the foundry business from a share perspective and the other three device types were mid-teens. And today, we're a very balanced portfolio. And I think that served us really well in 2019, both from a revenue volatility standpoint significantly less than the peers in the industry, but also from a gross margin standpoint. The Company has performed pretty well in the most recent downturn.", "As we go forward foundry, logic is going to continue to be a strong market for the industry. The trend line on foundry, logic is up into the right. Every quarter won't be a record, but we will see an upward trending market, less volatility and higher highs and higher lows. Embedded within that strength in foundry, logic is growth in specialty nodes and technologies as edge devices proliferate. This is a great business for a strong driver of cash flow, strong driver of operating margins.", "You're also seeing us in the broad set of markets drive businesses like etch over time. We are making significant share gains into the NAND market, into -- followed by DRAM and then foundry, logic and the Company is performing really, really well growing that market share and we're going to continue to do that going forward.", "And so you see an evolution in profile change of the business. You also see our services business growing structurally larger. It's a great source of stable revenues, cash flows and operating margin for the business. And so we're a broader, bigger more resilient business and it's going to change the profile of the business over time.", "As you look at gross margin for the rest of this year, our semi systems business on a half over half progression looks fairly linear. And then you see a growing services business into the back half of the year and a growing display business into the back half of the year. And all three of those business look to -- look positioned to grow well into 2021. And so where we are guiding Q2 we expect to be around those levels for the rest of 2020 against this mix profile as we see into the back half of the year.", "Are we ever satisfied with gross margins as they exist today? No. Are we looking to continually optimize the performance of this Company and drive as much value for our shareholders? Absolutely. And we're going to continue to drive as hard as possible at delivering that value. But I think that gives you a good sense of where gross margin is going to go for the rest of this year and some of the drivers of our business that deliver that result." ] }, { "name": "C.J. Muse", "speech": [ "Very helpful. I guess as a quick follow-up, can you speak to, I guess, the improved visibility that you have to memory and kind of what are the guide posts that gives you the confidence on the second half and off [Phonetic] from foundry over to memory and sustain the growth through the year and into next year? Thank you." ] }, { "name": "Dan Durn", "speech": [ "Yeah. Thanks C.J. I think the best way I described the profile and shape of the business in 2020. We're going to continue to see strength in foundry, logic throughout the year and we're seeing early signs of memory recovery today. I think ultimately what happens in 2020 is really going to depend on the magnitude of the memory recovery later in the year. We posted a really strong fiscal Q1. Our guide into fiscal Q2, we see, is very strong. And we see that strength continuing into the back part of the year. Again, we're going to be relatively balanced half-over-half in our systems business and the ultimate shape of that systems business and strength in the back part of the calendar year is going to be a function of what we have been saying for a couple of quarters now which is it's going to depend on the magnitude of the memory recovery later in the year. But right now we feel really good given what we see, fairly balanced half-over-half from a semi systems standpoint. And I think there is an opportunity to do better in our fiscal Q4 and our fiscal Q1, as the memory recovery begins to accelerate." ] }, { "name": "Gary E. Dickerson", "speech": [ "Yeah, C.J., this is Gary. I'll add a little bit more color. Certainly, what we see for the year is foundry, logic, NAND, DRAM pretty balanced. And relative to the memory recovery and timing, we talked about the supply and demand, the inventory levels on the prepared remarks and then obviously, we also have demand signals coming from our customers. So that's really what is driving our comments relative to the way the year is going to shape out and also the balance in all of those different segments." ] }, { "name": "Michael Sullivan", "speech": [ "Thanks, C.J." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Atif Malik from Citi. Your line is now open." ] }, { "name": "Atif Malik", "speech": [ "Hi. Thanks for taking my questions and good job on results and guidance. I have a question on the display business, a flattish outlook, not super exciting this year, Gary. Does this make you look at some of the disruptive products in the R&D pipeline like the evaporation or the inkjet tools differently? And if you can share the long-term view on display market." ] }, { "name": "Gary E. Dickerson", "speech": [ "So display we still see as a very attractive adjacent market for the Company. If you look at the growth that we've seen over the last few years, it's up significantly. I think we are around $0.5 billion. The business was up over $2 billion. Down a little bit this year, but still a very, very attractive market.", "And certainly our near-term guidance is impacted also because of the coronavirus. Some of our customers are in areas that are impacted. And so that reduced our guidance in terms of Q2. But as Dan said, we see the second half of the year being very positive. And we also -- if you think about visual experiences and the way they differentiate different mobile devices or all of the trillion connected devices that will be happening -- will be growing over the next several years, we see that that market is going to continue to grow. So 2021, we certainly see the business being up a fair amount over what we see in 2020. The capital intensity is rising as new technologies are adopted. So we see a good opportunity in our core business.", "And certainly, just like we do in semi, we're very focused on enabling customer roadmaps and enabling new structures, new materials for our customers. So we have those investments that we're also making in terms of display. We're making good progress on those -- on the pipeline of those new opportunities. We're not going to announce anything here on the call today, but we're still very optimistic overall about the business and also those new opportunities." ] }, { "name": "Atif Malik", "speech": [ "Great. And a quick one for Dan. Dan, on opex, I know you don't like to peg opex to a ratio and how should we think about the spending for the rest of the year?" ] }, { "name": "Dan Durn", "speech": [ "Yeah, I think in the current environment $820 million a quarter feels like about the right level. You'll obviously see us continue to drive discipline into our spend. I think you've seen that over time over the last handful of years, operating leverage has delivered some pretty significant reductions of opex as a percent of sales. And right now R&D as a percent of opex is at an all-time high for the Company. So I think the Company is being very disciplined from a discretionary spend standpoint and investing the right amount of money to capture the significant opportunities we see in front of us. But we'll continue to monitor those opportunities and guide one quarter at a time. But this level feels about right." ] }, { "name": "Michael Sullivan", "speech": [ "Thanks, Atif." ] }, { "name": "Gary E. Dickerson", "speech": [ "Yeah, I guess I would add one thing to that. I think we're not emotional over the investments we're making. We make investments where we think we can have -- drive shareholder value. So that's basically the way we look at this.", "We have -- we do have a point of view. I think as a leader, you need to have a point of view and courage in terms of how you drive your business. We believe that this business is going to be fundamentally bigger based on AI, Big Data, IoT layering on top of mobile, social media and PCs. So we see that that business is going to be larger and the new playbook that I talked about in the prepared remarks for AI and Big Data is absolutely essential as Moore's Law, the classic Moore's Law is slowing.", "So we see tremendous opportunities. Applied is in the best position if you look at the five aspects of that new playbook and we're going to make those investments. And as I said earlier, 2021 shapes up really well for us. Many different aspects come together and we definitely see great growth opportunities going forward. But we also are not emotional about how we make those investments. So we're not married to anything." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of John Pitzer from Credit Suisse. Your line is now open." ] }, { "name": "John Pitzer", "speech": [ "Yeah, good afternoon guys. Congratulations on the solid results. Gary, you've given us a lot of sort of qualitative guidance on semi cap equipment spending for this year. I'm wondering if you can give us a sense of what you think the overall WFE market grows in calendar year '20. But perhaps more importantly, how important is China in your mind to that growth? And can you help kind of profile the Chinese spend between sort of memory, foundry, logic? I've got to imagine a lot of the trailing edge logic step you were talking about in your prepared comments is situated in China. But how do we think about that?" ] }, { "name": "Dan Durn", "speech": [ "Yeah. Thanks, John. This is Dan, I'll jump in and take that. So let's break it up into pieces. Let's first talk about WFE in 2020 and the growth rate over '19 and then I'll come back and talk a little bit about China and what we see in that market embedded in that overall growth rate.", "So we think 2020 is going to be a really strong year for the industry. We feel good about that. The ultimate question around growth rate is a function of what you use as a starting reference point for 2019. So I'm going to break this up piece by piece. Hopefully I can shed some light and be helpful to clear up I think some of the confusion that exists in the market. So what's important is is we established a reference point for 2019 and then we talk about growth off of that. So we know the number for 2019 WFE. It's not mid 40%s [Phonetic].", "I think one advantage we have is is we've got a very broad portfolio and we've got insight into all the different device types. And that gives us some unique insights in terms of market sizing. So let me share with you what we're seeing and hopefully we can help out.", "2018 was $56 billion. That's according to Gartner. It's a good number, it's validated by a third party. So 2018 was $56 billion. Off of that number, we see 2019 as it down 10% to 12% and that's the baseline we're using for 2020 growth. We see 2020 as a market up 10% to 15% based on everything we see and likely at the high end of that range given the conversations we're having with customers. So while it's too early to know 2020 with precision, 2019 is very clear as a baseline. So hopefully now the baseline for 2019 is clear. Off of that baseline we're likely up 15%. We expect to significantly outgrow the market with our semi systems business and it's not one device type.", "Coming to China embedded in that outlook. As we think about 2019 and where that ended, we see that market as about $6.5 billion and we see growth off of that market of about $2 billion to $3 billion. Embedded within that, if you take a look at that $2 billion to $3 billion, I would say, a third of it is 200 millimeter trailing node foundry logic, two-thirds of it is 300 millimeter business. Of the two-thirds of 300 millimeter business it's roughly evenly split between trailing nodes, foundry, logic and the memory. And there is balance within the memory profile. And so I think that gives you a sense of what we're thinking for the China market.", "And if I were to take a step back and distill down what we're seeing, we see consistent steady ecosystem building, investments in technology roadmaps with modest capacity additions. And even if we look at the $2 billion to $3 billion of incremental spend that we're seeing in China and -- domestic China and we take a look at what it costs to build new memory factory $7 billion to $8 billion or a new foundry, logic factory of $15 billion to $18 billion, even embedded within that $2 billion to $3 billion of growth, it's modest capacity additions. And part of that spend is 200 millimeter, part of it is 300 millimeter with diversification across device types. Hopefully that helps shed some light on both the overall WFE market, John, as well as what we're seeing in China." ] }, { "name": "John Pitzer", "speech": [ "No, that's great color. And then quickly as my follow-up, I want to make sure I heard you correctly, I think you said in the prepared comments that for the full fiscal year '20 you expect flat panel to be roughly flattish year-over-year, which would kind of imply a second-half run rate of close to $1 billion if not slightly over. I'm just kind of curious why you're confident about that. Is it mainly because of the $300 million cushion you have in the April guidance for the coronavirus is mostly coming out of flat panel or -- am I thinking about the math right on that?" ] }, { "name": "Dan Durn", "speech": [ "Yeah, so let me start with the math. You are thinking about the math correctly. We've had a point of view now for a couple of quarters that revenue in 2020 in the display business is going to be similar to what we saw in 2019. Everything we see in the market today increases the confidence we have in terms of that outlook. So no change to the full-year guidance.", "As we look at the risk we've assessed as part of the coronavirus, we think we're taking a -- first of all, we think the risk is temporary and we think there is no change to our full-year outlook -- fiscal year outlook as a result of that. And so we think we're being prudent in de-risking our guide by about $300 million and we see recovery of those revenues in Q3, Q4 as we unpack for the $300 million across our reporting segments. We've talked about services would have been our first $1 billion quarter, but we've de-risked it based on the virus.", "In terms of rank order of the $300 million, first most impacted is our semi systems business followed by our display business followed by our service business. So if you put the pieces together without being point specific on any one of those, I think you get a sense of how much we've de-risked our services business. Display will be incrementally more than that. And semi systems will be incrementally more than that. The sum of those three will equal $300 million. Our thesis around display being or I'm sorry TVs being a recovery market -- going through a digestion period in the market, you'll see recovery of the handset market that framing of the profile of spend in display still holds. We see both markets looking good into 2021 and we think we returned to nice growth profile in the back part of the year and into 2021." ] }, { "name": "John Pitzer", "speech": [ "Great color. Congratulations again, guys." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Krish Sankar from Cowen & Company. Your line is now open." ] }, { "name": "Krish Sankar", "speech": [ "Yeah, hi, thanks for taking my question and Dan again, thanks for the terrific color on all the industry stuff. Two-part question, number one is based on your guidance of roughly $3 billion for semis and around the same, maybe plus or minus $200 million for the rest of fiscal '20, it looks like when I look at your last cyclical peak in April 2018, you guys did about $3 billion and then the sales trailed off. I understand at the time it was SSG, now it's semi systems, there is probably some shift in numbers, but overall, it looks like you can sustain this $3 billion sales number for the rest of the fiscal year. I'm kind of curious from your vantage point, how much of this growth versus the prior peak number was capital intensity going up versus AMAT's specific share gains?", "And then the second quick housekeeping question, on your color on China, if I remember right, I think you said 200 millimeter is going to be a third of your number, which is about $3 billion for China WFE. I'm going to surprise it's [Phonetic] that high given the fact that last year, if I remember right, China 200 millimeter was only $0.5 billion. Why is it jumping up so much this year? Thank you." ] }, { "name": "Dan Durn", "speech": [ "Yeah. Thanks, Krish. So, taking the second question first, we've been talking about specialty nodes. We've been talking about trailing node geometries. We've been talking about billions of edge devices and intelligence on the edge and sensor technologies that are supporting the build-out of the Internet of Things. And we see trailing node geometries is one place that China can in the near-term play a strong role in helping to build out their ecosystem in a disciplined way. And so it fits in with the framing that we've been talking about, technology development, ecosystem development and disciplined investments to support that ecosystem from a capacity standpoint. And so it's very consistent from a framing standpoint." ] }, { "name": "Gary E. Dickerson", "speech": [ "Yeah, I think on the -- maybe I can add something on this -- on this part of the question. If you look at this market IoT, communication, auto, power, devices, sensors, it has a very, very high growth rate and innovation is driven by materials innovation. So 2018 was the first year machines generated more data than people. In the next five years the forecasts are the machines will generate 10 times more data than people. And when you go to CES you see everything getting smarter. So this market is a big market.", "I think, specifically to your question in China, your numbers are roughly correct. Our numbers are a little bit different, but roughly correct that there is a lot of growth in China in these areas and they can build those types of devices. And so if you look at trillion connected devices at the edge by 2030, the explosion of data and really the transformation of many industries, healthcare, education, you see retail, transportation, all of these areas growing very fast and the companies that are growing quickly from a market cap standpoint are companies that are data centric companies. So again I think that's really what we're seeing is this explosion of data and this market is a very big market. Applied has a very strong position. We've put together in the last year a team of great leaders across the Company for 300 millimeter and smaller wafer sizes. I personally am meeting many of the CEOs and R&D leaders in this ecosystem and we have really, really strong momentum.", "One example is one particular large customer where we won two-thirds of the available opportunities in a market that is very, very sticky over a long period of time. So I think you're correct in that maybe it's surprising that the market is growing like that, but we think this is really the early inning of these particular markets, IoT, communication, auto, power and sensors from a growth perspective. And Applied has a really great position inside that market." ] }, { "name": "Dan Durn", "speech": [ "And, Krish, coming back to the first part of your question where you talked about growth and how much of it is share gain versus capital intensity, I think it's important to take a step back and set a context around how the Company has evolved over time. If we were to go back a handful of years, we were strong in foundry, over 20%, and around mid teens in all three other device types. Today we're balanced across all of the device types. The Company has made steady progress on that front over the last handful of years since Gary took over the Company.", "Your specific question referenced the time period in 2018. We were high teens, a little over 19% from an overall WFE share standpoint that year. Today we're -- I'm sorry -- 2019, we were a little over -- probably a little over 20% in 2019. So we feel really good about the progress we've made in significantly outperforming the peers and the market in 2019. So you definitely see some share accretion playing out in the current environment.", "The second thing I would say our thesis around increasing capital intensity, you see it in foundry, logic, you see it in NAND, you see it in DRAM. That thesis of increasing capital intensity over time is firmly intact. We know our customers are investing a lot of money in WFE. And so their profitability -- WFE as a percent of their profitability has come down since 2012. WFE as a percent of EBITDA in memory and foundry, logic is down 25% over the last half a dozen years. And so they're spending a lot, but they're making a lot of money. And so, the health of our customers is as good as it's ever been.", "And then from a capital intensity standpoint, what we see is WFE as a percent of overall semiconductor industry revenue bottomed around 2013 at 9%. Of course, we're taking the one data point around the '08, '09 downturn of 6% off the table. 2013 it was about 9%. And Gary referenced in his prepared comments we've been in a tight band centered around 11.5% for the last five years. So it's a clear indication this industry is experiencing increased capital intensity. The macro demand drivers driving the overall semiconductor industry are firmly in tact. Semiconductors are going to go structurally larger as the data economy kicks in. And by implication, our industry and Applied Materials are going structurally larger. So we think the opportunities in front of us has never looked this -- has never looked as good as they do today and we're really excited about what we see." ] }, { "name": "Krish Sankar", "speech": [ "Thanks, Gary. Thanks, Dan." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Harlan Sur from JP Morgan. Your line is now open." ] }, { "name": "Harlan Sur", "speech": [ "Good afternoon. Great job on the quarterly execution. One way to combat the slowing of traditional Moore's Law on the manufacturing front, but still drive Moore's Law like performance improvements at the chip level is through the use of these advanced packaging whether that's chipless [Phonetic] strategy, multi-chip, die stacking, you guys have a pretty strong position in these markets. How is this segment expected to do this year and roughly how big is your advanced packaging segment relative to the size of your overall semi business?" ] }, { "name": "Gary E. Dickerson", "speech": [ "Yeah, thanks for the question, Harlan. So you're right, we talked about this new playbook going beyond the classic 2D shrinking and Moore's Law and packaging is one of those five drivers for the new playbook and it really, really, really is very important. The one example is if you take GPU in a new package and this is a product that was released over the last couple of years, you'll get 50% lower power and 3x increase in speed, three times increase in speed, just from the package. So definitely really important as part of the new playbook.", "From an Applied perspective, we had record revenues in packaging in 2019 and we have really strong momentum into 2020. We have the most comprehensive portfolio of solutions to support the packaging roadmaps for our customers. And as you talked about heterogeneous integration approaches, in 2019 we won over 50% of the applications we competed for and we have this broad portfolio with CVD, PVD, CMP, plating and etch where we have highly differentiated new products.", "We have very deep engagements with leading customers and there is a lot of focus on innovating with new packaging architectures. Applied has very deep engagement with really across the whole ecosystem. That -- those engagements are really driven by two things. One, we have the broadest portfolio of current and new products that haven't been announced yet that are enabling from a packaging perspective. We also have the most advanced packaging lab, where we could run entire end-to-end process and co-develop new packaging technology with leading customers and partners. So again, overall very strong momentum with record business in '19.", "And I think this area, we haven't quantified it in terms of a dollar amount but it's sizable. And I would say, relative to growth opportunities as one of the elements of the new playbook, it's under appreciated and the opportunities are bigger than what people would think relative to our growth potential here." ] }, { "name": "Harlan Sur", "speech": [ "Thanks for the insights there. And then you guys have talked about memory spending recovery with NAND leading the way this year. But with DRAM pricing now steadily rising, especially in mobile and servers and looking to be sustainable and you've also got the new gaming console platforms launching in the second half that are driving pretty strong demand growth for graphics DRAM, are you guys starting to get some visibility on a return to spending by some of your DRAM customers in the second half of this year?" ] }, { "name": "Dan Durn", "speech": [ "Yeah, thanks Harlan. I will take that. I think what we see, we talked about the magnitude of the growth we see in WFE year-over-year into 2020. Our view on that is it's broad based. I think that you'll see a good profile from foundry, logic. I think you see a good profile from memory and I think you will see balance across device types within memory. The growth profile into 2020 is going to be across those different device types. And yes, so we will start seeing DRAM this year." ] }, { "name": "Harlan Sur", "speech": [ "Great. Thank you." ] }, { "name": "Michael Sullivan", "speech": [ "Thanks, Harlan. And operator, we saw the number of people in the queue, I'd like to have us please move to one question per person. Thank you very much." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Pierre Ferragu from New Street Research. Your line is now open." ] }, { "name": "Pierre Ferragu", "speech": [ "Hi. Thanks guys for taking my question. On foundry, logic, so you have had a [Phonetic] record growth of $1.9 billion. I was surprised -- I was curious to see how much of that comes from deep UV nodes [Technical Issues] 10 nanometer node. And how much of your revenues are already coming from the new EUV nodes?" ] }, { "name": "Michael Sullivan", "speech": [ "Hi, Pierre. This is Mike. Unfortunately, I couldn't hear your -- I think you are maybe on a cellphone. So we can tell you're talking about foundry and the mix of getting to a number like $1.9 billion. But we unfortunately couldn't hear the rest of the details of your question. So we're not sure how to respond. Could you try one more time, please?" ] }, { "name": "Pierre Ferragu", "speech": [ "Oh, yes. [Indecipherable] better now?" ] }, { "name": "Michael Sullivan", "speech": [ "That is a little better. Let's try again." ] }, { "name": "Pierre Ferragu", "speech": [ "Okay. Sorry for that. So I was wondering how much of your revenues come from like EUV nodes where capacity is being added at the moment, so 7 nanometer foundry and [Indecipherable] 10 nanometer IGM and how much is coming from the new EUV nodes ramping today?" ] }, { "name": "Dan Durn", "speech": [ "Yes. So thanks, Pierre. Let me take a stab at that and see if Gary wants to add anything. So what I would say is we won't share our internal forecast of how foundry, logic breaks out across nodes. But I think, let me provide some color and context around the $1.9 billion. I think we would say that we're seeing strong adoption at 7 nanometers as they build out the node, strong adoption node over node as 5 nanometers gets deployed from a capacity standpoint and the logic equivalents of that.", "And while we talk about a more balanced market in foundry, logic, I think what you would see in the near-term environment that it's going to be significantly more weighted in the near term to these leading-edge technologies. And so we really like the way the business is performing node-over-node. In fact, as we look out into 3 nanometers we really like the position and we think we can significantly enhance our relative position node-over-node. So we really like the way the business is performing on the leading edge. And what you see in the near-term environment, given the strong ramp around 5 and 7 nanometers is less balance in the market in the near term, but the long-term trend of diversification within foundry, logic is still intact." ] }, { "name": "Gary E. Dickerson", "speech": [ "Yeah, Pierre the only thing I would add relative to the leading foundry, logic, is that all of these customers are driving performance, power area cost, PE pack improvements and that's really all about new materials, new structures to drive power and performance. And so for Applied, as Dan said, really from a leading perspective -- leading node perspective, it's really -- it is those EUV now like 5-nanometer, where you see that adoption, but still we achieving record revenue. We have so many opportunities when we're driving these new structures, new materials, new architectures, all of those different areas. So we see record revenue there. We're also seeing growth not only in transistor interconnect and patterning with some of our leading products, but we also have growth in areas where we have had lower share. In etch, we have many new critical etch steps that we've won, new self aligned multi patterning wins and the EUV patterning steps, where we really didn't participate in the past. So when we look at our etch business in foundry, logic we are extremely optimistic about the growth that we're seeing as new nodes are adopted, even as EUV is also being adopted as one of the five drivers of power, performance area and cost.", "The other thing I talked about is in process control we have continued strength in eBeam. We also have strong adoption of a new inspection tool and we had record revenues in that market this last quarter. So again, it's really about driving that new playbook along those five vectors, power and performance. Our leading products, we're seeing new steps being adopted. And in some areas we have room to grow. The opportunities for us have never been better and our position has never been better than today." ] }, { "name": "Michael Sullivan", "speech": [ "Thanks, Pierre." ] }, { "name": "Pierre Ferragu", "speech": [ "Thanks, Gary. Thanks, Dan." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Joe Moore from Morgan Stanley. Your line is now open." ] }, { "name": "Joseph Moore", "speech": [ "Great. Thank you. I wonder if you could -- if you could address the $300 million of kind of deferred revenue that pushes to next quarter. Can you talk about why that's happening? Is that just sort of issues with your customers getting up and running, is it logistics issues getting tools to them, or is it supply constraints that you have getting kind of sub-assemblies to build tools? Just can you kind of tell us what's driving the deferral?" ] }, { "name": "Dan Durn", "speech": [ "Yeah. Thanks, Joe. I think the best way to describe it is the actions China is taking to contain the spread of the virus has led to travel restrictions and logistics of moving things around the country. We see those impacts as being temporary and it reprofiles revenue from Q2 to the back part of our fiscal year. And so in the early stages of the China workforce coming back after the Lunar New Year and after the imposed restrictions by the government, we're seeing some early signs that are encouraging of some return to normalcy. It's a fluid environment. It's too early to draw a conclusion from it. But we like some of the early indications that we see.", "We're going to continue to monitor the situation closely and update as necessary. And again as we break out that $300 million rank order it semi systems, display, services, it's about getting our people into the factories and being able to service the equipment that certainly puts some restrictions on it. We know Wuhan is an important geography in our display business. Getting our systems into the factories in that region are impacted in the near term and then semi systems, it's more of the same. And so we think that given everything we know it's a prudent approach to the environment we see. We're going to continue to monitor it. There is an opportunity to do better in Q2. We think the customer demand is there and we do think that we'll recover in Q3, Q4 and our full-year fiscal year outlook remains intact." ] }, { "name": "Joseph Moore", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Vivek Arya from Bank of America Securities. Your line is now open." ] }, { "name": "Vivek Arya", "speech": [ "Thanks for taking my question and congratulations on the strong growth and for all the color you gave. A lot of questions were asked on the product side. I wanted to ask about services. Were you surprised to see the slowdown in services in the last few quarters? What drove that? And then more importantly, let's say you're targeting a 15%, 20% growth for next year, how much does AGS need to grow for that or how much can AGS grow in that kind of a product growth environment? Thank you." ] }, { "name": "Dan Durn", "speech": [ "Yeah, thanks, Vivek. So as we look at services we talked about the framework of growth in that business in the prepared comments. It's size of the installed base, it's complexity of the leading node technologies and it's the execution against the long-term service agreement opportunity we have. Those underlying growth drivers are absolutely intact. This is a business that's grown strong double digits over the last handful of years.", "Q1 was a record quarter for us and significantly above seasonal. Q2 would have been our first $1 billion quarter. And so the team is doing a great job executing. We also know the slowdown in the near term is a function of the memory correction that we're seeing profile throughout 2019. As industry utilizations come down our transactional component of the business has reflected what's happening to industry wide utilizations. The team is still executing against the long-term service agreement opportunity and grew that business nicely in the mid teens in 2019.", "What we like about the set up through the back half of the year and as we look into 2021 with the services business in particular, as the memory recovery begins to take hold and as we look at that building momentum throughout 2021 foundry, logic demand continues to be strong. Those are going to provide a nice tailwind for that business to grow into the back half of the year and into 2021. So underlying demand drivers intact, team is executing well and we like the profile going forward." ] }, { "name": "Gary E. Dickerson", "speech": [ "Yeah, just one more data point I talked about in the prepared remarks, we added 15% increase in the tools under service agreements and those -- that subscription type revenue is very sticky and also gives us a higher entitlement per tool. So that's been a big focus. It's been a tremendous change in the last few years, the significant growth and it's really based on the value that we're providing our customers." ] }, { "name": "Vivek Arya", "speech": [ "Okay. Thank you." ] }, { "name": "Michael Sullivan", "speech": [ "Thanks, Vivek. And operator can we have just two more quick questions, please?" ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Timothy Arcuri from UBS. Your line is now open." ] }, { "name": "Tim Arcuri", "speech": [ "Thanks a lot. I guess I wanted to go through some numbers with you guys. So your -- I think you said Dan 19.2% of WFE last year. So if I assume that the second half is flat versus the first half, that would put SSG sort of in the $11.5 billion to like $12 billion range. So I don't think you would argue with either of those numbers since that's what you guided. So if I use that and then I assume that you don't gain or lose any share this year, that would imply like a $61 billion WFE number. You're sort of saying, well, it's probably going to be more like $57 million. So if I just average those two and take $59 million and if I try to figure out how much revenue is required to support that much WFE. And I listened to what Gary said which I totally agree with about WFE intensity that it usually peaks out at about 12%. So if you take 12% that would imply that you need over $500 million worth of semiconductor revenue this year which would be up like 25% year-over-year. So I definitely get that YMTC is some of the incremental WFE and they don't -- and they don't have much revenue. But how can you build a path to have enough revenue to support this? I guess that's the question. It's just hard to see WFE growing off of this, like it's going to take a long time for revenue to kind of grow into these WFE levels. Thanks. Yeah. Thanks," ] }, { "name": "Dan Durn", "speech": [ "Yeah, thanks, Tim. Appreciate the question. So, couple of things. We have insight on what we think our semi-systems business can do against the backdrop of the environment we see. And we're very confident in our ability to significantly outgrow the market. And then from a modeling standpoint, here is I guess how I would get at some of the assumptions.", "We think 2020 is going to be a really good year. We expect to outperform the market. One of the key variables in the model that you're putting together is what you assume for market share and small changes in market share can make big differences in the model. So we see continued strength from foundry and logic and our business throughout the year. We've got signs of memory recovery and as we've been saying for a couple of quarters, ultimately it depends on the magnitude and shape of the memory recovery [Indecipherable]. And if we see more momentum in that than we're currently planning for, then I do think that we have an opportunity to outperform in Q4 and into our fiscal Q1. And so net net we don't see this being an isolated pocket of performance. We're relatively balanced half over half. And we feel really good about how we're positioned and how we're performing this year." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Patrick Ho from Stifel. Your line is now open." ] }, { "name": "Patrick Ho", "speech": [ "Thank you very much for squeezing me in. Gary, maybe just to follow up on the share position for Applied, both in terms of the customer spending mix which is influential for you as well as some of the competitive and design wins. You've talked about process control being a record revenue year. How do you look at the next couple of years, as I guess, new products continue to be introduced and additional competitive wins you believe can drive the Company on this outperformance." ] }, { "name": "Gary E. Dickerson", "speech": [ "Yeah. Thanks, Patrick. So I would say, I've never been more optimistic relative to the market. Again you have new demand drivers that are layered on top of mobile, social media, and PC. So the market is going to be bigger than we've seen in the past and you can also see indications over the last few years, the market is structurally larger and less volatile. We have very good share spread across all of the different segments, the leading foundry, logic we have momentum as customers are driving improvements in power, performance area and cost. In the specialty nodes, we have very, very strong positions, whether it's an image sensors or any of the other markets like IoT, communication auto, and power devices. So we have strength there. We've grown a significant amount in DRAM and in NAND relative to market share. Dan talked about this earlier. We've grown several points over the last few years.", "So we have very strong balance, and what I would say is again the path forward for the industry is really this new playbook around new architectures, new structures, new materials new packages also where we had record last year and we have strength and new ways to shrink. So we have the product pipeline and we have some very significant products in the pipeline that are targeted at multi-billion dollar types of opportunities.", "But the other thing I would say that's really important is the combinations of these different technologies with Integrated Material Solutions driving significant improvements in throughput and drive current or power the things really that are crucial for the edge in the cloud, we have unique capabilities to combine these technologies, some of them under vacuum. So you're not damaging interfaces electrically. So that's another area. We have engagements across every single customer with Integrated Material Solutions. We have very good momentum there besides the current products we have and the products that we have in the pipeline. So again, from my perspective, I've never been more optimistic. I spent a huge amount of my personal time with the R&D leaders for the customers through this entire ecosystem. They're struggling to drive the performance, power improvements that are needed. And I think Applied is in the best position that we've ever been relative to our ability to drive our opportunities and growth going forward." ] }, { "name": "Patrick Ho", "speech": [ "Thank you." ] }, { "name": "Michael Sullivan", "speech": [ "Yeah. Thanks, Patrick. Thanks for your question. Dan would you like to help us close the call?" ] }, { "name": "Dan Durn", "speech": [ "Sure, Mike. First, our sympathies to everybody who has been affected by the coronavirus situation. I want to personally thank all of our employees who are helping their families and their communities while also taking really good care of our customers. Applied's outlook for 2020 remains really positive. We expect to deliver strong double-digit growth in our semi-systems business this year, significantly outperforming our end markets.", "Looking out into the future, I really like the setup. I really like what I see, continued strong pull foundry, logic, improvement in memory, both of those elements are going to drive and fuel growth in our services business over time. I like what I see in display increasing into the second half of 2020 and into 2021 and we expect to close the Kokusai transaction in the middle of this year. So I really like the setup in 2020 and 2021. Gary and I hope to see many of you tomorrow at Goldman and next week. I'll be on the East Coast and look forward to seeing many of you as well.", "Let's close the call Mike." ] }, { "name": "Michael Sullivan", "speech": [ "Okay, great, thanks. We'd like to thank everybody for joining us today. A replay of our call is going to be available on our website by 5 o'clock Pacific Time. And we would like to thank you for your continued interest in Applied Materials." ] }, { "name": "Operator", "speech": [ "[Operator Closing Remarks]" ] } ]
AMAT	2018-02-14	[ { "description": "Head of Investor Relations", "name": "Michael Sullivan", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Gary E. Dickerson", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Daniel Durn", "position": "Executive" }, { "description": "Citi Research -- Associate Analyst", "name": "Atif Malik", "position": "Analyst" }, { "description": "Evercore Group LLC -- Senior Managing Director", "name": "J. Muse", "position": "Analyst" }, { "description": "Credit Suisse Securities -- Equity Research", "name": "Farhan Ahmad", "position": "Analyst" }, { "description": "J.P. Morgan Securities -- Executive Director, Equity Research", "name": "Harlan Sur", "position": "Analyst" }, { "description": "Goldman Sachs & Co -- Managing Director", "name": "Toshiya Hari", "position": "Analyst" }, { "description": "Morgan Stanley & Co. -- -- Semiconductor Industry Analyst", "name": "Joseph L. Moore", "position": "Analyst" }, { "description": "Stifel, Nicolaus & Co. -- Managing Director", "name": "Patrick Ho", "position": "Analyst" }, { "description": "Needham & Co. -- Equity Analyst", "name": "Edwin Mok", "position": "Analyst" }, { "description": "Wells Fargo -- Stock Analyst", "name": "David Wong", "position": "Analyst" }, { "description": "Deutsche Bank Securities, Inc. -- Equity Research Analyst", "name": "Sidney Ho", "position": "Analyst" }, { "description": "B. Riley & Co. -- Director of Research", "name": "Craig A. Ellis", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in a question-answer session.", "I would now like to turn the conference over to Michael Sullivan. Please go ahead." ] }, { "name": "Michael Sullivan", "speech": [ "Good afternoon, everyone. I'm Mike Sullivan, Head of Investor Relations at Applied Materials. We appreciate you joining us for our first quarter of Fiscal 2018 Earnings Call, which is being recorded. Joining me are Gary Dickerson, our President and CEO; and Dan Durn, our Chief Financial Officer.", "Before we begin, let me remind you that today's call contains forward-looking statements, including Applied's current view of its industries, performance, products, share positions, and business outlook. These statements are subject to risks and uncertainties that could cause actual results to differ materially and are not guarantees of future performance. Information concerning these risks and uncertainties is contained in Applied's most recent Form 10-K and 8-K filings with the SEC. All forward-looking statements are based on management's estimates, projections, and assumptions as of February 14, 2018 and Applied assumes no obligation to update them.", "Today's call also includes non-GAAP financial measures. Reconciliations to GAAP measures are contained in today's earnings press release and in our reconciliation slides, which are available on the Investor Relations page of our website at appliedmaterials.com.", "And now, I'd like to turn the call over to Gary Dickerson." ] }, { "name": "Gary E. Dickerson", "speech": [ "Thanks, Mike. I'm happy to report another record quarter for Applied with revenue of nearly 30% for the same period last year. 2018 already looks like another great year and we expect each of our three major business segments to deliver strong double-digit growth. We have tremendous momentum across the company and we are confident this momentum is sustainable for two reasons.", "First, we see an expanding set of market drivers as more and more industries are disrupted by emerging technologies. From retail to entertainment, healthcare, manufacturing and transportation, the way companies create value and compete increasingly depends on their ability to capture, store, and understand huge amounts of data. The overall market for electronics is increasing and, as those electronics get smarter, semiconductor and display content grows even faster.", "Second, Applied is in a great position to outpace our markets. We are turning our investments into a strong pipeline of differentiated products and we are using our broad set of capabilities to bring highly enabling new technologies to market faster than ever before.", "In today's call, I'll talk about the major trends driving sustainable growth in our markets. I'll describe our strategy and how we're translating our broad portfolio of products and capabilities into differentiated performance for our businesses. Then Dan will provide details about our financial execution and capital allocation, which reflects our increasing confidence in the sustainability of our markets.", "This is an incredibly exciting time in the electronics industry because we are at the start of a new era of growth. The Internet of Things, big data, and artificial intelligence will transform the economy over the next decade. As a result, a broad spectrum of companies are making substantial investments in these technologies to position themselves for the future. These large, powerful trends are already driving a fundamental shift in demand for semiconductors and displays. While these are only the early stages of AI and big data, there are already applications that have significant traction and are starting to scale.", "The first example is AI natural language processing, which is being integrated into more devices and driving silicon content at the edge and in the cloud. Voice-assistants are fast becoming the hub for home automation. A typical voice assistant has around 30 chips and a total of 200 square-millimeters of silicon. That's about twice the area of a smartphone application processor. Language processing is compute-intensive and the leading companies are building dedicated data centers to support it. These AI workloads require new server architectures that have up to 8 times more logic and 4 times more memory content by area than traditional enterprise servers.", "Another important AI trend for 2018 is neural processing units in smartphones. This is a great example of AI at the edge, where machine learning is used to enable a phone's camera to identify and react to what is seen.", "The third example is self-driving cars. It's reported that $80 billion has already been invested as technology companies and traditional auto makers race to get Level 4 vehicles to market. We believe Level 4 vehicles will have approximately 8 times more silicon content than a standard car has today.", "These powerful emerging trends layer on top of traditional demand drivers, such as smartphones, data centers, and storage, which continue to evolve and grow. We see leading cloud service providers announcing significant increases in their capital investments to expand data center capacity. To keep pace with the explosion of data generation, the storage market is growing rapidly and NAND is taking a larger share. Recent data suggests that NAND will grow from 18% to about 30% of the total data storage market in the next three years. And, while smartphone unit growth is relatively flat, the value of the silicon content in smartphones grew more than 30% in 2017.", "All these demand drivers add up to a very positive outlook for Applied-served markets. In semiconductor, market fundamentals are strong and we see disciplined investments in capacity and technology across a broadening customer base. Based on the timing of customer projects, we expect DRAM and logic spending to be higher in 2018, while the overall mix between foundry logic and memory investments will be similar to 2017. We see a steady ramp of spending in China, which is positive for Applied because of our strong a growing market share and high service penetration as both multi-national and domestic manufacturers.", "At the end of last year, we expected total wafer fab equipment spending in 2017 and 2018 combined would be more than $90 billion. As we look further ahead, we believe combined spending in 2018 and 2019 could be around $100 billion. While it's too early to comment on timing of that spending, we believe the overall trend line is clear. In display, there are two equally large market inflections driving capital investments, the introduction of Gen 2.5 substrates for TV manufacturing, and organic LED displays. In mobile the transition to OLED displays is compelling. This is because rigid OLED offers significant performance, power, and cost advantages over LCD and flexible OLED will enable new form factors, such as curved and, eventually, foldable screens.", "As a result, our positive outlook for 2018 and beyond remains unchanged. Display is a unique growth driver for Applied and we expect to increase our revenue by more than 30% in 2018 on top of nearly 60% growth last year. At Applied, our vision is to make possible the technology shaping the future and we have aligned our investments and our organization around this vision. It is increasingly clear that the breadth of our capabilities in product portfolio is an importance source of differentiation because we bring together the most enabling capabilities in one place. We are in a unique position to help customers accelerate their time to market, which is tremendously valuable to them.", "Against this backdrop, I'll now provide updates for each of our business segments. In Calendar 2017, we grew our semiconductor process equipment more than 40% and our inspection and metrology business more than 10%. We expect to grow faster than these markets in 2018 and beyond with three major growth drivers. First, in areas where we're traditionally strong, we are extending our leadership. Our leadership products create the material that determine the power, efficiency, and performance of devices. To drive the major advancements in transistor and interconnect needed to enable high performance computing in AI, customers are increasing their focus on innovative materials and structures. This is translating to significant growth in areas like PVD, where we grew revenues about $800 million in 2017. Second, we're focused on capturing more share in markets where we have room to grow, specifically, patterning inspection and metrology. In patterning, we are providing materials and abled solutions to customers' three most significant scaling challenges: resolution, the 2-dimensional geometric shrinking of a device's features, 3-D scaling, ways to increase transistor or memory cell density, and, increasingly important, placement, which is the vertical alignment between the layers of device.", "By focusing on these key areas, we are on-track to generate over $1 billion of patterning revenue in 2018 and, regardless of the e-beam adoption, we expect our patterning opportunity to grow considerably over the next several years. Management of placement errors is also a driver for accelerated adoption of our e-beam inspection technologies. E-beam is the fastest growing segment in the inspection and metrology market and we're on-track to grow significantly faster than the market in 2018.", "Third, we are finding new ways to combine our innovative technologies in materials deposition, materials removal, materials modification, and materials analysis. Based on these capabilities, the pull from our customers for earlier and deeper collaborations is stronger than ever and we're working with them to develop new solutions that accelerate their technology roadmaps and expand Applied's market opportunities.", "In service, on a year-on-year basis, we've grown revenues every quarter since the end of 2013 and we're confident we can continue to grow at least 15% per year. This sustainable growth is driven by a growing install base, and increasing number of tools under long-term service agreements, and advanced service products that help customers shorten ramp times, improve device performance and yield, and rapidly optimize their factory output and operating costs.", "Before I turn the call over to Dan, I'll quickly summarize. With record performance in the first quarter, 2018 is off to a great start and we're confident we can deliver strong double-digit growth across our semiconductor, display, and service businesses. We see sustainable strength in our markets as new demand drivers, including IoT, big data, and AI layer on top of traditional computing and mobility. Applied is uniquely positioned to outperform our markets as we enable customers to accelerate their device roadmaps using our broad portfolio of products and capabilities.", "Now Dan will give his perspective on our financial execution and outlook, as well as provide additional color on our capital allocation." ] }, { "name": "Daniel Durn", "speech": [ "Thanks, Gary. I'd like to begin by sharing some of my observations about the environment Gary described and discuss how we plan to allocate the company's capital as a result. The semiconductor industry is fueling a new data economy and, today, we're already seeing record semiconductor industry revenue of over $400 billion. We're excited about the Internet of Things and artificial intelligence and we believe this next era of computing will be built out over the next decade or more. Of course, nobody can guarantee that the growth will follow a straight line, but the future we envision is non-discretionary to the world's largest industries and semiconductor process technology and systems are at the foundation.", "All of the leading indicators of our equipment are positive and Gary shared that we see strength in 2018 and 2019. I believe WFE spending is going to remain significantly higher and less cyclical than it was during the PC era, which many people still identify with. Consider these facts: 300-millimeter technology arrived in the year 2000 and gave customers 2.3 times the number of chips for every wafer, while semiconductor revenue grew, equipment spending actually declined between 2000 and 2013 as WFE intensity dropped from a peak of 17% to a low of 9% over that same time period. But, from 2013 to 2017, while semiconductor sales grew, wafer fab equipment grew even faster and WFE intensity kicked higher to 12%.", "With technology getting more complex, I think it's hard to imagine WFE intensity drifting much lower. So, consider what happens if the semiconductor industry grows from today's levels at a modest 5% pace as multiple forecasts predict. Then, if WFE intensity stays flat at 12%, WFE investments of $50 billion or more should not be considered unusual in the near term and spending could potentially reach $75 billion by the middle of the next decade. We'll leave forecasting to others -- the point I want to make is that demand is much broader today than during the PC era. WFE intensity has stabilized and the industry is likely to be a lot more attractive in the years ahead.", "So, the future looks bright, especially for Applied Materials because we have a growing semi business, a growing services business, and a unique growth opportunity in display. I believe Applied Materials will become larger, and more profitable, and generate significantly more free cash flow than we do today.", "Against this backdrop, here is how we plan to deploy the company's capital going forward. Our capital allocation priorities are unchanged. Our first priority is to invest in the growth of the business with an emphasis on organic growth. We will continue to invest with discipline. This means every dollar of R&D is tied to an attractive margin target. This means every dollar of R&D is tied to an attractive margin target and we will continue to look every quarter for opportunities to shift money from lower return areas to high-return areas before increasing R&D. We will also stay laser-focused on maintaining G&A efficiency.", "Our second priority is to maintain a robust and flexible balance sheet. We remain committed to a strong investment-grade credit rating. Our third priority is to return excess cash to our shareholders. In fact, since 2000, Applied has returned nearly 90% of free cash flow to shareholders and, today, we're announcing a change in the dividend policy. We've said that our markets are bigger and less volatile, which gives us the opportunity to pay higher dividends. Applied's board of directors has approved a 100% increase in the quarterly cash dividend and declared the first $0.20 quarterly dividend will be payable in June. We'll review our distribution practices on a regular basis and evaluate further dividend increases as we continue to grow the business.", "At the same time, we strongly believe in the future growth and value creation of the company. Accordingly, the board has also increased our buy-back authorization by $6 billion. Combined with more than $2.8 remaining from the previous authorization, we have a significant opportunity to increase shareholder value through buy-backs. We plan to be opportunistic, repurchasing more shares when we believe they are significantly undervalued.", "Next, I'll discuss the impacts of the U.S. corporate tax reform, which is beneficial to Applied because it gives us greater flexibility in how we deploy future profits to serve our customers, grow the company, and return capital to our shareholders. With freer access to profits generated offshore, we now have greater flexibility to invest within the U.S., where we do much of our advanced technology development and manufacturing. This year, we plan to add new engineering jobs in the U.S. and invest in new labs and office space to support our growth objectives.", "In Q1, the new tax legislation resulted in a one-time repatriation tax of about $1 billion. As you may know, the tax amount is payable over eight years and the payments are significantly back-end weighted. Because of this one-time repatriation tax, Applied's gap tax rate for the quarter was 88.4%. Our non-GAAP tax rate was 6.3% for Q1 and we're using a 6.5% tax rate in our planning for the rest of Fiscal 2018. Beginning in Fiscal 2019, we expect our non-GAAP tax rate to be in the range of 11% to 12%. This increase reflects a minimum tax on foreign income that becomes effective next year.", "Now I'll comment on our financial execution on Q1. We delivered our eighth consecutive quarter of year-on-year growth in both revenue and non-GAAP EPS, which was $1.06 or $1.02 when excluding a $0.04 tax benefit. On a year-over-year non-GAAP basis, we increased gross margin by 1.3 points, reduced OpEx as a percent of sales by 2.3 points, and grew operating margin by 3.6 points.", "Turning to the segments, we delivered record revenue and operating profit in both semi equipment and services. In semi equipment, we grew revenue by 32% year-on-year and delivered the highest operating margin in almost seven years. I'm particularly impressed with the growth of our services business. AGS grew revenue by 30% year-over-year, which was above our expectation, mainly due to higher than expected spare parts demand. AGS also delivered record operating margin in display. Revenue and operating margin were both lower sequentially following a record Q4, which we anticipated due to lumpiness of the business. We expect display revenue operating margins to trend higher in the balance of the year.", "Now I'll share our business outlook for Q2. We expect revenue to be in the range of $4.35 billion to $4.55 billion. The midpoint would be up nearly 26% year-over-year. We expect semiconductor systems revenue and services revenue to both increase by about 23% year-over-year. And our display revenue should increase by about 48% year-over-year. We expect the non-GAAP gross margin percentage to be approximately flat sequentially. Non-GAAP operating expenses should be in the range of $755 million, plus or minus $10 million. At the mid-point, OpEx would be approximately 17% of revenue, down 1.4 points year-over-year. And we expect non-GAAP EPS to be in the range of $1.14, plus or minus $0.04. The mid-point of the range is up nearly 44% year-over-year.", "And now I'll turn the call back to Mike to start the Q&A." ] } ]	[ { "name": "Michael Sullivan", "speech": [ "Thanks, Dan. Now, to help us reach as many of you as we can, please ask just one question at this time. If you have an additional question later, please just call the operator and we'll do our best to answer it later in the call. Operator, let's please begin." ] }, { "name": "Operator", "speech": [ "Thank you, sir. Ladies and gentlemen, at this time, if you would like to ask a question over the phone, please press * and then 1 on your telephone keypad. If your questions have been answered or you wish to remove yourself from the queue, simply press the # key. And, as a reminder, please limit yourself to one question.", "And our first question will come from the line of Atif Malik with Citigroup. Your line is now open." ] }, { "name": "Atif Malik", "speech": [ "Hi, and thanks for taking my question and congratulations on your strong return rate. First question for Gary, Gary, can you talk about the mix of mobile versus TV in your unchanged 30% year-over-year outlook for display business?" ] }, { "name": "Gary E. Dickerson", "speech": [ "Sure. Thanks, Atif. Just, overall, again, in '18, we're still seeing greater than 30% growth and 2019 and beyond also look very strong. If we look at '18 mobile versus TV, your question, it's about 50/50 mix. In TV, we see increased adoption of larger screens, we're tracking 13 Gen 10.5 projects. And, also, great example here is on 65-inch TVs -- if you produce them with Gen 10.5, you have eight 65-inch TVs and only three with Gen 8.5 so that's driving the TV business. OLED is the other half of our business in '18 and we still see very strong opportunity in OLED. Previously, we had one customers that was more than 50% of the business. Now, greater than 50% of the business is coming from multiple customers -- we talked about ten customers in OLED. And the transition to OLED displays is really compelling. Original LED gives you better performance, faster refresh rates, power, cost advantages over LCD. Flexible OLED gives you new form factors such as curved displays and, eventually, foldable screens. So, again, we're on-track for greater than 30% growth in 2018 and on-track with our longer-term model. Thanks, Atif." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question will come from the line of C.J. Muse with Evercore. Your line is now open." ] }, { "name": "J. Muse", "speech": [ "Yeah, good afternoon. Thank you for taking my question, I guess a question on your capital allocation plan. Obviously, with the doubling of the dividend, you're feeling good about the sustainability of this heightened level of spending in WFE. Would be curious to hear your thoughts around your framework of returning that capital? You announced buy-back program that's now $8.8 billion. Would love to hear whether that is going to be opportunistic or systematic -- overall, would generally like to hear how you think about free cash flow generation and plans to return excess back to shareholders? Thank you." ] }, { "name": "Daniel Durn", "speech": [ "Thanks, C.J. Let me see if I can help you with that. So, as you pointed out, we do see strength in our end markets, we're really encouraged by the diversification of those end markets, we're encouraged by capital intensity rising, and we're encouraged by the help of our customers. So, we've got a strong view of our markets into the future. From a capital allocation standpoint, the company's got a great history. Since 2000, the company has returned nearly 90% of free cash flow back to shareholders. As part of this announcement, we're changing the mix a bit -- we're going to increase our dividend by 100%. We've also announced a $6 billion share repurchase. When combined with the $2.8 billion that is outstanding from the prior authorization, it gives us an opportunity to opportunistically be in the market to drive even more value for shareholders. And so, we feel good about our end markets, we feel really good about the performance of the company, and we're going to remain committed to being very shareholder friendly with our excess free cash flow." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question will come from the line of Farhan Ahmad with Credit Suisse. Your line is now open." ] }, { "name": "Farhan Ahmad", "speech": [ "Thanks for taking my question and congrats on the great result. My first question is on the long-term drivers for the business. You talked about AI, IoT, and the general data economy. Have you guys done any sort of work to try to figure out what portion of the business is currently being supported by these non-consumer markets?" ] }, { "name": "Gary E. Dickerson", "speech": [ "So, as we look into the end markets and what's driving WFE, what we see is a lot of confidence in macro trends that are going to be driving a significant amount of efficiency into very large industries and we see that spend as non-discretionary. It is foundational to company's competitiveness. It's difficult to unpack those macro trends and slice them by WFE to see what part of WFE specifically supports each trend. What we see is a noticeably larger end market. We see strength across all device types, whether it's logic foundry, whether it's memory. And, within logic foundry, we see strength in both end markets. Within memory, we see strength in both NAND and DRAM. So, we're really encouraged by the breadth of the strength we're seeing and we think it bodes well for the market, but I think it's too difficult to unpack specifically how much is attributed to each end market trend. Thanks, Farhan." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question will come from the line of Harlan Sur with J.P. Morgan. Your line is now open." ] }, { "name": "Harlan Sur", "speech": [ "Hello. Good afternoon and congratulations on another well-executed quarter. Good to see the boost in the capital return program. And this goes back to your previous answer, but if I use net income as a poxy for free cash flow, this calendar year, you guys are going to be generating about $4 billion in free cash flow. So, the dividend increase you guys announced today is going to consume about 20% of that free cash flow -- I guess the question is the team committed over a multi-year period to its 90% free cash flow return, which would imply, at least for this year, about $3.2 billion in repurchase activity? And the reason why I ask this is that many semi companies and some of your peers are articulating capital return as a percent of free cash flow, so I guess the question is, 90% of free cash flow, is that how we should think about the capital return commitment from the team on a go-forward basis?" ] }, { "name": "Daniel Durn", "speech": [ "Thanks, Harlan. Let me see if I can add a little more color on this to try to be helpful. I would look at the 90% historical number as a mindset of this management team, as a mindset of Applied Materials to be committed to getting cash back in the hands of shareholders. We're going to remain committed to that going forward. I don't think what you will see from us is a formulaic approach to that. From a dividend standpoint, we made a big move on the dividend. We're going to continue to look at that performance of the business and the way we grow the business and review that policy on a periodic basis and look to grow our dividend as we grow the business. We're going to complement that the way we have historically by being aggressive repurchases of our shares when we feel intrinsic value is not fully reflected in the trading price of our stock and we're going to continue to do that.", "So, rather than be formulaic, I think we're going to look to be opportunistic with the repurchase, committed to the dividend, committed to reviewing that policy over time as we grow the business, and I think our track record into the future will be similar as our historical track record of getting a substantial amount of excess free cash flow back to shareholders but we do not want to be formulaic in that approach today. Thanks, Harlan." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question will come from the line of Toshiya Hari with Goldman Sachs. Your line is now open." ] }, { "name": "Toshiya Hari", "speech": [ "Hi, guys. Thanks for taking the question. Dan, you're guiding gross margins this quarter flat sequentially, despite display becoming a bigger percentage of your overall business, which I think, historically, would have been detrimental in gross margins. So, I guess what's driving the fundamental improvement in gross margins? And, longer-term, you shared the 47% target in your mid-term plan but we're kind of there, so how should we think about potential upside from there going forward? Thank you." ] }, { "name": "Daniel Durn", "speech": [ "Thanks, Toshiya. So, the company's got a really good track record over the last four years. The last four years, we've increased gross margin by 5 points. We've also articulated a model that says we're going to capture about 70 basis points of material costs of sales savings each year as we drive the business forward. That model still holds, but that's assuming a constant mix. You rightfully point out that we're going to have composition of our business -- the mix composition of our business -- that's going to create a bit of a headwind and mask some of that fundamental progress. So, to see a quarter where we see strong sequential growth in display and have us hold the gross margin flat, I think is a reflection of all the hard work that's going on behind the scenes to continue to drive the profitability of the company.", "What I would say is, our long-term model, we'd like to articulate a long-term model once a year during our Analyst Day and resist the temptation to update it along the way. What I would say is that we're going to be aggressive about looking for opportunities to do better than what we've advertised in our long-term model and, where we see opportunities, we will pursue it aggressively and make sure we're delivering as much value as possible for shareholders. Given the mix of businesses and the growth profile going forward, we'd like to stay consistent with our 47% gross margin out into the 2020 timeframe and, if we have an update, we'll review it in the fall at our Analyst Day. Thanks, Toshiya." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question will come from the line of Joe Moore with Morgan Stanley. Your line is now open." ] }, { "name": "Joseph L. Moore", "speech": [ "Great. Thank you. I wonder, when you talk about the $100 billion of WFE for the next few years versus the $90 billion you talked about for the next few years 12 months ago, how much of that increment do you think is coming from which segment -- how much is memory versus foundry logic -- and is there a level where you start to worry about supply growth being too high? Or just how are you guys thinking about these levels because they keep ratcheting higher?" ] }, { "name": "Gary E. Dickerson", "speech": [ "Thanks, Joe. So, implicit in the question is a framing that says we're ratcheting our estimates higher. What I would say is that we're extending the range of our forecast out into the 2019 timeframe and we feel really good about our end markets. What we're encouraged by is driven by three primary reasons. Macro trends, diversification of our demand drivers is the first. Second, capital intensity is up across the board and that's all device types. And the third, customers are very, very healthy right now. So, just double clicking on each of those three elements, we've got macro trends shaping how we live our lives right now. We've been talking about it for a while -- I think probably back into 2016 timeframe at our Analyst Day. Artificial intelligence, big data, Internet of Things, autonomous driving -- these are playing out. We view these trends as real. They're making an impact. Demand for silicon is going up. Semiconductors are on the critical path of enabling each of these trends. Content and data centers is going up, content and edge devices is going up, and, again, we're seeing strength across all device types.", "So, the macro trends are incredibly favorable. As we look at capital intensity, capital intensity is up across the board. In foundry, 7-nanometer is up 100% over 28-nanometer. Memory, both NAND and DRAM, is up between 40% and 60% over that same time period. Foundry is 3 times more capital intensive than the memory market. And we used to have wafer size transitions where you would get 2.3 times the number of chips per wafer, for instance, when you go from 200 to 300-millimeter.", "The last transition was in the year 2000 -- WFE intensity went from 17% in that year to a low of 9% in 2013, when all of the efficiency gains of that transition were absorbed. And, from 2013 to today, we've seen it trend up from that 9% to 12% and we don't have another wafer size transition on the horizon so we feel really good about the capital intensity that underpins our markets.", "And I guess the third thing, customers are healthy. They're investing a lot of money to drive business growth into the semiconductor industry, but they're also making a lot of money. Their WFE spend, as a percent of EBITDA, is down. In 2012 to 2018, the three largest memory providers and the three largest foundry logic providers are all down 60% WFE spend as a percent of EBITDA.", "So, we're really encouraged by what we see: macro is good, markets are good, and customers are profitable. We think it's a really healthy market and we're encouraged by it. Thanks, Joe." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question will come from the line of Patrick Ho with Stifel, Nicolaus, and Co. Your line is now open." ] }, { "name": "Patrick Ho", "speech": [ "Thank you very much and congrats on the nice quarter. Gary, in your prepared remarks, you talked about some of the share gains you generated over the past few years, particularly in patterning and e-beam inspection. A lot of it is due to the industry transition to 3D NAND and your ability to introduce some of the new products for that product. At the same time, we're seeing now the industry transition on the logic side to 10 and 7-nanometers. Can you discuss some of the opportunities there and maybe some of the share gain potential you have as that segment of the market makes a pretty sizable transition?" ] }, { "name": "Gary E. Dickerson", "speech": [ "Sure, Patrick. Let me first start big picture and then I'll cover the question that you asked. So, in '17, we grew process equipment more than 40%. PDC grew about 10%. Now, if you look back over the last three years -- 2014 to 2017 -- process equipment grew much faster than the PDC market and we see that playing out in '18 and probably in future years, also. But, again, process equipment, very, very strong growth and, as you said, very strong balance for us. It used to be that, if it was a good foundry year, Applied would do well and not as well on the memory years. We've increased our share of memory about 7% over the last few years of total spending. So, in '17, we had very balanced share in all the different segments -- device segments -- around 20% or more in all of those different segments. And then what we're looking for, 2018, is strong double-digit growth in our leadership businesses, in our growth businesses, and also in PDC. PDC, we have new capabilities, new products that will increase our growth a fair amount above what we accomplished in 2017.", "In foundry, there really are two big drivers: one of those drivers is in the trailing geometries. There was a question earlier about AI and what's driving AI. You really have data generation -- many, many smart devices -- data storage, and then you have the high-performance computing to process the information. So, if you look at the trailing geometries, China is increasing investment in 2018 a fair amount, both with domestic and global companies. We have a great position in China -- it's one of our highest share positions in semiconductor and display -- and we expect that we'll outgrow the market in China in 2018.", "Patterning is a great opportunity for us. We've gained about 19 points of share in patterning over the last few years. If we look forward, patterning in 2020 will be about a $5 billion TAM. We anticipate that we could add another $1 billion, approximately, in revenue over the next four years in patterning. And then, if you look at scaling challenges -- scaling, you have different drivers. One is resolution -- 2-dimensional shrinking of features -- there, multi-patterning is growing. 80% layers are multi-patterning. Those are growing and that's a great opportunity for Applied Materials. 3-D scaling certainly happened in 2-D to 3-D NAND, but you also see that in logic. The contact over active gate is one example where you see that and that's also materials-enabled scaling for customers and, certainly, you see that in high-performance computing and advanced foundry and logic.", "And then another big industry challenge where we're in a great position -- one of the biggest challenges for customers -- is pattern placement, the alignment of one layer to the next, edge placement errors. And there was a conference in early January: two of the top technologists from leading companies talked about edge placement errors being one of the biggest industry challenges and what they said is that materials is the key driver for solutions to pattern placement. And, if you look at our position with all of the selective technologies we have and materials technologies we have, we're in a very strong position to grow, especially in foundry and logic as they move to these new technologies.", "So, again, overall, '17, we grew over 40% in process equipment. We see strong double-digit growth in all of our segments -- leadership growth, PDC. And the other thing I would say that we're seeing tremendous pull from customers is accelerating their roadmap. If they can bring those high-performance computing or AI chips to market faster, that's worth a tremendous amount of money and our ability to create, modify, remove, and analyze materials is really unique. So, we're seeing deeper engagements with customers than we've ever seen in the past and I would say I've never been more optimistic about our markets and also our positions in those markets. Thank you, Patrick." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question will come from the line of Edwin Mok with Needham & Co. Your line is now open." ] }, { "name": "Edwin Mok", "speech": [ "Hey, thanks for taking my question. Sorry about the background noise. So, I have a question about China. You guys sound very confident about investment by the local Chinese manufacturer but, recently, you haven't seen a lot of product coming out there or a lot of design coming out. What keeps you confident that investment will come maybe later this year or 2019 timeframe?" ] }, { "name": "Gary E. Dickerson", "speech": [ "Yeah, thanks for the question. So, we have pretty significant visibility in China. We have the highest share -- we also sell the manufacturing automation systems -- so we have a lot of leading indicators relevant to all the projects that are happening in China. And, as I said earlier, we have the largest share and our share is growing in China, both in semiconductors and display. And what we see in 2018 is a market that's going to grow. We're more optimistic, I would say, in terms of the growth in China. It's pretty balanced between global and domestic companies and, again, we're working very closely with all of those different companies. Domestic China is higher in foundry and logic than it is in memory. And one of the things that we talked about is data generation -- smarter devices, increasing censor technologies -- that's an area where China has capability and, certainly, the demand for those trailing geometries is not 40% of the foundry market and we're seeing very strong growth there in China.", "For the global companies, they're more weighted toward memory versus foundry and logic. Another thing that Dan talked about in the prepared remarks was our service growth -- I think something like 30% year-over-year in service. China's also a market where our penetration in service is very high helping global and local companies ramp new fabs and new locations. And so, we had some one-time parts, increases in our quarter that increased the rate of growth and service above the model that we gave. We think we may be a few points higher than that model, but that certainly contributed to an extraordinary quarter relevant to service growth.", "So, anyway, we have very, very good visibility in China. The investments there are strategic investments and we believe that that's going to remain a very good market, and especially good for Applied Materials." ] }, { "name": "Daniel Durn", "speech": [ "Yeah, I just want to build on very quickly the point Gary was making about our services business. I think the way we've profiled this year from a service perspective will be different than we've seen historically because of the dynamic Gary talked about. I think you'll see a seasonally stronger first half and different profile into the back half of the year as a couple of these fabs facilitated by international customers are brought online in China. I think the way to think about the back half of the year because you've got visibility now on Q1 and Q2, think about the back half of the year is take our long-term compound growth rate in our services business of 15% and, as you look at full-year 2018 revenue over full-year 2017 revenue, we're likely to be about 3 points above our long-term compound growth rate. I think that gives you a good framing on how to think about the services business throughout the course of the year so you can dial in your models. Thanks for the question, Edwin." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question will come from the line of David Wong with Wells Fargo. Your line is now open." ] }, { "name": "David Wong", "speech": [ "Thanks so much. In terms of the growth you're expecting in display equipment this year, is this driven primarily by growth in your traditional display products or are you seeing meaningful growth from moving into new areas and increasing your addressed market in displays?" ] }, { "name": "Gary E. Dickerson", "speech": [ "So, display market in 2018 is roughly 50% TV and 50% mobile and they're really with the same products that we have had in the market previously so no real growth from significant new products forecasted in 2018 and the mix is really about 50/50 between mobile and TV." ] }, { "name": "David Wong", "speech": [ "Great, thanks." ] }, { "name": "Gary E. Dickerson", "speech": [ "Thanks, David." ] }, { "name": "Operator", "speech": [ "Thank you. And our next question will come from the line of Sidney Ho with Deutsche Bank. Your line is now open." ] }, { "name": "Sidney Ho", "speech": [ "Thanks for taking my question. If you look back at the last calendar year, by my math, your semi system business grew about 34%, which is obviously very impressive. And it's also just a few percentage points better than the WFE market, but the outperformance was much higher the year before. When you talk about you expect the business to outgrow the market again this year, do you expect that outperformance to reaccelerate this year?" ] }, { "name": "Gary E. Dickerson", "speech": [ "Yeah, thanks for the question. So, again, if you break down our business, the process equipment business grew more than 40% in 2017. PDC grew 10%. So, it was more growth in terms of the process equipment business. If we look into 2018, we see strong double-digit growth, really, across all of those different businesses -- the growth businesses, the leadership businesses where we have extremely high market share, and also in PDC -- so strong growth across all of them, strong double-digit growth across all of those businesses in 2018. Thanks, Sidney." ] }, { "name": "Michael Sullivan", "speech": [ "And then, Operator, I'd like to let you know that we've got time for about two more questions, please, if we have them." ] }, { "name": "Operator", "speech": [ "Yes, sir. Our next question will come from the line of Craig Ellis with B. Riley FBR. Your line is now open." ] }, { "name": "Craig A. Ellis", "speech": [ "Thanks for taking the questions and congratulations on the very good quarterly execution and evolution in capital return. Gary, I just wanted to go back to the multi-year outlook and see if I could get some color from you just on how you're thinking about the potential for growth in 2019. I know it might be early to be real precise there, but it seems like a lot of the secular factors that are helping cause the uplift from where we've been as an industry to where we are now are multi-year in nature and they would seem to be as or more forceful next year so any color on the potential for TPFP growth next year would be appreciated. Thank you." ] }, { "name": "Daniel Durn", "speech": [ "Yeah, thanks, Craig. I'll go ahead and jump in and take this. I think it's too early to tell how spending profiles across that two-year sequence... I think it's important to just take a step back and look at what's really driving our view on a multi-year basis. Macro trends are real, capital intensity is up, and we're seeing modest discipline growth into China. Again, we think these macro trends shaping people's lives, we're in the early innings. Gary referenced $80 billion of investments in autonomous vehicles. By 2020, eight OEMs are going to have Level 4 vehicles on the road. By 2022, it's 12 OEMS. We're in the early stages of SSD penetration of hard-disk drives and, when we correlate it bottoms-up with dialogue we have with customers, all indicators look good, the best we can see, and fundamentals continue to look good into 2019. So, while those trends we have a lot of confidence in, too early to call how revenue profiles over the forecast horizon." ] }, { "name": "Operator", "speech": [ "Thank you. And our last question will come from the line of Farhan Ahmad with Credit Suisse. Your line is now open." ] }, { "name": "Farhan Ahmad", "speech": [ "Hi, thanks for taking my question. Just one question on how you're thinking about the buy-backs. You laid out a very positive long-term outlook and, if I do a DCF around it, I can get a very significant outplay from there. Your share prices currently are up, so is it fair to think that you could be a lot more opportunistic with the buybacks and it could be more front top-loaded if share prices are around current level?" ] }, { "name": "Daniel Durn", "speech": [ "Thanks, Farhan. Like we said, we will be opportunistic with our repurchases. We've got a strong point of view on where the markets are going and how our company is performing within those respective markets. It gives us a lot of confidence in what the future holds for our business -- more profitable, sustentative higher free cash flow generation potential -- and, whenever we see disconnects in intrinsic value as we see it in our company and how we trade in the market, I think you'll see us be opportunistic with respect to those repurchases." ] }, { "name": "Michael Sullivan", "speech": [ "Okay, Farhan, thanks for the question. Let's see, Dan, anything you want to add before we close the call?" ] }, { "name": "Daniel Durn", "speech": [ "Yeah, thanks, Mike. I think it's probably good to close with a couple of quick thoughts. Personally, I can't think of a better time to be in the semiconductor industry. We've talked a lot about multiple growth drivers that are important trends shaping our lives. These trends are going to drive tremendous productivity and the investments are non-discretionary for some of the largest, most competitive industries on the planet. It is fundamentally about staying competitive. Semiconductors are on the critical path of enabling those trends and, at the center of it, it all begins with what we do at Applied.", "When we bring all of this together, Applied's future is incredibly bright. Our breadth and depth is just an asset for the company. We're likely to be sustainably bigger, more profitable, and we're going to generate more cash than in the past. And, as we think about putting that cash to use, we talked about three important ways. No. 1, we're going to invest in new products. This is going to lead the way and drive the organic growth profile we've seen over the last few years. We will invest to drive organic growth. We will pay higher dividends and we're going to be buying back more shares to drive even more shareholder value going forward. Finally, we look forward to seeing many of you. We're going to be at the Goldman conference tomorrow and then, next week, we'll be on the road in New York, Boston, or Toronto. Know, as always, thanks for joining us. We really appreciate the support. So, Mike, let's go ahead and close the call." ] }, { "name": "Michael Sullivan", "speech": [ "Okay, great. Hey, thanks for that, Dan, and we'd like to thank everybody for joining us today. A replay of our call is going to be available on our website by 5:00 p.m. Pacific time today and we'd like to thank you for your continued interest in Applied Materials." ] }, { "name": "Operator", "speech": [ "Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program and we may all disconnect. Everybody have a wonderful day." ] }, { "name": "Craig A. Ellis", "speech": [ "More AMAT analysis", "This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see ourTerms and Conditionsfor additional details, including our Obligatory Capitalized Disclaimers of Liability." ] } ]
AMAT	2023-08-17	[ { "description": "Corporate Vice President", "name": "Mike Sullivan", "position": "Executive" }, { "description": "President and Chief Executive Officer", "name": "Gary Dickerson", "position": "Executive" }, { "description": "Chief Financial Officer", "name": "Brice Hill", "position": "Executive" }, { "description": "AllianceBernstein -- Analyst", "name": "Stacy Rasgon", "position": "Analyst" }, { "description": "Evercore ISI -- Analyst", "name": "C.J. Muse", "position": "Analyst" }, { "description": "Bank of America Merrill Lynch -- Analyst", "name": "Vivek Arya", "position": "Analyst" }, { "description": "Cowen and Company -- Analyst", "name": "Krish Sankar", "position": "Analyst" }, { "description": "", "name": "Unknown speaker", "position": "Other" }, { "description": "Goldman Sachs -- Analyst", "name": "Toshi Hari", "position": "Analyst" }, { "description": "JPMorgan Chase and Company -- Analyst", "name": "Harlan Sur", "position": "Analyst" }, { "description": "UBS -- Analyst", "name": "Tim Arcuri", "position": "Analyst" }, { "description": "Wells Fargo Securities -- Analyst", "name": "Joe Quatrochi", "position": "Analyst" }, { "description": "Morgan Stanley -- Analyst", "name": "Joe Moore", "position": "Analyst" }, { "description": "Stifel Financial Corp. -- Analyst", "name": "Brian Chin", "position": "Analyst" }, { "description": "Melander -- Redburn Partners -- Analyst", "name": "Timm Schulze", "position": "Analyst" }, { "description": "Needham and Company -- Analyst", "name": "Charles Shi", "position": "Analyst" } ]	[ { "name": "Operator", "speech": [ "Welcome to the Applied Materials' earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in a question-and-answer session. I would now like to turn the conference over to Michael Sullivan, corporate vice president.", "Please go ahead, sir." ] }, { "name": "Mike Sullivan", "speech": [ "Good afternoon, everyone, and thank you for joining Applied's third quarter of fiscal 2023 earnings call. Joining me are Gary Dickerson, our president and CEO; and Brice Hill, our chief financial officer. Before we begin, I'd like to remind you that today's call contains forward-looking statements which are subject to risks and uncertainties that could cause our actual results to differ. Information concerning the risks and uncertainties is contained in Applied's most recent Form 10-Q filing with the SEC.", "Today's call also includes non-GAAP financial measures. Reconciliations to GAAP measures are found in today's earnings press release and in our quarterly earnings materials, which are available on the IR page of our website at appliedmaterials.com. And with that introduction, I'd like to turn the call over to Gary Dickerson." ] }, { "name": "Gary Dickerson", "speech": [ "Thank you, Mike. In our third fiscal quarter, Applied Materials delivered results at the high end of our guidance range. Across the business, our teams are executing well. We are making incremental improvements in our operations as we productively scale the company, and we're driving our technology road map, introducing enabling new products and solutions for our customers. In my prepared remarks today, I will start with our big-picture view of the IoT AI era and how this is driving growth and innovation across the industry.", "I'll then summarize Applied's strategy and how this is enabling us to outgrow the industry this year while also positioning us for sustained outperformance over the longer term. And finally, I'll cover our near-term performance and outlook, including some recent business highlights. In the summer of 2018 at our AI Design Forum, Applied laid out a thesis explaining how we expected IoT and AI to drive a new wave of semiconductor growth and innovation. Five years later, IoT and AI inflections are having a profound impact across many sectors of the economy as well as within the semiconductor industry. We view IoT and AI computing as two sides of the same coin. At the edge, consumer devices, vehicles, buildings, factories, and infrastructure are all getting smarter and more capable.", "Our customers that serve these IoT communications, auto, power, and sensors markets, or ICAPS, are growing and represent the largest portion of wafer fab equipment sales in 2023. Increasingly intelligent edge devices are fueling an explosion of data generation that can then be transmitted and combined to create very large data sets for training AI models. High-performance AI computing is primarily enabled by hardware innovations. As a result, AI is becoming the key driver of the leading-edge logic and DRAM road maps, as well as heterogeneous integration, which creates exciting new innovation opportunities for device designers. In summary, the first part of our thesis is that the combination of IoT and AI drives demand for significantly more chips, as well as next-generation silicon technologies. The second part of our thesis relates to how those chips and new technology innovations will be supplied.", "In terms of technology, as the benefits of traditional Moore's Law 2D scaling slow down, the industry is moving to a new playbook to drive improvements in power, performance, area cost, and time to market. The PPACt playbook has five elements: new system and device architectures, new 3D structures, new materials, new ways to shrink, and heterogeneous integration. The transition to the new playbook is positive for Applied in two key ways. First, as the road map evolves, it is increasingly enabled by advances in materials engineering where Applied has differentiated capabilities. Key examples of this include the move to gate-all-around transistors and backside power distribution in advanced logic. Second, the PPACt playbook is inherently more complex, and we can help customers manage this complexity by providing more comprehensive solutions, which include integrated products and advanced services to accelerate R&D, technology transfer, ramp, as well as yield and cost in volume production.", "And parallel to the new PPACt playbook being implemented, we're also seeing regionalization of semiconductor supply chains as countries seek to build resilient local capacity to support industry verticals that are essential to their economies. As a result, hundreds of billions of dollars of government incentives will be deployed globally over the next five years. At Applied, we recognized these trends early and made important changes to our strategy, organization, and investment profile. In the past five years, we created a dedicated organization to focus on the ICAPS market and released more than 20 new products for ICAPS applications. We also formed a team focused on co-optimized and integrated products to accelerate solutions for leading-edge logic and memory. This has resulted in much deeper strategic relationships with our customers, new highly differentiated products, and increasing market share.", "We developed a very strong portfolio of products to enable multiple generations of DRAM technology that is fueling share gains in this market segment and contributing to our outperformance. And we established a clear leadership position in heterogeneous integration and advanced packaging. In fact, we just announced five new heterogeneous integration products at SEMICON West in July. This strategy, an increased focus on IoT and AI-driven inflections, has enabled us to deliver more value to customers and strong performance in 2023 even during a period of very low investment by memory makers. It also positions us for ongoing outperformance in 2024 and beyond. Let me highlight a few key areas.", "In DRAM, our revenues in the first half of 2023 were higher than our two closest process equipment peers combined. Our strength in DRAM is underpinned by multiple factors. We have gained significant share in DRAM patterning, both for EUV-based and multi-patterning. We have developed unique co-optimized hardmask solutions which are a key enabler for capacitor scaling. We have successfully ported key technologies developed for logic to DRAM, where they are used in the peripheral circuitry to significantly increase I/O speed.", "And we are the largest supplier of advanced packaging solutions with leadership positions and micro-bump and Through Silicon Via that enable multiple generations of high-bandwidth memory. As DRAM investments increase, we feel very positive about our opportunities, especially in high-performance DRAM for the data center. High-bandwidth memory is less than 5% of DRAM capacity today, but it is expected to grow at a 30% compound annual growth rate over the coming years. If you look at an HBM2 die compared to DDR5, it's about 25% larger because of additional I/O routing and the area needed for the TSVs. On top of this, the extra processing steps needed for die stacking further increase our total available market by approximately 5%.", "Another key growth driver is our ICAPS business. We see ICAPS demand as sustainable as these customers are delivering enabling technology for large global inflections that will play out over the next decade. These include industrial automation, electric vehicles and vehicles with advanced driver assistance systems, solar and wind energy where each megawatt generated requires $3,000 to $4000 of power chips, and the smart grid which could drive $50 billion of annual silicon demand by the end of the decade. ICAPS investments are also expected to be underpinned by government support around the world, and we expect these markets to be a significant beneficiary of regional incentives. The increasing complexity needed to enable the PPACt playbook, combined with a broadening of the industry's geographic footprint, are both key growth drivers for our service business. AGS delivered record revenue this quarter and is on track to grow in 2023 even with this year's low fab utilization rates and after absorbing the impact of new U.S. trade rules.", "This year, more than 60% of our service revenue is generated from subscriptions in the form of long-term agreements. These agreements are growing at a faster rate than the installed base and have a high renewal rate of more than 90%. With strong customer pull for our services and a robust pipeline of new capabilities, we believe we're on track to achieve low double-digit AGS growth in the coming years. While I'm excited about the opportunities ahead, it's important to recognize that, to deliver this future, the industry must also overcome significant challenges relating to complexity, costs, and our combined carbon footprint. At Applied, we believe the way to do this is through closer collaboration and higher velocity, innovation, and commercialization of next-generation technology for energy-efficient computing.", "In the past quarter, we announced two major initiatives: our EPIC platform in the United States and a collaborative engineering center in India. These investments will support even faster and better relationships with customers, universities, suppliers, and government partners to accelerate time to innovation and time to commercialization while increasing our combined R&D productivity. In addition, we're also driving a collaborative approach to reduce carbon emissions as the industry grows. In July, we rolled out our collaborative net-zero playbook and we announced two major new products that help customers with carbon reductions: our Vistara platform, which lowers platform energy consumption by up to 35% and increases throughput density by as much as 30%; and EcoTwin that enables customers to monitor, model, and optimize chemical and energy consumption by tool and by recipe. Before I hand it over to Brice, I'll quickly summarize. Advanced chips are at the foundation of major global inflections, and as the IoT AI era takes shape, it's driving a new wave of growth and innovation for the semiconductor industry. At Applied, we have focused our strategy and investments to deliver high-value technologies that enable key IoT and AI-driven inflections. We have strong leadership positions in ICAPS, leading-edge foundry-logic, DRAM, and heterogeneous integration using advanced packaging.", "This strategy is enabling us to consistently deliver strong results in 2023 despite lower overall wafer fab equipment spending and positions us for sustainable outperformance over the coming years. Now, Brice, it's over to you." ] }, { "name": "Brice Hill", "speech": [ "Thank you, Gary. On today's call, I'll discuss the business environment, summarize our Q3 results, provide our guidance for Q4, and frame the investments we're making in our R&D infrastructure. Before covering the near term, I'll remind you of our longer-term thesis. First, we believe the semiconductor industry is on track to grow faster than the overall economy over time and reach $1 trillion in sales by 2030.", "Second, Applied's leadership in materials engineering is increasingly critical to our customers' road maps. Third, Applied's broad portfolio of differentiated products, balanced market exposure, and growing services business make us less volatile today than in the past and more likely to grow faster than our markets. And fourth, our efficient business model generates strong profitability and free cash flow, which enables us to both invest in profitable growth and deliver attractive shareholder returns. Moving now to the Q3 business environment. We continue to see strength in ICAPS, which largely offset weakness in leading-edge foundry-logic and NAND. ICAPS demand was broad-based, generating record revenue in 200-millimeter systems and record revenue in Europe.", "In fact, the United States, Japan, and Europe are the fastest-growing ICAPS regions this year. Around the world, customers and governments are making long-term investments to ensure future supply of a wide range of semiconductors needed to support growing demand in key industries such as automotive, medical equipment, and renewable energy, to name a few. Turning to our operational performance in Q3. Our teams delivered strong results. We exceeded our revenue guidance across semiconductor systems, services, and display. We improved our delivery performance in systems and services and made further progress reducing inventory.", "Cash from operations and free cash flow were both the second highest in our history. Now, I'll summarize our Q3 financial results. Company revenue was nearly $6.43 billion, down 1% year over year and in the upper end of the guidance range. Non-GAAP gross margin was slightly above our guidance, and operating expenses were slightly below. Non-GAAP EPS was $1.90, down 2% year over year and near the high end of guidance. Turning to the segments.", "Semi systems' revenue of $4.68 billion was down 1% year over year. Segment non-GAAP operating margin was 34.8%. Applied Global Services generated record revenue of over $1.46 billion and non-GAAP operating margin of 29.3%. This was AGS' 16th consecutive quarter of year-over-year revenue growth. While 200-millimeter system sales contributed to the growth, the team also made strong progress driving the leading indicators of our subscription business.", "For example, tools under service agreement are up 5% year over year to over 16,000 systems; and tools under comprehensive service agreement, which have the highest revenue per tool, are up 7% year over year, reaching 12,000 systems. In display, revenue grew sequentially to $235 million, and segment non-GAAP operating margin was 15.7%. Turning to cash flows. We generated $2.58 billion in operating cash flow during the quarter, which is 40% of revenue.", "We produced over $2.3 billion in free cash flow, which was 36% of revenue. We distributed $707 million to shareholders through quarterly dividends and share buybacks. We paid 268 million in dividends, and the dividend per share was $0.32, reflecting the 23% increase announced in March. We used $439 million to repurchase nearly 3.4 million shares at an average price below $130. Now, I'll share our guidance for Q4.", "We expect Q4 company revenue to be $6.51 billion, plus or minus 400 million. We expect non-GAAP EPS of $2, plus or minus $0.18. Within the guidance, we expect semi systems' revenue to be around $4.75 billion. We expect DRAM revenue to be up by around $500 million quarter over quarter, primarily driven by trailing-edge shipments. We expect AGS revenue to be about $1.42 billion, and display revenue should be around $290 million. We expect Applied non-GAAP gross margin to be about 47%, and we expect non-GAAP operating expenses to be around $1.17 billion.", "We continue to model a tax rate of 12.3%. Finally, as we said last quarter, we plan to make a multibillion-dollar investment in new R&D infrastructure over the next several years to significantly expand our capacity to collaborate more closely and productively with our customers as we develop next-generation materials, process technologies, and equipment. The scale of the investment will depend on our ability to secure government support. The EPIC Center is expected to come online in fiscal 2026. Ad while we expect our capital expenditures to be higher over the next several years, there is no change to our strong commitment to shareholder returns.", "In summary, Applied Materials continues to execute well. We are making good progress against our internal goals and outperforming our markets. While wafer fab equipment spending is lower in calendar '23, our semi systems' revenue in the first three calendar quarters is trending slightly up year over year, and our services business remains on track for year-over-year growth. We've aligned our business with the fastest-growing end markets and are winning key decisions across leading-edge foundry-logic, DRAM, ICAPS, and advanced packaging. We are in a great position to invest for technology leadership and growth, generate strong free cash flow, and increase shareholder returns. Now, Mike, let's begin the Q&A." ] }, { "name": "Mike Sullivan", "speech": [ "Thanks, Brice. Our goal is to help as many of our analysts as possible. With that in mind, please ask just one question on today's call. If you have another question, please requeue, and we'll do our best to come back to you later in the session. Operator, let's please begin." ] } ]	[ { "name": "Operator", "speech": [ "[Operator instructions] Our first question comes from the line of Stacy Rasgon of Bernstein." ] }, { "name": "Stacy Rasgon", "speech": [ "Hi, guys. Thanks for taking my question. I wanted to ask about the -- the DRAM in the quarter and in the guide. So, DRAM in the quarter was strong and you've got a lot of growth in the next quarter.", "You said it was mostly from trailing edge. Am I right in reading that as primarily the Chinese customer driving that? And maybe you could sort of talk a little bit about your strength in China that is from DRAM versus foundry. It almost sounds like the DRAM piece is stronger than the ICAPS piece in China right now." ] }, { "name": "Brice Hill", "speech": [ "Thanks, Stacy. Thanks for your question. This is Brice. Yeah, so we highlighted in Q4 that we'll see sequential growth in DRAM.", "It is related to confirming technologies that we can ship to customers in China. We've gotten lots of customers about that -- or questions about that during the quarter. So, we wanted to make sure that people got that answer. So, you'll see -- you'll see that growth in Q4. It probably won't be the only quarter where we'll have shipments along those lines, but we wanted to make that clear on the trend quarter over quarter.", "And one more thing that I'd add, we think that's probably something that's not well understood by the investors that, you know, well, the memory market has been weak for our customers. The DRAM market actually has been fairly strong this year from an equipment perspective, and this is just a continuation of -- of that profile for us. We've got a good position in DRAM, and, you know, that is manifesting in Q4." ] }, { "name": "Stacy Rasgon", "speech": [ "That's same drivers for Q3? Oh, go ahead, I'm sorry." ] }, { "name": "Gary Dickerson", "speech": [ "Yeah, maybe just let me add some color, and then you can ask the following question. So, DRAM, we've added about 10 points of overall DRAM wafer fab equipment share in the last 10 years. So, if you look at the big inflections in DRAM, the periphery moving to high-speed I/O for high-bandwidth memory, we're taking logic technologies into DRAM. That's a -- that's a really big driver for our share gains. Capacitor scaling is an area where we have strength, patterning share gains, advanced packaging, especially high-bandwidth memory.", "So, all of those areas are really big drivers for Applied and have contributed to this 10% overall WFE share gain in DRAM over the last 10 years.", "And, yeah, you have another question, Stacy?" ] }, { "name": "Stacy Rasgon", "speech": [ "I --" ] }, { "name": "Brice Hill", "speech": [ "Yeah, I think I got it, Stacy. Yeah." ] }, { "name": "Stacy Rasgon", "speech": [ "Yeah, I just wanted to follow up on -- for the -- for the -- for the quarter, DRAM was pretty strong in Q3. Was it the same drivers?" ] }, { "name": "Brice Hill", "speech": [ "Q3, there was a small amount of shipments to Chinese customers, so relatively small. Q4 would be larger." ] }, { "name": "Stacy Rasgon", "speech": [ "Got it. Thank you so much." ] }, { "name": "Mike Sullivan", "speech": [ "Thanks, Stacy." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of C.J. Muse of Evercore ISI." ] }, { "name": "C.J. Muse", "speech": [ "Hey, good afternoon. Thanks for taking the question. I wanted to focus, I guess, on sustainability. You know, you're talking about, you know, significant outperformance versus WFE here in calendar '23.", "And so, a two-part question. So, if you look out to the January quarter, you know, representing calendar year, are you suggesting that, you know, you guys should be kind of in the flat to down 4% kind of year? And then, as you look to calendar '24, can you -- can you speak to, I guess, what kind of pent-up demand in terms of deferred revenues is helping this year that -- that won't be replicated next year versus gains where you see leverage to the right end markets and/or new technologies that can drive, you know, relative outperformance? Thanks so much." ] }, { "name": "Brice Hill", "speech": [ "Okay, thanks C.J. You know, maybe I'll start with the 2024 because I think you were embedding a question there on, in '23, how much did we benefit from, you know, unserved orders in '22. We think that's about a half a billion to $1 billion. All of that was served, you know, in the first half of the year.", "So, you know, what you're seeing from us in '23 besides that half a billion to 1 billion is largely tracking with the business that we see -- the WFE business that we see during the year. So, there shouldn't be an overhang. There shouldn't be a benefit from any, you know, previously booked business that we see now or going forward. And, you know, as far as sustainability, you know, that's one question we get regularly. The second question that we get regularly is just about ICAPS and the sustainability from China. And, you know, well, that's the most -- the largest country in ICAPS for -- for China.", "It's not the fastest growing. That's sort of a -- that's a global trend and a global demand function. We see that as very sustainable. We think gate–all–around will start shipping in earnest in '24.", "We think our services business will grow in '24. We think that the display business will be a little bit better in '24. So, those are kind of the -- the bits that we've given for '24. Otherwise, you know, we're not going to give a specific forecast yet for 24 or for the January quarter." ] }, { "name": "Gary Dickerson", "speech": [ "C.J., this is Gary. Maybe I'll add a little bit more color. On the -- on the leading-edge foundry-logic, what we see is more of that spending moving to materials-enabled technologies, which is the sweet spot for Applied. So, if you look at, again, the -- the nodal spending, more is shifting to materials engineering.", "Gate–all–around, we've talked about that's $1 billion opportunity for us. Backside power, when that comes in, that really leverages all of our strength, and interconnect. And, you know, that's probably the same ZIP code in terms of size of opportunity for Applied. ICAPS, we've talked a lot about, you know, formed the organization four years ago. We've introduced 20 major new products since we formed the organization, and we still have room to grow in ICAPS share.", "DRAM, I talked about, I think people really maybe don't understand the strength we have there. I talked about those big inflections and gaining 10 points of overall DRAM WFE share over the last 10 years. Packaging, that's $1 billion business for us now, and we see an opportunity to double that over the next few years. And as Brice said, services, you know, we're going to be up in services in a relatively weak memory market in terms of utilization, and we're still on track for low double-digit growth. So, again, those are some of the things that -- that really will help us outperform over the longer term." ] }, { "name": "Mike Sullivan", "speech": [ "Yeah. Thanks, C.J." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Vivek Arya of Bank of America Merrill Lynch." ] }, { "name": "Vivek Arya", "speech": [ "Thanks for taking my question. I wanted to understand what measures do you have in place to ensure that there isn't a pull forward of your mature technology shipments because of geopolitical reasons or because of takeaway arrangements. Do you have ways to measure the utilization of what you are shipping? And if I kind of just ask that same thing in a different way, do you think Applied will grow in line above or below whatever WFE does in 2024?" ] }, { "name": "Brice Hill", "speech": [ "Hi, Vivek, thanks for the question. I'll answer the second part first. So, we do think Applied will grow faster than whatever the WFE is for the market, and that's a good way to think of it because we think of -- we think and plan for long-term secular growth, and we think we'll grow faster. On the question of pull forward and specific, you know, to China, we've got many ways to test that equation. One of the things that we do is we look at the amount of local capacity relative to local consumption.", "We think that, you know, there's strategic direction in the country and strategic incentives in the country to make the investments that will at least equal local consumption. And we think those things are tracking together and can rationalize what they've put in place from that perspective. We also triangulate the overall capacity being purchased relative to semiconductor market itself. As you know, we test that with intensity and we make sure that equation makes sense to us. And then, from a micro perspective, we also look at the installation of our equipment.", "So, we make sure when it lands in China, we understand that it's installed, and then we track the utilization also at a macro level in the market. And we know that all that equipment is being installed and operated, and so we don't see signs of, you know, unneeded or unwanted or unused equipment pulling up from that perspective. And we think the buys are rational at this point." ] }, { "name": "Vivek Arya", "speech": [ "Thank you." ] }, { "name": "Mike Sullivan", "speech": [ "Thanks, Vivek." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Krish Sankar of Cowen." ] }, { "name": "Krish Sankar", "speech": [ "Yeah, hi, thanks for taking my question. I kind of have a two-part technology question for Gary. You spoke about high-bandwidth memory and how it's benefiting advanced packaging, which makes a ton of sense given the exposure to TSV, etc. But on the other side, it seems like hybrid bonding is slowing down and some of your hybrid bonding customers are looking at things like thermocompression bonding.", "Can you give any color on that? And along the same path, Gary, you''ve spoken about gate-all-around being like $1 billion for every 100,000 wafer starts per month incremental opportunity and five-point share gains with Applied. You're there in most of those core technologies like XP vertical, at the ALD, selective edge, etc. Are customers engaged all around making bundling decisions, or are they still going with best-of-breed solutions? Thank you." ] }, { "name": "Gary Dickerson", "speech": [ "Well, thank you. Those are two big questions. Let me start off with high -- high-bandwidth memory packaging. So, that uses two critical packaging technologies, Through Silicon Via and micro-bumping, to enable stack DRAM.", "And, you know, the great thing for Applied is that we have the broadest portfolio to enable, you know, all different types of packaging, CMP, PVD, CVD, etch, and plating. So, you know, this opportunity for us is meaningful. The TAM for HBM increases about -- the overall packaging by about 5%. We're the overall leader in packaging. As I've talked about, it's $1 billion business, And, you know, we're on track to double that over the next three to five years.", "So -- so, that's definitely a good opportunity. On the hybrid bonding, what I would say is that we absolutely see hybrid bonding as a great opportunity over time. It's not something that is going to generate significant revenue in the short term. But chiplets are something that every single company is focused on. And I do believe all of the things that we've discussed relative to growth rates there, we're still, you know, believe that's on track.", "And then, gate-all-around, the other question that you asked, we still see that as about $1 billion opportunity for 100,000 wafer starts per month. And in FinFET, we had close to 50% share of that overall FinFET opportunity. We've indicated, with the full adoption of gate–all–around, we have an opportunity to increase our share 5%. And I think one of the things that helps us a lot is that we're deeply engaged with every company in gate–all–around even with their integration teams because we have so many of those critical enabling technologies. So, all the things that we talked about back to our master class when we size that around $1 billion is basically still on track.", "And we -- relative to ramping gate–all–around, we believe that is toward the end of 2024." ] }, { "name": "Unknown speaker", "speech": [ "[Inaudible]" ] }, { "name": "Gary Dickerson", "speech": [ "Yeah, well, the other thing is on the -- the unit processes in IMS. There are some areas of that market where we're combining different technologies together under vacuum, which is something that's completely unique for Applied Materials that has a big impact on electrical performance. But -- but the main message is we have very very deep engagements with all of those integration teams, and gate–all–around is pretty much on track to what we had talked about previously." ] }, { "name": "Krish Sankar", "speech": [ "Thanks again. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Toshiya Hari of Goldman Sachs." ] }, { "name": "Toshi Hari", "speech": [ "Hi, good afternoon. Thank you so much for taking the question. I had a follow-up on your ICAPS business, maybe -- maybe for Brice. So -- so, how big was ICAPS as a percentage of your business in the July quarter? Where do you see that going in the second half of the calendar year? And maybe more importantly, you know, yourself and Gary talked about sustainability in the business.", "I think the rationale for China makes a ton of sense. How are you thinking about, you know, the U.S., Europe, and Japan where, you know, your customers, yes, they're strategic but -- but they also care about near-term, you know, profitability and returns? With some of the end markets slowing, is there a fear that the non-China business within ICAPS could slow going forward? Thank you." ] }, { "name": "Brice Hill", "speech": [ "OK, thanks, Toshiya. Good afternoon. On the ICAPS, we haven't articulated exactly how big it is. What we've said is, this year, it's our largest market.", "You know, it grew very strongly last year. It's growing strongly again this year. And we've said, you know, over the longer term, as you think about the business, it's probably a third ICAPS, a third leading logic, and a third memory. And that's about as much. But you can -- you know, you can get a feel for it.", "As we've said all year, the ICAPS business growth has been strong enough to offset weakness in NAND and leading logic. So, those -- that will let you probably get a ballpark. On the regionalization, we do think that, you know, regionalization leads to a little bit more spending globally for ICAPS, but we also look and see whether that's a sustainable trend from our perspective. We look at the underlying businesses and the growth rates of all the device types that are being invested, whether it's China or whether it's the different markets across the world. And, you know, we rationalize that, and we think all of the investment that's being made is consistent with the growth rates of those underlying devices' end markets. So, 6%, 7%, 8%, 9% CAGRs for the different device types that fall into that like, you know, computer vision, analog, power chips, those sorts of -- those sorts of markets.", "And then, on the last piece --" ] }, { "name": "Mike Sullivan", "speech": [ "Different geog and probability [Inaudible]." ] }, { "name": "Gary Dickerson", "speech": [ "Yeah, one thing I would say on the -- Toshiya, this is Gary. Relative to regionalization of the supply, one of the things that is extremely important is some of those ICAPS segments are tied to very large vertical markets in those different regions. So, having a secure supply chain is something that is a big focus for every country. You know, there are hundreds of billions of dollars of incentives there, you know, for -- for supporting those different ICAPS markets. So, that's another thing that -- that certainly we're seeing.", "And the last thing I'd say is, relative to opportunities, the -- not only is it systems, but as companies are moving into new locations, that's a really great opportunity for our service business because there is no service infrastructure set up for those companies moving into new regions. And that -- that certainly will help us. We're on track for the low double-digit growth in our service business, but, you know, the opportunity is supported by this regionalization." ] }, { "name": "Brice Hill", "speech": [ "Good. And, Toshiya, yeah, I forgot the last piece of your question was on, you know, the business -- the health of the business today and whether customers are lowering starts or changing their plans, and that certainly happens in the environment. We've seen it. But I would just remind you, you know, the way people are doing equipment investments, it's a two-, three-, four-year planning horizon. So, they're really making investments for what the demand function they see that far out in time, and that makes their purchasing a little bit more stable than, you know, whatever the current demand function is." ] }, { "name": "Toshi Hari", "speech": [ "Thank you for all the color." ] }, { "name": "Brice Hill", "speech": [ "Yeah." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Harlan Sur of J.P. Morgan." ] }, { "name": "Harlan Sur", "speech": [ "Hi. Good afternoon. Thanks for taking my question. Team have been doing very well in process control.", "It's about 10% to 12% of your systems business. I think it grew about 55%, 60% faster than your overall systems business last year. You know, Gary, you talked about strong technology inflections and benefits across the wafer equipment portfolio, but I'm assuming this is also pulling strong requirements for more and better process control. So, with that, I mean, can you just give us an update on process control portfolio? And how is that segment performing relative to your overall systems business this year?" ] }, { "name": "Gary Dickerson", "speech": [ "Hi, Harlan. Yeah, thanks for the question. So, PDC, for us, there are really two major areas of focus. One is, as you've talked about, is growth within PDC.", "But the other thing that is increasingly important is the synergy with PDC and our -- our process equipment, both for units -- unit equipment and integrated material solutions, accelerating R&D for some of these major inflections. So, on the PDC growth, the business grew about two times between 2020 and 2022. eBeam is one of the fastest growing segments there, and we've maintained our leadership with around 50% overall share in eBeam. We have new products coming to market. We've talked about in our master class the cold-field emission with the highest resolution and fastest imaging. So, that's helping that -- that business growth.", "And then, on the synergy, we had discussed the capacitor formation in DRAM, where we're bringing new materials, new etching solutions together with eBeam technology, again, to accelerate those inflections, nano sheets and gate–all–around. You know, these technologies are incredibly complex, and you can't fix what you can't see, you know. And our eBeam imaging is world-class, ahead of anyone else, and so that synergy value is increasing. That will also help our growth in our market share overall in our semiconductor product group but in PDC.", "So, again, we're really in a great position, strong pipeline of products coming in PDC and great synergies with overall Applied." ] }, { "name": "Harlan Sur", "speech": [ "Great insights. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Stand by for our next question. And the next question comes from the line of Timothy Arcuri of UBS Securities." ] }, { "name": "Tim Arcuri", "speech": [ "Thanks a lot. I had a two-part question. First of all, Brice, can you give us a sense, of the -- of the 1.7 billion that's in July for China revenue, can you tell us how much of that is domestic China chipmakers versus other, you know, multis that might have fabs in China but they're not domestic Chinese chip makers? And then, the -- you know, part two of the question is -- is how do you handicap the potential that this China DRAM is a -- is a pull-in? I mean, we have -- Micron has been banned in China. We have a, you know, China memory maker now taking $500 million more worth of your tools in October versus July.", "You know, that's $2 billion to $2.5 billion worth of extra WFE that's just in -- that's just in that, you know, one quarter. So, how do you handicap sort of how you run the production factory? Do you count on that being sustained? Do you think that it's possible that it could be a pull-in? If you can just comment on that. Thanks." ] }, { "name": "Brice Hill", "speech": [ "Sure. Thanks for the questions, Tim. So, on the 1.7 billion for China, about 27% of our revenue, it's almost -- it's almost all -- it's not 100%, but it's almost all domestic Chinese customers, very little on the multinational at this point. And then -- and just a reminder, it does include, you know, a portion of our services business. It does include a portion of our display business in that number also.", "And then, on the -- on the handicapping, whether it's a pull-in for the traditional or legacy DRAM, I certainly don't think it's a pull-in. This is a technology that was viewed as not being part of the rules where technologies were restricted for China. So, it's a -- it's an existing technology. I think they'll put that equipment into operation as quickly as possible. And just in general, if we -- if we go up to 100,000 feet on this -- on this question, for equipment like that that's being installed in China, our view is that it's not incremental if -- if it weren't allowed to be shipped there, that it would be shipped somewhere else In the world for production. So, we just view it as mainly location, and we triangulate the amount of equipment we're selling against the overall demand function.", "So, we view it as location, not -- you know, not incremental." ] }, { "name": "Tim Arcuri", "speech": [ "OK, Brice. Thank you so much." ] }, { "name": "Brice Hill", "speech": [ "Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Joe Quatrochi of Wells Fargo." ] }, { "name": "Joe Quatrochi", "speech": [ "Yeah, thanks for taking the question. When we look at your ICAPS portfolio, how do we think about your technology leadership over some of the emerging competitors and specifically in China, just given some of the comments around, you know, their efforts to localize their supply chain? I guess what -- are there certain markets where, you know, you have broader leadership or more competitive advantage? I guess, how do we think about that competition?" ] }, { "name": "Gary Dickerson", "speech": [ "Yeah, thanks for the question, Joe. So, I would say we're always focused on competition even in non-critical process steps. And the main focus for us at Applied is to keep innovating in all areas of our portfolio and create deeper strategic relationships with the leaders in all device segments. In ICAPS, as we've talked about four years ago we formed that group, this has paid off with share gains, helped us build deep strategic relationships with all the leading customers. And I'd say that those strategic relationships being in with the integration teams, whether it's in the leading edge or in ICAPS, is super important because those technologies are always moving very quickly, and learning faster than others is really important.", "We've talked about, in ICAPS, since we formed this group, we launched 20 major new ICAPS products. And I would say that we also have strong pipeline of new innovations that will continue to strengthen our positions. The last thing I'd say in ICAPS is there are still -- again, we have the strongest strategic position, broadest portfolio. We're working with those integration teams on their next-generation technologies, but we also have room to grow in certain segments like etch and PDC. We have momentum in those segments, and that certainly is going to help us continue to gain share in the coming years." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question -- please stand by. Our next question comes from the line of Joseph Moore of Morgan Stanley." ] }, { "name": "Joe Moore", "speech": [ "Great. Thank you. I was surprised to see services at a record level given the utilization issues in memory. Can you talk about that? And are you still -- are you seeing headwinds from the memory side that are incremental and you're just offsetting that with strength elsewhere? And kind of what does that tell us about where that business can go when utilizations come back up?" ] }, { "name": "Brice Hill", "speech": [ "OK, thanks, Joe. This is Brice. So, yes, the services business, 16 consecutive quarters of year-over-year growth. You know, it was a record this quarter.", "And yeah, the puts and takes there are that the transactional spares and the transactional activities that sort of are associated with utilization are, you know, significantly lower in the quarter. And then, what we see that's higher in the quarter that drove that growth was really the 200-millimeter equipment. So, we talk about ICAPS growth and the strength of those markets, and that 200-millimeter equipment is really what's driving the significant upside in the services business for the quarter. And then, on the second part of the question, incremental headwinds for memory, when we -- when we think about the memory market, you know, there's been discussion of when will it be turning around and when will we see upside. The indicators that we follow, price, inventory, and utilization, we still see, you know, trending in the -- in the negative direction or flat.", "So, we haven't seen a turn at this point. But we wanted to be careful to point out that, in the DRAM market, we have seen strength this year. And, you know, it's sort of a normal year from an equipment perspective on the DRAM side even though the -- the memory market itself has been weak." ] }, { "name": "Gary Dickerson", "speech": [ "Yeah, Joe, this is Gary. I think the other thing that I'll add is that part of our business is based on service agreements, and that also helps us have higher level of stability. We're over 60% on the service agreements, and again, that's keeping that part of the business much more stable even though the memory utilization is down. And the other thing I would say is that there is a significant amount of complexity if you think about all the inflections, whether it's in memory, with, you know, DRAM, or ICAPS, or leading-edge foundry-logic. About a third of our revenue are these integrated material solutions with multiple technologies combined in a single platform under vacuum. Those are increasing -- those steps are increasing, and the service opportunity for us is also increasing.", "So, we've talked about the low double-digit growth in service. Once you come back to more normal levels of utilization, we have high confidence we're going to be able to achieve that." ] }, { "name": "Joe Moore", "speech": [ "Great. Thank you very much." ] }, { "name": "Operator", "speech": [ "Thank you. Please stand by for our next question. The next question comes from the line of Brian Chin of Stifel." ] }, { "name": "Brian Chin", "speech": [ "Hi there. Good afternoon. Thanks for letting us ask a few questions. Maybe, firstly, it seems difficult to imagine AI not driving incremental foundry capital spending in the next upcycle.", "So, have you thought about how much incremental WFE spend in future years could result from AI-driven wafer start expansion?" ] }, { "name": "Brice Hill", "speech": [ "Hi, Brian, thanks for the question. We certainly have. When we think about the WFE share of the different end markets, data center has approximately 20%. We think AI is about 5%.", "AI-related WFE is about 5% of our overall market. And, you know, you've heard different peers talking about a high growth rate, you know, varying between 30% and 50% for the -- for that workload and the amount of capacity. So, if you view 5% as, you know, relatively small amount, we do think that it's growing rapidly and be an important workload going forward. So, that's our sizing for now. And as a comparison, we would hold that next to, you know, 10% to 15% of wafers that would be associated with IoT.", "And we think those things, you know, IoT wafer starts and WFE, will also grow at an elevated rate." ] }, { "name": "Brian Chin", "speech": [ "Yeah, got it. That's helpful. And heterogeneous integration is sort of supplemental to that as well, right?" ] }, { "name": "Brice Hill", "speech": [ "That's right." ] }, { "name": "Brian Chin", "speech": [ "And although it wouldn't be detectable from your results, did you see any pushouts from advanced foundry and logic customers? And also, when you think about the several domestic foundry shells that are either constructed or are being constructed and ready to be filled now until, I guess, into next year, what's kind of your current expectation for the timing and significance for some of those expansions?" ] }, { "name": "Brice Hill", "speech": [ "Yeah, there's -- there's still a lot of movement, you know, underneath the macro number and our results. There's still a lot of movement underneath, as you're suggesting with that question. So, we have seen a delay in installation of some of the tools, and we have seen pushouts with some of the leading foundry customers. So, that's consistent with what we're seeing. And then, I would just highlight again the strength in ICAPS and the strength in DRAM, both Q3 and Q4.", "Our outlook is, you know, really what's offsetting that." ] }, { "name": "Brian Chin", "speech": [ "OK, great. Thank you." ] }, { "name": "Mike Sullivan", "speech": [ "Thanks, Brian." ] }, { "name": "Operator", "speech": [ "Thank you. Please stand by for our next question. Our next question comes from the line of Timm Schulze-Melander of Redburn." ] }, { "name": "Timm Schulze-Melander", "speech": [ "Hi there. Thank you very much for taking my question. I wanted to ask about longer-term R&D intensity. You mentioned about the higher capex for the EPIC R&D Center and just thinking about the mix of the business sort of revenues from ICAPS, probably intuitively a lower R&D intensity.", "The other two-thirds, leading-edge logic -- logic and memory, as you say, more materials intensive and maybe higher R&D-to-sales intensity. Just wondering what we should expect the net of those two factors to be on a kind of multiyear view, please? Thank you." ] }, { "name": "Brice Hill", "speech": [ "Yes, thanks, Timm. Well, our spending at this point, you know, is 18.1% of revenue. It's a little bit higher than our model, but we're very comfortable with our spending level. We put about 66% of our spending, you know, two-thirds toward R&D, and we -- we are fully focused on the road map.", "So, when we think about the business, we think about the longer-term trajectory of the business. Our perspective is we're investing in a secular positive trend. We think about semiconductors growing, you know, high mid-single digits, so 6%, 7%, 8%, 9%. We think there'll be -- it's becoming more complex to build those semiconductors, which drives more equipment, so that's an additive function. And we also think that Applied, looking forward, designing for the inflections with our customers will gain share on top of that. So, we think there's an additive function between the market growth of semis, the more -- the higher complexity of the equipment, and then the increased intensity from materials engineering and Applied's participation.", "So, all those things add up to a significant growth rate. And so, what I would expect is, you know, the spending level you see today will focus on, you know, maintaining approximately that spending level as we identify the best R&D projects to work on as we go forward. And then, I would also highlight that, just for investors who are working on their models, you know, we've held our spending flat for pretty much three quarters. And we said we've been very conscientious and very focused on strategic hires only. As we move to Q1, so the first quarter of our fiscal next year, we'll see our normal pay raise cycle and we'll see our normal raise of spending in that cycle. So, I just wanted to highlight to people that that's what they'll see if they're modeling that function." ] }, { "name": "Timm Schulze-Melander", "speech": [ "Super helpful. Thank you." ] }, { "name": "Operator", "speech": [ "Thank you. Our next question comes from the line of Charles Shi of Needham and Company." ] }, { "name": "Charles Shi", "speech": [ "Hey, thanks for taking my question. I want to ask, the largest customer in Taiwan talked about capex leveling off on a dollar basis. Wonder what's the impact you may be seeing in terms of your revenue coming from that particular customer in 2024 and beyond. And any preliminary thoughts on the relative outperformance of WFE maybe in '24 by segment, meaning leading-edge foundry-logic, ICAPS, DRAM, and NAND? Thank you." ] }, { "name": "Brice Hill", "speech": [ "OK, thanks, Charles. All I can say about any particular customer, but you know, especially leading-edge customers, is that we're current on their forecasts. So, we understand, at an account level, what they're forecasting in the future. They've -- they've all started -- you know, as we went through the supply chain crisis, we're getting better visibility into their road maps top to bottom. So, we have that -- you know, we have a good perspective on that.", "In general, you know, we haven't called the number for WFE in '24 or for our business in '24. I just highlighted in the prior question that our view of the long-term growth of the market, you know, sort of what guides our investments, etc. What we have said for next year is that we expect the ICAPS business to be stable. So, that growth is durable, if you will. It's grown at a high level for the last two years, and we expect that business not to fall off but be stable.", "We expect our display business to grow modestly. We expect our services business to grow at the low double digits as we've described. And I think that's -- that's the color that we've given so far for the market. That leaves out, you know, memory and leading logic, and we'll just have to wait until we get closer to give a forecast." ] }, { "name": "Gary Dickerson", "speech": [ "Yeah, Charles, this is Gary. Relative to longer term, as I mentioned earlier, we're in a great position. If you look at this incremental spending for the future technology nodes, a higher percentage of that incremental spending is going to materials-enabled technologies. And as I said, that's a sweet spot for Applied, gate–all–around, backside power, where you get power and performance benefits, but also you're going to get area savings with that inflection. So, we have been growing our position from -- for each technology node.", "I think that gets even better going forward." ] }, { "name": "Mike Sullivan", "speech": [ "Yeah, thanks, Charles. Operator, we have time for one more question, please." ] }, { "name": "Operator", "speech": [ "Yes, sir. Please stand by. Our final question comes from the line of Sidney Ho of Deutsche Bank." ] }, { "name": "Unknown speaker", "speech": [ "Great. Thanks for squeezing me in, guys. This is [Inaudible] on for Sidney, and I want to ask about gate–all–around. Gary, you've been very clear about how big this opportunity could be, both in terms of revenue and market share.", "And so, maybe can you speak to the revenue contribution from this inflection in '24?" ] }, { "name": "Gary Dickerson", "speech": [ "Yeah, thanks for the question. I think that -- that we're not going to give a specific dollar amount, but what I would say is that that inflection is just starting to ramp in the latter part of '24. So, you know, it's not going to be a significant driver in '24, but certainly, going forward, our opportunity there is significant." ] }, { "name": "Unknown speaker", "speech": [ "That's great. Thanks." ] }, { "name": "Mike Sullivan", "speech": [ "Great. OK, thanks for your question. And I'd like to just see if, Brice, would you like to give us any closing comments before we close the call." ] }, { "name": "Brice Hill", "speech": [ "Sure. Thanks, Mike. Just one content note that I wanted to add. So, you know, we get a lot of questions about modeling gross margin.", "And I just wanted to highlight for the people that are doing their models, our 47% guide for Q4, that's a little bit higher than, you know, what we would have expected with rich mix in Q4. We're probably running underneath that at a normal mix around 46.6, 46.7, somewhere around that. So, as people think about modeling their next year, we think we'll continue to make progress from 46.6 or 46.7 to -- on our way to 48 to 48.5 in '25. So, if that helps from a modeling perspective, I just wanted to highlight that. From a closing comments perspective, we're executing well.", "We're outperforming our markets. The semi systems' year-to-date revenue is trending up year over year. Our services business is on track for year-over-year growth. We're aligned -- we've aligned our businesses with the fastest-growing end markets, and we're winning in leading-edge foundry-logic, DRAM, ICAPS, and heterogeneous integration. We're investing for technology leadership and growth. We're generating strong free cash flow and increasing shareholder returns.", "I hope to see many of you at the Jefferies conference in Chicago. And Gary will be keynoting at the Goldman Sachs conference in San Francisco. Now, Mike, let's go ahead and close the call." ] }, { "name": "Mike Sullivan", "speech": [ "OK, great. Thanks, Brice. And we'd like to thank everybody for joining us today. A replay of the call is going to be available on the IR page of our website by 5:00 Pacific Time today.", "And we'd like to thank you for your continued interest in Applied Materials." ] }, { "name": "Operator", "speech": [ "[Operator signoff]" ] } ]

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